What’s in Store for Vanguard’s Funds, ETFs, and More in 2024

Key Takeaways

• The last two years for the market, value was doing really, really well. But the pendulum really swung back in favor of growth this year.
• The important thing to realize here is that Vanguard and BlackRock are like the two 800-pound gorillas in the room. You look at the leaderboard of flows in any given year, and they’re always at the top.
• We’ve been in the zero interest-rate environment for 10 or 12 years. We’re finally coming out of that over the last two or three years.
• Compared with their U.S. business, Vanguard’s international business is tiny.

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Vanguard’s index funds and ETFs are popular choices with investors, thanks in large part to their low costs and competitive long-term performances. Did Vanguard’s stock and bond funds deliver for investors in 2023? And what should Vanguard investors be on the lookout for in 2024? Joining me for a comprehensive conversation about Vanguard today is Dan Sotiroff. Dan is a senior manager research analyst with Morningstar, as well as our specialist on Vanguard.

Nice to see you, Dan.

Daniel Sotiroff: Nice to be here. Thank you for having me on.

Vanguard in 2023

Dziubinski: Yeah, thank you for being here. Let’s start out with a look back at Vanguard in 2023. Let’s start with the performance of some of the company’s largest mutual funds and ETFs. In general, how did their performance rank up against their category peers, and did those low fees continue to give Vanguard an advantage in 2023?

Sotiroff: Short answer, sure, yeah, the low fees, it’s an objective performance advantage, right? So, it’s going to be there no matter what happens in the market. But to paint some context around that, let’s look at what happened in the market over the past year. The last two years value was doing really, really well. But the pendulum really swung back in favor of growth this year. We had the “Magnificent Seven” that were leading the market, and they’re still to a certain extent leading the market. And that’s really the story that you see play out with Vanguard because so much of their assets are tied to just indexes. When you look at what performed best overall at Vanguard, it was really Vanguard Mega Cap Growth ETF and the associated mutual fund share classes that had about a 46% return for the first 11 months of the year. Information Technology, which is also an index-tracking sector fund, was very close behind it, almost similar type of performance. Those were really at the top of the heap, and then their growth index funds correspondingly were right below that.

It gets a little more nuanced when you get into the actively managed stuff, because there’s more moving parts with a lot of those funds. And it was a mixed bag. You saw some successes and maybe some misses, I guess you would say. Vanguard Growth Investor, Vanguard Primecap both outperformed the Russell 1000 and Russell 1000 Growth. Those were the hits. And then you had some misses, Vanguard Primecap Core, Capital Opportunity, and Vanguard Growth and Income didn’t perform as well. I think the important thing to remember here is these are all long-term investments. So, what happens in any given year, you expect some ebb and flow. Nothing to worry about, but that was kind of how things shook out.

Were There Any Surprise Performances in 2023?

Dziubinski: Were there any performances that either maybe surprised you a little bit on the upside or on the downside in 2023?

Sotiroff: Not too much. I think, in general, we saw a lot of what we expected. And again, with some margin of error there; there’s going to be some hits and misses. Probably one thing to point out was what happened with Windsor II. So, if you remember back in 2019, there was actually a manager change on that fund. And what that did is it effectively changed the style of that fund. It had long been a large-value fund. They changed the manager out. And then what has happened is that it started to migrate over into the large-blend category. So, as a large-value fund, it looked really good. It outperformed in a year that value didn’t look that great. But really underneath the surface, it’s more of a blend fund. It’s been slowly migrating. And I think the story there is, if it tends to continue to do that and stay within that large-blend segment of the style box, you could expect in the near future that that’s probably going to be reclassified as a large-blend fund.

What Is Going to Happen to Vanguard Dividend Growth?

Dziubinski: Makes sense. Now, Vanguard is of course best known for its passive funds. But as you alluded to, many of its actively managed funds are actually quite good and highly rated by Morningstar. One in particular I wanted to touch on is Vanguard Dividend Growth, very popular. And it saw its longtime manager, Don Kilbride, retire in late 2023, Jan. 1 of 2024. So, what are our expectations for this fund after his retirement, and is his retirement having any impact on our Medalist Rating for the fund?

[Correction (Jan. 19, 2024): This video misstates Donald Kilbride’s role at Vanguard. He stepped away from his responsibilities for Vanguard Dividend Growth Fund on Jan. 1, 2024. He did not retire and is still managing portfolios for Wellington.]

