At Midyear, Vanguard on Pace to Break 2016 Inflows

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Vanguard continues to lead the pack in terms of mutual fund asset inflows. Joining me to discuss this and other developments at the firm is Alec Lucas. He is a senior analyst in Morningstar's manager research group.

Alec, thank you so much for being here.

Alec Lucas: Thanks for having me.

Benz: Alec, let's discuss this flows issue. It's been pretty tremendous, if people have been watching Vanguard inflows over the past several years, they have been dwarfing their competitors. Let's talk about what's been going on there.

Lucas: Well, it continues. It's continued thus far in 2017. There's two trends Vanguard is benefiting from: One is low fees and the other is the shift from active to passive, and the two are of course linked. And Vanguard's strong in both respects and that shows in the numbers. They took in $126 billion in 2017's first half, and for context, that's 6.8 times more than their closest competitor, Dimensional Fund Advisors. They are on pace to break the number of inflows that they got in 2016 which were very substantial.

Benz: OK. So, the flows have been going mainly to the index products or the active products or has it been a combination?

Lucas: Flows to both, but primarily to passive.

Benz: OK. So, you mentioned that that's been a huge trend in the marketplace and that's obviously been a huge area of emphasis for Vanguard for many years. Let's discuss something investors may have been paying a little bit less attention to. In this robo-advice space, people may have heard of some of the upstarts, whether Betterment or Wealthfront, but you noticed that--or you have noted that Vanguard has made a huge footprint there and really has jumped ahead of everybody else. Let's talk about Vanguard's effort in the area of providing advice to the masses.

Lucas: Yeah. So, they've got a budding robo-advice business, about $65 billion in assets. They have a higher minimum that they require than some other shops, it's $50,000 and then there's more hands-on service when you get to $500,000. They combine human advice with computer-directed outputs and obviously, Vanguard has a strong brand it can build upon, which puts them ahead of a lot of shops that have less name recognition.

Benz: One thing I want to cover with you, Alec, is the issue of whether asset growth has a potential to lead to problems at Vanguard. And I know you and the team are watching at kind of the fund level, whether it's causing any changes in how the funds are managed. But another thing that I've been wondering about, and I know you and the team have been wondering about, is customer service issues. Our colleague, Kevin McDevitt, wrote a piece about Vanguard generally and in the comments section I know a number of us were kind of taken aback when commenters said that they really had experienced in many cases sub-par customer service. So, let's talk about that issue. Is that something you and the team are in the position to monitor and what's your take on that issue?

Lucas: It's hard for us to assess customer service. And I certainly have my own views based on--I'm a Vanguard client myself and I've had good experiences and bad experiences. Kevin wrote a Fund Spy in September of 2016 and the title of it was No Signs of Complacency at Vanguard, and that elicited a number of responses from readers about customer service issues that they've had and some came into the defense of Vanguard. They said it's a no-frills approach.

Either way, I'd like to think of Vanguard as kind of like the supermarket Aldi, if you're familiar with that. You bring a quarter with you, you get a cart that incentivizes you to put the cart back. They don't have to have employees do it. If you want a bag for your groceries, you either have to buy it or bring it. So, you know what you're getting with Aldi. It's no-frills, it's low cost, and in some ways, you could call Vanguard the Aldi of mutual fund managers.

Benz: OK. So, if you want a higher-touch experience, maybe Vanguard isn't your shop?

Lucas: Yeah. You need to have the right expectations with Vanguard. But what they do, they do well overall, obviously though they face challenges given the level of assets and new shareholders they are taking on.

Benz: OK. Let's discuss the ratings distribution among Vanguard funds. I know you and the team are constantly reviewing the analyses for the various funds, reviewing your ratings. When I look at the ratings distribution, what I see is that a lot of Vanguard funds receive some of the highest ratings. So, they are either Gold or Silver-rated.

Lucas: Yeah, it's quite striking. It's a testament to the power of low cost and the power of retaining good active managers, like a Primecap or a Wellington Management. Across the board, we rate about 100 Vanguard funds with our forward-looking Morningstar Analyst Rating, and there are about 50 of them that are Gold and roughly 30 that are Silver. So, about four fifths of the funds we rate are Gold and Silver medalists and there's currently only three Neutral-rated funds. So, it's an impressive testimony to what investors can get at Vanguard. There have been some downgrades recently though. We've downgraded Vanguard Selected Value from Gold to Silver and what drove that was volatility. The volatility of the fund has increased with more assets going to Pzena and that's what drove that. But nonetheless, continues to be a strong fund.

Benz: Well, one thing I wanted to point out is that it has been a really good performer. So, it's a little bit indicative of the fact that you and the team aren't looking strictly at performance when you're doing these ratings changes. You really want to dig into the fundamentals of the products.

Lucas: It does. And one of the things we're cautious about is volatility, and volatility is going up that if the fund is going up and you're benefiting from volatility, you can look very good and Vanguard Selected Value has had a very strong first half in 2017 and a strong trailing year versus its peers.

Benz: OK, Alec, thank you so much for being here to provide a midyear recap of what's been going on at Vanguard.

Lucas: Thanks for having me.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.