Beyond low costs: What investors need for success

December 27, 2017

 
Joe Brennan

Joe Brennan

Low investment fees make a lot of sense.

After all, a low expense ratio allows 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 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.

"Low fees are a good starting point, but to us they are just that—a starting point," said Joe Brennan, head of Vanguard Equity Index Group (EIG). "Our culture, our funds, our services—they are all grounded in a singular goal: to help our investors achieve the best outcome, no matter what their financial goal."

A sound approach validated by research

Vanguard's merits were 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 emphasized 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 is an ownership structure that allows us to put investors first. Vanguard is owned by its funds, which are, in turn, owned by their shareholders. This structure aligns our interests with those of our investors.

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

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

A global team and philosophy carry stewardship

The report emphasized that passive investment sponsors can be good stewards of their investors' assets by investing in portfolio management and technology. Over time, these capabilities can help funds better track their respective benchmark indexes.

This is reflected in the work of EIG, which manages all our domestic and international stock index funds through a global trading operation in Malvern, Pennsylvania; 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.

"We expend a lot of time and resources on execution so that our funds do a great job of tracking their benchmarks," Brennan said. "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."

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 emphasized that good stewards of investors' capital return a majority of that revenue to the funds.

Unlike some 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 even when 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. Morningstar used as a proxy for prudent product development 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 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 to ensure that our lineup is enduring and diversified. We eschew the hot trends. We want our funds to be the cornerstones of investor accounts or to round out diversified portfolios.

"We don’t launch funds simply to attract assets," Brennan said. "Our investors invest in our funds for decades, so they must be great solutions that are long-term and enduring."

A long heritage

Vanguard's history is rooted in low-cost investing. But as the Morningstar report reveals, that is just part of the story. Vanguard's funds, services, processes, and people are all aligned to help investors 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."

Source: Morningstar, Inc., Partnering with passive fund sponsors that have your back, October 18, 2017.

Notes:

  • 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.
  • All investing is subject to risk, including the possible loss of the money you invest. Diversification does not ensure a profit or protect against a loss.
  • Past performance is no guarantee of future results.

 

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