I love Vanguard. I think we’d all be better off if everyone invested in Vanguard funds. And, in my opinion, Jack Bogle’s honorary knighthood and Presidential Medal of Freedom are long overdue.
But is the world’s biggest asset management company perfect? Even this diehard fan would have to admit that it’s not.
I sometimes wish, for example, that Vanguard were more responsive to what the academic evidence tells us about investing. We’ve known, for instance, since the early 1990s, that there are certain risk factors that tend to deliver higher investment returns over the long term. But only recently has Vanguard started to offer funds designed to enable investors to capture those specific premiums.
Similarly, Vanguard has remained stubbornly loyal to market-cap weighting. Yes, cap weighting has its advantages, but there is now a wealth of evidence that there are more effective ways to design an index. Equal weighting in particular has much to recommend it.
Also, despite the fact that it takes its corporate governance responsibilities very seriously, Vanguard could be doing more to tackle the growing problem of excessive corporate pay. A recent study into the voting habits of large investors identified it as one of four asset managers (the others being Fidelity, Wellington and Northern Trust) that tend to back management proposals on remuneration.
A gripe that advocates of evidence-based investing often have with Vanguard is that it also offers actively managed funds. Its active management arm is well established in the US, and now it’s announced that it’s launching four active funds in Europe. The funds will be managed by outside firms, with ongoing charges of between 0.6% and 0.8%.
People tend to assume that I disapprove of Vanguard selling active funds, but in fact I don’t. No company has done more to promote price competition in the fund industry, and this latest development will, I hope, prove to be the first salvo in an active management price war on this side of the Atlantic. As Jack Bogle said the other day, “there is room for active management, but at a significantly lower price”.
So, is the price on offer to European investors sufficiently low to warrant including one or more actively managed Vanguard funds in their portfolio? The evidence suggests the answer is No.
Yes, these new Vanguard funds are significantly cheaper than average. The cost of a typical, UK-domiciled, actively managed fund, once you factor in transaction costs, is more like 1.75%, or 175 basis points. Research has repeatedly shown that cost is the biggest single predictor of fund returns. So investors in active Vanguard funds have a very good chance of earning higher net returns than the average active investor.
But that’s not to say that they will also beat the average passive investor; in all probability they won’t. You can now buy UK equity index funds for as little 0.06% and global equity index funds for 0.15%. The difference between those figures and 0.6 – 0.8% may seem small, but over time the additional cost of the active funds will make a large dent in your returns.
Yes, given a choice between two active funds, you should generally go for the cheaper one. Research published by Morningstar last summer showed that over a 10-year period from 2004 to 2014, active funds, domiciled in the US, with below-average costs were more likely to outperform higher-cost active funds. However, low-cost active funds still had lower average annualised returns compared with the average passive fund in nine of the 12 categories the researchers looked at.
This begs the question, then, How low do fees need to go to make it worth using active funds? In my view, if you could invest in an active fund for fewer than 30 basis points all-in, there may be a case for sparing use of them in a broadly diversified investment portfolio.
I suspect Vanguard will get there eventually, but it’s still a long way off. Even Vanguard, you see, isn’t perfect.