Vanguard's Take on Active ETFs

Scott Burns: Active management ETFs? What does Vanguard think about that?

Hi, there. I'm Scott Burns, director of ETF research with Morningstar. Joining me today to answer that question is Rick Genoni, head of Vanguard's ETF product group.

Rick, thanks for joining me.

Rick Genoni: Thanks, Scott.

Burns: One thing is, a lot of people, before we even get into ETFs, I think there's this general perception in the world that Vanguard is not active management at all, that Vanguard is passive. Vanguard equals passive, and other competitors out there equal active, and never the two shall twix.

But there are some stats on Vanguard that I think would shock a lot of people. What percentage of total Vanguard assets are currently being actively managed?

Genoni: It's roughly 50/50. We hear often that clients think that Vanguard's just a passive firm, that we only run index funds. Frankly, that just speaks to the quality of product that we've brought to the marketplace, but certainly we have some very high quality, actively managed funds offered at very low fees also.

Burns: Now let's get back to ETFs a little bit here, and active management ETFs. We were discussing a little before we came on camera here.

I think I sit on one side and say, Look, active management and ETF, transparency's not an issue. But I think you have a little different take.

Genoni: I do. I think broadly, most active managers are not willing to be fully transparent in their holdings every day for the risk of front running. Now that's broadly.

Looking at some of the top, top tier active managers, they're very close to the vest. They don't want to show others what their holdings are, either at a single stock level or just broadly what their strategy might be, whether they're tilting to certain sectors or others.

So I think it's something that the marketplace is thinking about, and it's one of the reasons why we haven't seen more active equity products at least entering the marketplace.

Burns: Right. We've seen filings, and I'd say a lot of the filings are actually definitely tilted more towards fixed income. Do you think that matters? Do you think if someone comes in and says, "I'm going to be an active Treasury manager, " is the chance of front running that less than, say, equity?

Genoni: Certainly, it's less. Vanguard has a filing in right now for an active TIPS product. That's a product that we actually feel very good about being fully transparent on the fund holdings because most of the alpha in that fund is coming from our trading strategies around those holdings, and not from selections of the underlying bonds or any bets we're making on the curve.

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Burns: Right. So that is different, I guess, than what most people's perception of traditional active really is sitting around picking, "I'm buying this sector, but not that sector." This is an alpha that's being generated by your trading prowess.

Genoni: True, yes.

Burns: I guess it's kind of active, but it's not necessarily active. But you won't be tracking an index as most of of your ETF products do. Is that correct?

Genoni: Well, there's a benchmark that you're looking to beat, so it isn't tracking to try and match that benchmark. But in this space, frankly, active management gets you close to the index.

Running an index product against the TIPS market actually would likely mean that you would under-perform the marketplace. You actually need a little bit of the active management with hopes to bring the performance of the fund up closer to where the index is overall.

Burns: Are there other areas that you're investigating for this kind of active management?

Genoni: Vanguard always asks the question with each new product that we're offering in the marketplace. One: whether it should be multi-class or single-class. Always chosen multi-class.

Also, should it be a passively managed fund, or should it be an actively managed fund? Vanguard oftentimes has both active and management funds using the same basic underlying benchmark, so it's a choice that we have to make every product launch.

In most cases, again, we've chosen to go down the index route, but we will keep our eyes open for the right opportunities in the active space.

Burns: All right. Well, thanks for joining me and sharing your thoughts, Rick.

Genoni: Thanks, Scott.

Burns: I'm Scott Burns with Morningstar. For this and other ETF commentary, please check out Morningstar.com's ETF Center and Morningstar's "ETF Investor" newsletter.