Has Brennan Been Good for Vanguard?

A version of this article previously appeared in the Vanguard Fund Family Report.

Earlier this year Vanguard chairman and CEO, John J. Brennan, relinquished his president title and said he would  give up the CEO job by year-end. Let's assess his tenure and look at what his successor, F. William McNabb III, might have planned.

Has Brennan, who will remain chairman of the firm and its fund boards, been good for Vanguard? He presided over a period of impressive growth. When he became Vanguard's CEO in 1996, the firm had $200 billion in assets in 90 funds and 4,000 employees. Vanguard now has $1.3 trillion in assets in 150 funds and employs 12,000. Although the firm is still known as the house that indexing built, Vanguard also has expanded its capabilities on Brennan's watch. Besides rolling out exchange-traded funds (albeit much later than rivals such as Barclays), Vanguard also offers online brokerage, a competitive lineup of target-date retirement funds, 529 college-savings plans, and more advice options. It began courting financial advisors, grew its institutional business, expanded internationally, and actively managed more money in-house.

Recently Vanguard has stretched its wings into esoteric areas, adopting a market-neutral fund and launching new funds designed to act like miniendowments for individual investors. A big proponent of technology, Brennan also helped Vanguard morph from a company that dealt primarily with its clients via the phone to one that encourages all shareholders to interact with the company through the Internet. During Brennan's tenure, Vanguard took the lead in rendering prospectusese into readable English. Its "Plain Talk" prospectus format became the standard for fund communications. More importantly for Vanguard investors, since Brennan took charge in 1996, the firm's average expense ratio has fallen from 0.32% to 0.20%. Part of that is due to the family's humongous size, but much of it also comes from Brennan's focus on passing economies of scale.

There have been some disappointments.  Vanguard U.S. Growth (VWUSX) has been dismal for more than a decade despite switching and adding subadvisors. The family also needed a do-over on its target-date retirement funds. They were a little too conservative when they first launched in 2003, so the firm revamped them in 2006 with more international stock exposure (including emerging markets) and with larger helpings of equities overall for longer periods of time. By and large, though, if you were a Vanguard investor during the Brennan years, there's a good chance you owned an above-average fund.

St. Jack's Long Shadow
Perhaps Brennan's biggest challenge has been maintaining Vanguard's unique culture as it has grown. When Brennan joined Vanguard from consumer products company S.C. Johnson & Son in 1982, the family was still the brash, antiestablishment player in the industry and was led by a visionary and vocal entrepreneur, Jack Bogle. It would have been difficult for anyone to follow Bogle, who famously turned his dismissal from Wellington Management into an opportunity to start a new mutually owned fund company selling index funds. And the transition between the Jacks wasn't smooth. In 1999, Vanguard's board, then chaired by Brennan (who also uses the name Jack), asked a reluctant Bogle to resign as a director when he reached its mandatory retirement age of 70, despite the protests of ardent Bogle fans. Bogle ultimately retired but still keeps an office at Vanguard's headquarters and has voiced skepticism about industry trends and innovations, such as ETFs, that Vanguard under Brennan has embraced.

This has prevented many Vanguard investors from regarding Brennan with the same warmth that they feel for "St. Jack," as some call Bogle. Brennan may have been the right man at the right time, though. Vanguard needed an operations and efficiency expert to manage the transition from upstart to industry leader. Not that Bogle wasn't a stickler for operational excellence (in fact, he was notorious for it), but Brennan, with his Ivy League MBA, brisk and efficient manner, and affinity for technology and the nitty-gritty of management, was well-suited for consolidating and extending Vanguard's gains. Unlike his predecessor, Brennan was not an evangelical leader prone to tossing rhetorical bombs at rivals or castigating the industry for its high fees. Brennan was more apt to talk about Vanguard's Six Sigma efficiency and error-reduction program, Vanguard Unmatched Excellence, than he was to criticize competitors or the industry overall.

Evolution Instead of Revolution
When Brennan took over, Vanguard didn't need another missionary to seek converts or more growth. Growth would come as investors realized the value of the family's low costs, fair service, and steady, long-term strategies. To keep those investors, Vanguard funds rolled out Admiral Share classes that offered discounted expense ratios for shareholders with large balances or long account histories, as well as enhanced services for big investors. This is not to say that Vanguard didn't seek any growth. Vanguard has grown and evolved--in some ways that its founder didn't anticipate or endorse. By and large, though, it has done so responsibly. It launched ETFs, but they are among the more diversified and the cheapest available. The family has introduced a lot of new funds, but it has resisted chasing trends, such as the late 1990s tech-fund boom. It has often cautioned investors when it thought a fund's returns were unsustainable and has closed funds or raised minimum investments when asset flows threatened to overwhelm funds.

Morningstar has had its differences with Brennan. For example, he opposed regulations requiring quarterly fund-portfolio disclosure, annual disclosure of managers' investments in their funds, and proposals requiring independent fund board chairmen--ideas that we backed. It's hard to argue, however, that Vanguard investors are worse off since Brennan took over. Fund performance has been good. Solid investment options and services have multiplied. Expenses have fallen as assets have swelled. Ethics and clients' interests are still among top concerns of most people at Vanguard. Not everyone is always happy (there were a lot of service complaints in early 2004 when Vanguard was swamped with inflows), but individual investors can still trust the firm. The worst thing you can say about Jack Brennan is that he wasn't Jack Bogle. But who is?

Meet the New Boss
It's harder to predict what the McNabb era will look like. McNabb, 50, seems cut from a similar cloth as Brennan. Like Brennan, he attended Dartmouth as an undergraduate and went to an Ivy League school for his MBA (Wharton). He's been with Vanguard for 22 years and most recently ran Vanguard's $700 billion institutional and international businesses. He also is known outside of Vanguard, serving on the board of Employee Benefit Research Institute and testifying before Congress and the Department of Labor. Indeed, the transition seems set up to ensure continuity. If Vanguard were one mutual fund, this would be a comforting way to handle a manager change--pick a seasoned successor who has worked closely with the previous manager and allow their terms to overlap to ensure a smooth handoff.

McNabb is unlikely to make drastic changes, but Vanguard is sure to continue changing. Based on McNabb's background and published comments, you can expect Vanguard to keep courting financial advisors (McNabb spearheaded efforts to ramp up the family's efforts in that area). Overseas growth also will be important, as will the institutional business and solution-oriented funds like target-date retirement offerings and the new managed-payout funds. Vanguard's new leader will have to manage its continued growth. He also will have to be familiar with retirement markets because a good portion of the fund owners who grew up with Vanguard are nearing or in retirement. McNabb's experience with institutional benefit plans will help there. Finally, Vanguard needs a leader who is steeped in the family's culture to ensure that it's not compromised as the firm continues to develop. I can find nothing in McNabb's public record that implies he will be anything but a staunch defender of Vanguard's main edge: its mutual ownership structure and commitment to serving shareholders. 

Disclosure: Morningstar licenses its indexes to certain exchange-traded product providers, including Barclays Global Investors (BGI), First Trust, Claymore, and Merrill Lynch, for use in exchange-traded products. These exchange-traded products are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in the exchange-traded products that are based on Morningstar indexes.

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