Beyond low costs: What investors need for success

27 December 2017 | Topical insights


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Beyond low costs: What investors need for success

Low investment fees make a lot of sense.

After all, low fees allow investors to keep more money in their pockets. Just as important, there's a strong historical correlation between low fees and better-than-average fund performance.

Vanguard has been carrying the low-cost banner in the United States for more than 40 years. But low fees aren't the only thing investors should consider. Investment culture, people and philosophy – how we think about investing and how we manage our funds – are all essential to success.

Sean Hagerty

"Yes, low fees matter," said Sean Hagerty, who leads Vanguard's businesses in Europe. "But low fees alone don't sustain our mission to give investors the best chance for investment success. Our story is also about our culture of simply doing what's best for investors."

A sound approach validated by research

The ability of The Vanguard Group, Inc., to align its economic incentives with those of its fund-holders is underscored in a new paper, (Partnering with passive fund sponsors that have your back: What to look for in passive parents) from Morningstar, a Chicago-based research firm unaffiliated with Vanguard.

In the paper, Morningstar focused on the ten largest providers of passively managed mutual funds and ETFs (as of March 2017) that have also been assigned a Morningstar Parent rating, a proprietary measure of investment stewardship.

The paper emphasised several criteria for evaluating an asset manager and its index funds: ownership structure, investments in portfolio management capabilities, securities lending practices, product development and low fees.

An ownership structure aligned with client interests

What sets Vanguard apart from the other nine firms analysed in the paper is an ownership structure that allows us to put investors first. The Vanguard Group, Inc., is owned by its US funds, which are in turn owned by their shareholders. We're able to extend the benefits of this structure, which aligns our interests with those of our clients, to investors outside the United States.

Morningstar pointed out that other ownership structures can have competing stakeholders. For example, publicly traded mutual fund firms have shareholders that want to see the share price increase and fund holders who want to pay the lowest fees.

The Vanguard Group, Inc.'s "mutually owned structure most closely aligns the firm's economic incentives with its fund holders'," wrote Adam McCullough, a Morningstar analyst and author of the paper.

A global team and philosophy carry stewardship

The report emphasised that passive investment sponsors can be good stewards of their clients' assets by investing in portfolio management and technology. Over time, these capabilities can help funds do a better job tracking their respective benchmark indices.

This is reflected in the work of The Vanguard Group, Inc.'s, Equity Index Group (EIG), which manages all of our US and international stock index funds through a global trading operation located in Malvern, Pennsylvania, in the United States; London; and Melbourne, Australia. EIG's portfolio managers double as traders, allowing them to react quickly to new information and to execute trades around the clock, capturing value and the best price for our funds.

Joe Brennan

"We expend a lot of time and resources on execution so that our funds do a great job of tracking their benchmarks," said Joe Brennan, head of EIG. "Investors know what they are getting when they own a Vanguard index fund or ETF."

The group also promotes better outcomes for investors by advocating for sensible index construction. For example, EIG has advocated for multiday index reconstitutions, so that a fund isn't forced to buy all securities on one day. A new proprietary trading system will only help strengthen the process.

As for the team itself, EIG has a longer average tenure than many of its competitors. "We don't treat indexing as a starter investment management job," Brennan said. "It's a career. We keep great people for a long time."

Vanguard applies similar rigour to fixed income indexing, Hagerty noted. Globally, Vanguard managed £2.58 trillion in equity and fixed income index investments as of 30 September.

Lending a hand to investors

The Morningstar report also shed light on securities lending, which is a method passive funds can use to generate revenue, and emphasised that good stewards of investors' capital return a majority of that revenue to the funds.

Unlike most passive fund sponsors, Vanguard has a policy of returning 100% of its securities-lending revenues, net of program costs, broker rebates and agent fees, to the funds.

Morningstar found that although some firms pledge to return a similar level, the total amount differed according to the fees the firms paid.

Thoughtful launches that avoid hot trends

The mutual fund industry is known for its fair share of product launches and failures. As a proxy for prudent product development, Morningstar looked at fund launches and liquidations during the trailing one, three, five and ten-year time periods as of June 2017.

The research showed that Vanguard was one of a few fund companies that showed the most "restraint" when it came to product development. Its fund launches and liquidations accounted for just a small percentage of total funds.

Vanguard takes a thoughtful, research-based approach to fund launches that ensures our line-up is enduring and diversified. We eschew the hot trends. We want our funds to be the cornerstones of client accounts or round out a diversified portfolio.

"We don't launch funds simply to attract assets," Brennan said. "Our clients invest in our funds for decades, so they can't be gimmicky."

A long heritage

Vanguard has long been associated with low-cost investing. But as the Morningstar report reveals, that is just part of the story. Vanguard's funds, services, process and people are all aligned to help clients meet their financial goals.

"The Morningstar paper validated what we already knew," Brennan said. "The 'Vanguard Way' makes a lot of sense for investors taking a long-term approach."

Important information:

This material is for professional investors as defined under the MiFID Directive only. In Switzerland for institutional investors only. Not for public distribution.

Morningstar is not affiliated with Vanguard or Vanguard funds. The research paper mentioned here is neither an offer to sell nor a solicitation of an offer to buy shares.

This article is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. This article does not constitute legal, tax, or investment advice. You must not, therefore, rely on this article when making investment decisions.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

The opinions expressed in this article are those of the author and individuals quoted and may not be representative of Vanguard Asset Management, Ltd., or, in Switzerland, of Vanguard Investments Switzerland GmbH.

Issued by Vanguard Asset Management, Ltd., which is authorised and regulated in the UK by the Financial Conduct Authority. In Switzerland, issued by Vanguard Investments Switzerland GmbH.


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