Chairman's perspective on the markets

13 January 2017 | Markets and Economy


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Vanguard Chairman and Chief Executive Officer Bill McNabb shares his views on market and economic developments in a letter to our fund shareholders.

Valley Forge, Pennsylvania
December 2016

Dear Investor,

Bill McNabb

Over the three years ended 31 December 2016, investors poured more than US$1 trillion (about £815 billion) into index funds in the United States alone. Indexing now accounts for nearly a third of all US mutual fund assets – more than double what it did a decade ago and eight times its share two decades ago.1 (In the United Kingdom, where indexing is a more recent arrival, index funds accounted for about 13% of total assets as of March 2016, with about £110 billion under management – up from less than £20 billion in 2005.2)

By contrast, active management's commercial struggles have reflected its disappointing investment performance. Over the decade ended 31 December 2015, more than 80% of actively managed funds have either underperformed their benchmarks or shut down.3

This subpar performance has fuelled the explosion of asset growth in indexing among individual, retirement and nonprofit investors. So what might the trend mean for the future of actively managed funds?

Our research and experience indicate that active management can survive – and even succeed – but only if it's offered at much lower expense. High costs, which limit a manager's ability to deliver benchmark-beating returns to clients, are the biggest reason why active has lagged. Industrywide as at 31 December 2015, the average asset-weighted expense ratio for all UK active funds was 1.38%, compared with 0.49% for index funds.4

But even these big differences understate the real gap. These days, it's not hard to find an index fund that charges maybe 0.05% or 0.10%. So even if you have identified active managers who are skilled at selecting shares and bonds, to match the return of a comparable (much cheaper) index fund would require significant outperformance. Think about it. Any fund that charges 1.00% in expenses—not even the high end of the range – will find it extraordinarily difficult to overcome the index fund's head start.

The future of active management

In light of all this, people have been asking me whether active management is "dead".

My response is both yes and no. High-cost active management is dead, and rightly so. It has never been a winning proposition for investors. Low-cost active funds, though, can potentially play an important role for investors who seek to outperform the market.

Paying less for your funds is the only surefire way to improve your odds of achieving success in active management. But even if you have found an active manager with low costs, the odds of outperforming the market are still long. You have to be able to identify talented equity and bond portfolio managers with long time horizons and clear investment strategies. Look for managers with consistent track records and the discipline to stick closely to their investment strategy.

Despite the well-deserved reputation of indexing and the challenges for active managers, there's still a place for traditional active strategies that are low-cost, diversified and highly disciplined, and are run by talented managers who focus on the long term.

Worried about elections' impact on your portfolio?

On both sides of the Atlantic, 2016 saw some of the most intense and unpredictable political campaigns in history. In the aftermath of the Brexit vote and the US presidential election, investors may be left with lingering questions about what the outcomes mean for their portfolios.

In the US, the answer – based on Vanguard research into decades of historical data – is that presidential elections typically have no long-term effect on market performance. These findings hold true regardless of the markets' initial reaction. Whether there's a swoon or bounce immediately after an election, investors shouldn't extrapolate that performance to the long term. As you can see in the chart below, data going back to 1853 show that equity market returns are virtually identical no matter which party controls the White House.

Average annual equity market returns based on party control of the White House (1853–2015)

Sources: Global Financial Data, 1853–1926; Morningstar, Inc., and Ibbotson Associates thereafter through 2015.

In the United Kingdom, similarly, the unexpected result of the 23 June Brexit referendum has caused considerable uncertainty and a decline in the value of the pound, but despite an initial period of volatility its effects on the securities markets have thus far appeared to be temporary.

Although headlines at any given time may still cause concern, investors shouldn't overreact to short-term events. Instead, it's best to maintain a balanced and diversified portfolio and stay focused on your long-term goals.

But it's crucial for investors to be patient. Even active managers with the best track records frequently underperform their benchmarks when their investment styles are out of favour. Such periods, though temporary, can persist. So it's important when entrusting your assets to an active strategy to be in it for the long haul.

Make sure you know what you're buying and what the risks are. Active strategies are becoming more complex, so it's important to clearly understand what the investments in your portfolio are designed to accomplish and why you want to hold them. Otherwise, you run the risk of selecting strategies that don't fit your needs or objectives.

Keeping these considerations in mind can potentially boost your chances of success in identifying active strategies that may be able to help you reach your goals.

As always, thank you for investing with Vanguard.


F. William McNabb III
Chairman and Chief Executive Officer
The Vanguard Group, Inc.

1 Sources: The Wall Street Journal; Morningstar, Inc.; and Investment Company Institute, 2016.

2 Source: The Investment Association.

3 Source: Vanguard calculations using data from Morningstar. Because of fees, most index fees also underperform their benchmarks. Our analysis used expenses and fund returns for all active equity funds available for sale to UK investors that were alive at the start of each analysis period. Their performance was compared with their prospectus benchmark. Funds which were merged or liquidated are considered underperformers for the purposes of this analysis.

4 Source: Morningstar and Vanguard data.

Important information:

This article is directed at professional investors and should not be distributed to, or relied upon by retail investors. It is designed for use by, and is directed only at, persons resident in the UK.

This article was produced by The Vanguard Group, Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

Opinions expressed in this article are those of the individual author and may not be representative of The Vanguard Group, Inc.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.


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