New Leadership and Fund Launches for Vanguard

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. As 2017 winds down, Vanguard continues to gather assets at the expense of its competitors. Joining me to discuss this and other trends at the firm is Alec Lucas, he's a senior analyst with Morningstar.

Alec, thank you so much for being here.

Alec Lucas: Thanks for having me.

Benz: Alec, we discuss Vanguard frequently, and this flows issue seems to come up every time. Let's talk about 2017 year to date where Vanguard is in terms of fund flows in the absolute terms and also how it's doing relative to its competitors.

Lucas: A similar story to years past, they've had nearly $200 billion in inflows through November and are on pace to break the record they set in 2014. Their closest competitor for comparison is DFA, which has about $30 billion in inflows, whereas they've got 196.5 through November. Far ahead of their competitors. Interestingly enough 90% of the flows are going to passive options at Vanguard, so 10% active but it's important I think to recognize that, that's a pretty sizable actively managed business in its own right.

If you separated out the actively managed portion of Vanguard it would rank fourth behind other active managers. They have a big active managed business and you could argue that it's not just a shift to passive but it's a shift to lower cost options, and Vanguard can compete, both on the passive side on that as well as active.

Benz: At the end of 2017 Bill McNabb will turn the reins over to Tim Buckley as leading the firm. Let's talk about, from where you sit, what you think the implications of this changeover will be.

Lucas: Buckley's a known quantity in Vanguard. He joined Vanguard in 1991, and of course McNabb took over 2008 and has overseen a pretty sizable growth. The biggest challenge could be if we see another bear market and the kind of growth that Vanguard has experienced, that would fall to Buckley to navigate. Certainly he's well equipped based on his experience at the firm. He knows it well.

Benz: And what was his previous experience at the firm?

Lucas: It was chief information officer. I believe he's CIO currently.

Benz: Let's talk about a few new fund launches, a couple of funds coming out in 2017 and then a couple expected early next year, let's talk about those. Vanguard tends to be pretty judicious and maybe a little bit slow-moving when it comes to new launches but a couple new global funds now available to Vanguard investors.

Lucas: Yes. Vanguard Wellington and Vanguard Wellesley are well known, and there's going to be global options of those, in fact there are global options of those. They launched in October and both Vanguard Wellington and Wellesley had a pretty global footprint, but these funds will explicitly have a global mandate and should be good options for investors, especially those who are worried about U.S. market valuations being too rich. This gives them an option to have a more global playing field that their managers can fish in, if you will, to mix metaphors.

Benz: So similar strategies, is there any overlap in management teams?

Lucas: Yeah, same teams, same teams. (Michael) Reckmeyer leads Vanguard Wellesley and his team member, Ian Link, is going to lead the equity side of Vanguard Global Wellesley, and then Vanguard Global Wellington, Nataliya Kofman will manage that and she's on Edward Bousa's team, the equity team. And then the bond strategy is the same for both the domestic and global versions of those funds.

Benz: These funds will be run by Wellington Management.

Lucas: They're Wellington-managed funds, yeah.

Benz: I want to talk about these other new funds that are launching, I think raised a few eyebrows around here. Vanguard is jumping into the factor fray. Let's talk about these funds that will be coming to market.

Lucas: They're bringing low cost to factor based investing ...

Benz: Let's just describe what factor investing is, before we move on.

Lucas: You're investing in securities based on the characteristics they have. The ones that they're looking for volatility, value, liquidity, momentum, and quality. Quality tends to be profitability. You're trying to build a portfolio that's full of companies that exhibit profitability across the board. Vanguard is offering this so that advisors can put quality tilts to portfolios or round them out in whatever way they see fit. There's five single-factor ETFs that are coming out and then a multifactor ETF, which is momentum, quality, and value. And then it's open-end mutual fund counterpart. The costs are cheap ...

Benz: How cheap?

Lucas: ... 13 basis points for the single-factor ETFs and 18 basis points for the multifactor version.

Benz: Let's talk about leaders and laggards. It's been a strong year, the market has lifted almost every boat, certainly the equity market. Let's talk about some of the big winners when you look at the top performance so far in 2017.

Lucas: Vanguard International Value has done well, Vanguard International Explorer, Vanguard International Growth--you notice the international theme.

Benz: International is a theme?

Lucas: Schroders as a subadvisor on a couple of those funds. Vanguard Selected Value, which Jim Barrows managed for a long time, has had a very good year. On the laggard side a prominent fund, Vanguard Dividend Growth, it's one I actually own, it's in the bottom third of its category, but it's returned 20% for the year. It's hard to complain about that. This is a fund that's pretty resilient and the kind of thing that you would expect to lag in the kind of market environment we've had in 2017.

Benz: Kind of a quality focus.

Lucas: Yep.

Benz: You've alluded to this idea that we're all looking at U.S. equity market valuations, they're not what they once were. Let's talk about how you think Vanguard investors, especially those who maybe are newly arrived in the big core passive products, what do you think they'll do in terms of hanging on if we do encounter some sustained turbulence in the equity market?

Lucas: If you're going to go passive I think the best thing is to dollar-cost average to invest, to stay invested and not try and time the market, and if people can do that successfully they should be able to weather a downturn. ETFs are a bit of a different animal because you can of course trade intraday.

Benz: Right.

Lucas: I think it's a bit of an open question about how investors will fare if we see sustained volatility and big losses, the kind of thing we saw in the early 2000s and obviously the financial crisis. Given the shift to passive and the ability of investors to take money in or out that could create interesting conditions, which good active managers should be able to exploit.

Benz: We've all gotten really used to very low volatility and very good returns recently.

Lucas: Yes.

Benz: Alec, thank you so much for being here to discuss these trends.

Lucas: Thanks for having me.

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