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Can Vanguard Keep the Faith While Expanding Even Further?

The biggest U.S. fund firm still stands out.

Bridget B. Hughes, CFA, 05/21/2013

Morningstar recently issued a new Stewardship Grade for Vanguard. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is an A. What follows is Morningstar's analysis of the firm's corporate culture. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to subscribers of Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

Vanguard's total assets under management recently passed the $2 trillion mark. In nearly every category of core-oriented mutual funds--from municipal bonds to domestic and international equities to allocation funds to exchange-traded funds--the firm is number one or number two in market share. Overall, performance is strong.

But even for one of the United States' largest and most-successful mutual fund managers, there's more work to be done. And for a firm that's already entrenched in its home market and also committed to pursuing the righteous path of keeping investments simple, one attractive avenue is the building of a more-global business. While the concern that Vanguard could grow bigger still without getting bogged down in bureaucracy and without losing its character remains a legitimate one, the firm has dealt well with this issue and has grown quite gracefully to this point.

Although Vanguard long ago began overseas operations, thus far its international pursuits are small potatoes (relatively speaking) for a firm largely built on passive investing in the U.S. In 2012 just 7% of Vanguard's assets under management came from overseas accounts, gathered primarily through a few handfuls of ETFs in a few markets. But there are developments in other markets that work in Vanguard's favor. First, there's the shift to defined-contribution retirement accounts from defined-benefit arrangements, which can create a do-it-yourself, or at least a more engaged, investor base. And much as the U.S. has been going the way of fee-based investment advice and of the often-indexed assets that go along with it, some overseas markets are also moving in that direction. Of particular note is recent legislation in the United Kingdom and Australia, which affects how financial advisors do business and could encourage more fee-based versus commission-based accounts.

But Vanguard will have challenges, too. For starters, it's still a relative newcomer to global markets and may not yet enjoy the same kind of name recognition and high regard that it does in the U.S. and that some of its competitors already experience. To be sure, the ETF and passive investing trends are newer and growing overseas. Being a part of a swell will help--and Vanguard will easily be able to prove its prowess in indexing. But while Vanguard faced and overcame some of the same hurdles when it was founded in the mid-1970s, it had its charismatic and outspoken founder Jack Bogle making the case for his firm (and indexing generally). Today the organization itself is the missionary.

Vanguard has worked hard to build a team-oriented outfit. The public face of Vanguard used to be former chief investment officer Gus Sauter; Bogle; and Bogle's successor, Jack Brennan. Now a host of articulate Vanguardians--including bond manager Ken Volpert, investment counseling and research head John Ameriks (who was recently appointed to lead Vanguard's Active Equity group), economist Joe Davis, and investment strategy group leader Fran Kinniry--disseminate the family's research and opinions. CEO Bill McNabb, the firm's third, has been in his office since 2008. Otherwise, Vanguard often rotates senior managers among assignments--in fact, it recently shuffled a number of managers in the wake of Sauter's retirement at the end of 2012 and several months after now-CIO Tim Buckley assumed his post. Vanguard does this in part because it values fresh perspectives, but also to build its managers' repertoire. Its senior management team has grown over the past year to 11 members from nine, as the firm added roles for its financial advisor and international leaders, reflecting the growing importance of those areas.

Now a larger organization and one that aims to spread further around the globe, Vanguard is turning its attention to processes to help keep its character intact as it grows. McNabb says, for example, that there are a couple of large technology initiatives under way. He also notes the challenge in developing the next generation of Vanguard's leadership around the world and will depend not only on consistent processes but also on Vanguard's culture carriers, or those who share the firm's missionary zeal.

Much may hinge on Tim Buckley. As Vanguard's CIO, his experience with investments is more limited than some others' in the ranks. But Buckley does have experience in leading the firm's technology efforts, as well as some other areas at the firm, and he's a firm believer in process. He's also considered one of the firm's culture carriers, having spent his entire career at Vanguard, beginning in 1991 as the assistant to the chairman (then Bogle). About Vanguard and its potential challenges overseas, he is cool, professing simply, "We have a better way of investing." When asked whether he's an active or a passive investor, he says he's a "low-cost" investor, covering his bases but also highlighting one of Vanguard's most important values.

Bridget B. Hughes, CFA, is an associate director of fund analysis with Morningstar and is also happy to chat with you.

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