Successful indexing is harder than it looks

September 25, 2018

Joseph Brennan

Joseph Brennan

Indexing can seem like a simple and straightforward endeavor, but the process is highly sophisticated with multiple moving parts—a dichotomy that can make it difficult to evaluate index fund managers.

Realizing this, Morningstar, a Chicago-based research firm unaffiliated with Vanguard, published Partnering With Passive Fund Sponsors That Have Your Back: What to look for in passive parents.1

The 2017 report underscores Vanguard's merits as an index fund manager, emphasizing 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.

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

An ownership structure aligned with client interests

What sets Vanguard apart from the other nine firms analyzed in the report 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 clients.

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.

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 report.

A global team and philosophy carry stewardship

The report emphasized 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 benchmark indexes.

This is reflected in the work of Vanguard's Equity Index Group (EIG), which manages all of our domestic and international stock index funds through a global trading operation located 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," said Joe Brennan, Vanguard's global chief risk officer. "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 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. Our fund launches and liquidations accounted for just a small percentage of our 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 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 must be great solutions that are long-term and enduring."

A long heritage

Of course, Vanguard's history is rooted in low-cost investing. And low investment fees make a lot of sense. 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.

"Low fees are a good starting point, but to us, they are just that—a starting point," Mr. Brennan said. "Our culture, our funds, our services—they are all grounded in a singular goal: to help our clients achieve the best outcome, no matter what their financial goal."

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

Vanguard announced on September 12, 2018, that Joe Brennan has been appointed to the newly created position of Vanguard's global chief risk officer, reporting to Vanguard CEO Tim Buckley. Brennan's current role as head of Vanguard's Equity Index Group has been assumed by Vanguard veteran Rodney Comegys.

1 Adam McCullough, 2017. Partnering With Passive Fund Sponsors That Have Your Back: What to look for in passive parents. Chicago, Ill.: Morningstar. (Morningstar Manager Research.)


  • Morningstar is not affiliated with Vanguard or Vanguard funds. The research report 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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