Top Honors Go to Vanguard and Its Strong Culture

Morningstar covers more than two thirds of Vanguard's funds, and most of those are Morningstar Medalists. All told, Vanguard's boasts 29 Morningstar Analyst Ratings of Gold, including its target-date series as one of those.

In fact, none of Vanguard's funds under coverage are rated Negative and just six are rated Neutral. All of those are actively managed and subadvised. The reasons for their Neutral ratings are varied, but all of them earn Positive Price Pillar ratings, as well as Neutral Performance Pillar ratings.

Despite Vanguard's prowess in indexing, not all of its index funds have Gold ratings. Thirteen of the 23 rated index funds earn Gold ratings, seven earn Silver, and two earn Bronze.

Vanguard's other medalists include funds that are actively managed and subadvised equity and sector funds, as well as a couple of actively managed fixed-income funds, which are run in-house.

Vanguard's impressive lineup of medalists reflects in part its strong corporate culture, which is considered in both Vanguard's Positive Parent rating and its Stewardship Grade of A, which was recently affirmed in June 2015. What follows is the Corporate Culture section of Vanguard's Stewardship Grade Report. 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 Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).

Once perhaps the fund industry’s underdog, Vanguard, at 40 years old, dominates the field. Whether considering its record-setting inflows over the past several years or its strong performance numbers, the firm is a force. As it’s grown, it hasn’t lost its true north, and evidence of its mission to help investors succeed is apparent. Although Vanguard isn’t perfect and risks remain, its identity is clear and its corporate culture is among the industry’s strongest.

Vanguard’s total assets under management have passed the $3 trillion mark; it holds near 20% market share of U.S. mutual fund assets, nearly double that of its next-closest competitor, Fidelity. Although market appreciation has certainly helped, the real story has been inflows. Over the past year, Vanguard has taken in more than $200 billion--well ahead of the competition and continuing a multiyear trend of topping the inflows chart. Most of those flows have gone into index funds, reflecting the current investor preference for passively managed strategies, though Vanguard had also enjoyed inflows to its actively managed funds. In particular demand have been the firm’s exchange-traded fund share classes, which reflects Vanguard’s continued success in penetrating the financial-advisor market. Although Vanguard recently has launched a few new offerings, most of the money has gone to existing, broad-based funds, including

For Vanguard’s fundholders, the primary benefit of such growth is a sharing in the economies of scale (and capacity issues aren’t relevant when tracking market-cap-weighted indexes). While investors at any firm can hope to see fund expenses go down as assets increase, Vanguard’s unique ownership structure means they are more likely to realize such an advantage. Vanguard is the only mutual fund company owned by its fundholders. Specifically, each mutual fund has a piece of Vanguard in its portfolio, providing capital to the firm. Plus, Vanguard operates its funds at cost, under an SEC exemptive order. Vanguard doesn’t have outside owners to pay dividends to or share profits with, and its at-cost model means it can’t merely stockpile reserves, so it returns its profits to its fundholders through lower expense ratios on its funds. In 2014, the firm’s average expense ratio dropped a basis point to 0.18% from 0.19% in 2013 and 2012. This model also makes Vanguard’s funds among the cheapest, if not the cheapest, offerings in their respective categories--often regardless of category.

It isn’t just scale that allows Vanguard to lower its fees; the firm is also proactive in saving the funds money. In 2013, for example, it switched to tracking FTSE indexes at its international index funds from MSCI indexes. There was a risk involved that its clients would balk at the change, considering MSCI’s dominance in benchmarking, but the decision in part was made to lower costs. Vanguard also saves its fundholders money elsewhere. Over the past year, for example, it merged all its Signal share classes into its cheaper Admiral share classes and lowered minimums to allow more investors access to the Admiral shares. In previous years, it has similarly expanded access to its lowest-cost offerings.

While there’s a very tangible benefit to the firm’s ownership structure and at-cost model, there’s also a cultural benefit. At other firms, whether publicly traded or privately held, the advisor serves two masters: its fundholders, who care about the funds' total returns, and its shareholders, who care about their returns on their equity in the firm. In Vanguard’s case, its fundholders are its shareholders, and vice versa, and those shareholders are "paid" only through the funds.

That scenario has meant that Vanguard has been responsible and choosy about what kinds of funds it brings to market, sticking generally with straightforward vehicles that it thinks it can run well either with an in-house manager or a suitable subadvisor with an attractive fee schedule. The firm’s most-recent launches have expanded the firm’s fixed-income lineup and in Vanguard’s view provide more ways for investors to diversify their portfolios. It launched Vanguard Ultra-Short-Term Bond VUSFX in early 2015 and Vanguard Emerging Markets Government Bond Index VGOVX and

Considering how well-represented the stock and bond markets are on Vanguard’s lineup, the challenge going forward may be to avoid the temptation to move out of the easy-to-understand-and-use funds that have characterized the firm's lineup. There are just a few examples of more-esoteric offerings, and they're relatively tame.