Sotiroff: So, kind of yes and kind of no. We make the assessment at the pillar ratings. So, the analysts went back in and talked to the team, figured out what was going on. The process is not changing. This is still very much going to be a dividend growth fund managed in a very similar way as it is now. The new manager will be Peter Fisher, who has been working alongside Kilbride, managing similar types of portfolios at Wellington. So, he is going to be taking the reins in January when Donald Kilbride officially steps down. We did take action to downgrade the People Pillar on that, mostly because we want to see that his success in those other vehicles translates actually over into this particular fund. So, we want to give him the opportunity to really earn that People Pillar rating on his own merit. But the overall Medalist Rating did stay at Gold. So, it’s something to watch for. We still think highly of it as an investment. We just want to see that Peter can actually deliver on that mandate over time.

Notable Vanguard Fund Departures

Dziubinski: Fair enough. Now, were there any other notable manager departures on other popular Vanguard funds in 2023? And what impact does Morningstar expect for these changes to happen?

Sotiroff: Great question. Yeah, there were a few. So probably one of the bigger ones was Vanguard High-Yield Corporate Fund. That’s a bond fund that is more in the high yield—we call it junk bond, but high-yield bond space. Michael Hong, just a little history here, Michael Hong was the sole Wellington manager on that until about mid-2022. Wellington added Elizabeth Shortsleeve to that fund as a comanager at that time. You fast-forward a year to, I think, around July or August of this year, they removed Michael Hong off that, so Shortsleeve was the sole Wellington manager on that fund. Similar to what happened with Dividend Growth, we ended up downgrading the People Pillar rating from Above Average to Average. Similar type of thing: She’s had success, she’s got a lot of experience in credit and stuff like that, but we want to make sure that that experience actually translates over into this particular fund. The process didn’t change. We still like that fund. It’s still at Above Average. It tends to play more in the higher-quality end of the high-yield market. But the overall rating on that one did drop from Gold to Silver as a consequence of that People Pillar downgrade. So, still a very good investment overall. We still really like it, but something to watch out for there as she gains a little bit of a track record on the fund.

Dziubinski: OK. So, that one is down to Silver, which is still a fine rating.

Sotiroff: People always ask about that. I own Silver funds. I don’t shy away from them at all.

Fund Flows for Vanguard in 2023

Dziubinski: Right. Great. OK. Let’s talk a little bit about fund flows for Vanguard in 2023. Now, of course, the firm remains the largest mutual fund and ETF manager in the U.S. But preliminary flows numbers, at least that I saw most recently for 2023 suggests that BlackRock and iShares raked in more in 2023 than Vanguard. So, if that does in fact hold for 2023, let’s talk a little bit about that.

Sotiroff: Sure. So probably the important thing to realize here is that Vanguard and BlackRock are like the two 800-pound gorillas in the room. You look at the leaderboard of flows in any given year, and they’re always at the top. And you think about why that is. Both of them really offer similar products at a very similar price point, very broad market indexes that are very cheap at the end of the day. And that’s really the flows story here. A lot of money is coming out of high-cost actively managed funds and then these low-cost market data index funds at the end of the day. And Vanguard and BlackRock are just the household names that are well known, and they’re going to get the most money in that regard. So, they’re always at the top of the leaderboard.

What happens in any given year, it’s like you’re just watching two giants slug it out. So, this year it was BlackRock maybe. The year isn’t over yet. Maybe next year it will be Vanguard. They go back and forth. I don’t really read too much into the nuanced details there. The bigger story is really that those two are winning above everybody else.

Dziubinski: Got it. So, this might continue in 2024, but at the end of the day, it’s very likely to be the two of them at the top of the leaderboard over time.

Sotiroff: Correct. Yeah. I would not be surprised to see the two of them at the leaderboard at the time. I expect that bigger trend from high-cost actively managed funds into lower-cost index funds to continue.

Dziubinski: Let’s talk a little bit about fund flows and what they mean for the everyday investor who maybe is invested in Vanguard funds. Does it really matter?

Sotiroff: Not really. If it did matter, usually flows are indicative. If you have really bad flows like a lot of money leaving the fund, it’s usually indicative of something else going on underneath. And at that point, we probably would have already caught it, like a manager change or really, really subpar performance from a change in process, we would have caught that stuff long before that actually happened. So, flows are usually like a lagging indicator of something else going on. It’s interesting to understand where the money is going, especially for someone in my position that’s watching this stuff all the time. But for the everyday investor, it doesn’t really change anything for me.

