Vanguard's Evolution in 2019

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. Vanguard founder Jack Bogle passed away in January 2019. But the firm has largely carried on with the playbook that he laid out. Joining me to recap the year at Vanguard is Alec Lucas. He's a senior analyst in Morningstar's Manager Research Group.

Alec, thank you so much for being here.

Alec Lucas: Thanks for having me.

Benz: Jack Bogle passed away in January 2019. And you think despite Vanguard's ever-burgeoning size that the firm in most important ways is really carrying on with his legacy. Let's talk about that.

Lucas: Yeah, Vanguard has definitely evolved since Bogle led the firm, but there's also a lot of continuity. CEO Tim Buckley, who had been the CEO for about a year by the time Jack Bogle passed away, started at Vanguard as Bogle's assistant. So, that obviously leaves him well-positioned to know how Bogle himself operated and ran the firm. And I think Vanguard is very well known as an index provider--that's certainly one of Bogle's legacies. But more than that, their legacy really is an investment philosophy, where you have a lineup that's characterized by low fees and rooted in relatively predictable strategies. And it's helpful to understand Vanguard's lineup in sort of three categories.

So, there's passive strategy or indexing, which they're well known for. But there's also in-house active management where they have money market funds, as well as fixed-income funds. And they're very good at that precisely because they have competent investors and low fees. And that's been a winning recipe for them. And then, they have subadvised active, and there they have a very strong relationship with Wellington Management, who runs about 60% of those assets. And they've made investments in all three phases of that business.

Benz: And those investments were ongoing in 2019. There were some manager hires and some new fund launches. So, let's quickly outline some of those. Within the passive group, let's talk about what personnel changes went on there.

Lucas: Yeah. So, Jeff Johnson is relocating to Melbourne. He's going to be co-head of bond indexing. So, they're making investments in bond indexing. Their in-house active--they've seen a number of changes. Sara Devereux joined from Goldman Sachs. She's going to global head of rates, replacing Ron Reardon, who's retiring. Nathan Will is taking a role in municipal credit research. Arvind Narayanan--he joined earlier in the year to replace Greg Nassour, who had left in 2018 unexpectedly. They also had a hire in the quantitative equity group as well.

And then, in terms of subadvised active, they're launching an International Core fund, subadvised by Wellington Management. That launched in September. They also launched an ESG fund in June.

Benz: And in terms of competitive threats, we've talked a lot over the years about Vanguard receiving a lot of inflows, but it does have some competitors nipping at its heels. Fidelity, for example, in 2018 came to market with those zero-cost index funds. Let's talk about the competitive landscape a little bit.

Lucas: Yeah. If you step back and just think about Vanguard as a business, if you have a preponderance of your assets in index products--and index products track indexes, and that's something that other players like Fidelity and BlackRock's iShares business can do well--then it leads them liable to competitive threats from low-cost producers. So, Fidelity launched free index funds, and it's hard to beat free. And so, one question I had, as I sort of watched the development of the industry is, What would we see from a flow standpoint, given that Fidelity in August of last year launched these free index funds? And if you look at the flows year-to-date, you see Vanguard continues to dominate in flows. They have lost ... they lost Amazon.com's 401(k) business to Fidelity, for example, recently. But you saw $145 billion in assets flowing into Vanguard funds, which is roughly 2.6 times what went into Fidelity and is about 1.5 times what BlackRock, including their iShares business, saw.

So, you see Vanguard continues to dominate in flows. You see most of those flows obviously going into passive strategies. Active U.S. equities are in outflows. But you do see positive inflows into taxable-bond strategies, as well as international equity.

Benz: How about on the performance front? Let's talk about some funds that had notably good performance during the year.

Lucas: Yeah, both Windsor funds, Windsor and Windsor II, have had good years so far. They've had some bond strategies do very well. Old, reliable Vanguard Wellington continues to do very well. Wellesley has had a competitive year. So, those are some of their bigger strategies that are doing well.

Benz: How about laggards?

Lucas: The Primecap strategies relative to their category rankings are not doing as well this year. Vanguard Primecap, for example, is in the bottom decile of its category ranking.

Benz: What's working against them?

Lucas: Well, tech picks, so DXC Technology is a stock that hurt them. It's one that's hurt other asset managers we think highly of. It had a legacy data center business and was trying to shift to the cloud, and the legacy data center business was its biggest business. But one asset manager I've talked to says the business was shrinking faster than anticipated. So, that's a pick that's hurt them. Not owning Facebook and Vanguard Primecap hurt them. HP has hurt them. They owned a big chunk of Biogen stock across all their strategies, where there was an Alzheimer's drug that got pulled, and that stock dropped quite a bit, and then they just put it back on the market. So, the stock did go back up. So, that's hurt them.

The value factor has really been out of favor. And even though Primecap as an asset manager is known for growth investing and is a growth investor, they can be very value-oriented when they build positions. And so, it's not surprising that in this kind of market climate they would lag. But you have to put that lagging in context. I mean, Vanguard Primecap's returned over 20% year-to-date. So, it's not a terrible year.

Benz: No, not at all.

Lucas: Yeah.

Benz: Okay. Alec, always great to get your perspective. Thank you so much for being here.

Lucas: Thank you.

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