Meanwhile, Vanguard’s international operations remain a fairly small percentage of assets, steady at 7%, even though the business has grown in terms of markets and assets to around $250 billion. (Vanguard’s exceptional growth stateside keeps its business heavily U.S.-centric.) But a few trends work in Vanguard’s favor abroad. First, there’s the shift to defined-contribution retirement accounts from defined-benefit arrangements, which can create a do-it-yourself or a more engaged investor base in newer markets. Elsewhere, fee-based investment advice and indexed assets are gaining traction.

Vanguard may be challenged by competitors with better name recognition or stronger distribution platforms, but CEO Bill McNabb is happy with successes so far and says having a global footprint is critical to the firm's long-term future. To that end, Ken Volpert, head of taxable bond, has relocated to London and has taken on new responsibilities. Volpert is now head of global fixed-income indexing--an area he has long been familiar with--as well as the head of U.K. investments. Volpert is a Vanguard veteran and one of its culture carriers. As Vanguard grows its staff internationally, this kind of connection to Vanguard’s roots and culture is important for it to sustain its investor-friendly reputation.

Volpert isn’t the only one in a new role. Fixed-income chief Bob Auwaerter retired in 2014, followed by two other senior leaders, spurring a number of rotations among Vanguard's leaders. Greg Davis returned to the fixed-income group, succeeding Auwaerter, after leading Australia’s efforts for a relatively short time. To address the other retirements, six other Vanguardians changed positions. Two of them were added to Vanguard’s “Senior Staff,” an 11-person decision-making body that includes representatives from Vanguard’s various functions.

Of particular note is Martha King’s assignment to head up Vanguard’s institutional investor group. (King is taking over from Chris McIsaac, who is assuming the spot of planning and development from Mike Miller, who is retiring at the end of June 2015.) From their beginning more than a decade ago, King oversaw Vanguard’s ETF efforts, which developed into the firm’s financial-advisor segment. That group has seen tremendous growth under her watch. From a small base, ETF assets have grown to roughly 15% of Vanguard’s assets, and financial advisors now represent roughly a third of Vanguard’s business mix. King acknowledges that the institutional business is more mature than the financial-advisory business was when she took over. Still, she’d like to grow it; currently institutional assets represent about a fourth of the firm’s assets under management. Vanguard’s target-date series, which carries a Morningstar Analyst Rating of Gold, has already gained some popularity with defined-contribution plans. King thinks it's well-positioned to gain more market share.

Shuffling among top managers can be a red flag, but it has long been Vanguard’s practice to rotate managers through different assignments through their careers. Vanguard thinks fresh eyes are important from time to time. These rotations also allow different culture carriers to touch various parts of the business, and help address succession and contingency planning.

Overall, Vanguard’s roster is large and diversified. It has recently grown but is still sensible. Like most fund families, when Vanguard evaluates whether or not to start a new fund, it wants to offer it in a competitive way so it can be one of the best in its category while having an enduring place in a portfolio. Those criteria have helped Vanguard’s Success Ratios, which report what percentage of a fund family’s offerings both survive and outperform their category averages. As of the end of May 2015, Vanguard’s Success Ratios stand at 72% over the past three years, 72% over the past five, and 77% over the past 10; these are among the highest of the largest 20 mutual fund firms. Morningstar analysts cover 71 of Vanguard’s 115 offerings (including the target-date series as one fund). Vanguard has earned 29 Gold Analyst Ratings, 25 Silver, 11 Bronze, and six Neutral.

There are potential risks lurking as Vanguard grows: It could lose its investor-centric corporate culture as more time and distance separate new employees from the firm’s passionate founder Jack Bogle. Or it may try new strategies that prove outside its circle of competency, or it may not pass on enough of its profits in the form of lower expense ratios when times are flush. It also could create costs to further growth efforts.

Those risks, however, are small. The firm has a long-established track record of doing right by its fundholders. Its mutual ownership structure underlies our confidence. Virtually every other fund family has to balance making money for its owners with serving fund owners. Vanguard has a structural incentive to operate at-cost and to put investors first.

There’s plenty of reason to trust Vanguard, not only as an investment manager but also as an investor advocate. This firm earns an A for Corporate Culture.

For a list of the open-end funds we cover, click here. For a list of the closed-end funds we cover, click here. For a list of the exchange-traded funds we cover, click here. For information on the Morningstar Analyst Ratings, click here.

This article is the Corporate Culture portion of the Morningstar Stewardship Grade for Funds for this fund family. Visit our corporate website to see Morningstar's Stewardship Grade methodology.