Morningstar Medalist Rating Changes in 2023 for Vanguard Funds

Dziubinski: Now you mentioned the idea of if something were going on you would have noticed it before—Morningstar would notice it before the flows happened. So, I want to go back to a question that I actually skipped by mistake was, Were there any other significant Morningstar Medalist changes from your perspective in 2023 on Vanguard’s funds?

Sotiroff: Yeah. So, Vanguard Lifestrategy funds, those are fixed allocation funds that have various mixes of stocks and bonds and they’re fairly static, those were downgraded to Silver from Gold. There wasn’t anything really that we changed on our Process or People Pillar ratings there. It was just more of a circumstance of what was going on in the peer group, and it’s gotten more competitive over time. So, that happens sometimes, unfortunately. Again, like we were saying before, Silver is still a great option. So, it’s not a bad investment if you already hold it or if you’re thinking about getting into it. There’s very nuanced differences between those Silver and Gold ratings often.

The bigger ones that are more popular I think are a lot of Vanguard’s index-tracking dividend funds. Vanguard High Dividend Yield, Vanguard Dividend Appreciation, and Vanguard International Dividend Appreciation, all of those funds have their Process Pillar upgraded to High from Above Average, and correspondingly, the overall Medalist Rating went from Silver to Gold on all of them. And that’s really just a reflection of our confidence in the processes underlying those because these are index funds; the process is basically the overall rating at the end of the day. And we’ve been watching those for years. We’ve been big fans of them for a very long time, and their track record just continues to reaffirm what we’ve always been thinking about them. So, we felt pretty confident in finally giving them a bump up to High this year.

New Fund and ETF Launches

Dziubinski: Let’s talk a little bit about some new fund launches and ETF launches from Vanguard in 2023. Now, Vanguard launched a few actively managed bond funds in 2023. Why do you think active bond management was something that Vanguard decided specifically in 2023 that this was the time for them to do?

Sotiroff: To be a little bit more precise, we’re actually in the throes of this actually happening. Just this morning I saw the final prospectus on the two actively managed bond ETFs that you’re referring to: Vanguard Core Bond ETF and Vanguard Core-Plus Bond ETF. The final prospectus came out today. So, we should probably time-stamp this as a Dec. 6 in the afternoon we’re recording in the studio here. They’re expected to be live any day now.

Why is it a bigger push for them? I think it’s more of an industrywide thing. We’ve heard some of their competitors have also said that. I think when you look at just what’s happened, we’ve been in the zero interest-rate environment for 10 or 12 years. We’re finally coming out of that over the last two or three years. So, there’s actually some interest rates attached to these things. So, it makes a little bit more sense. There’s also an appetite for income. Dividend funds are very popular, and fixed income for a long time before you got into the zero interest-rate environment fulfilled some of that. It’s sort of a fixed coupon that you can rely on for some income. I think for both those reasons, plus equity has been very picked over with strategic data and ESG and everything we’ve had over the years. If you’re looking to innovate, I think fixed income is sort of the final frontier at this point.

Dziubinski: I know you just looked at these prospectuses, so maybe you can’t even answer this question, but I’m still going to ask you. With what you’ve seen in these prospectuses, do we have any insights into who the managers are, do they manage other funds? Do we have just—I know they’re not even out yet, so we can’t rate them, but like, what would be some just preliminary things that maybe struck you or you noticed?

Sotiroff: Yeah. So, I think in general, it looks like good stuff. The managers are Vanguard managers that are on other funds. So, we have a little bit of familiarity with them. I think the bigger thing here is just how does Vanguard manage fixed income. They’ve long gone in the direction of just giving you broad access to the bond market or a segment of the bond market and then taking some opportunistic active risk around the edges where they think they can add a little bit of value. They tend to be very low fee, so there’s a very low hurdle, and because of that, they don’t have to take on a ton of risk in order to outperform. So, you get a little bit more of a conservative portfolio, but the potential for outperformance is still there because they’re relying on that low fee as really the catalyst to actually drive the performance. And that seems to be very much embedded into both of these ETFs that they’re coming out with. So, Vanguard Core Bond ETF that I mentioned, the expense ratio on that is 10 basis points. The Core Plus Bond ETF is 20 basis points. Really, the difference that you’re looking at there, I think, is going to be the exposure to the high-yield bond market. So, Core Bond, I think in the prospectus said about 5% or less in high-yield bonds. Core Plus, obviously, by its name is going to take on a little bit more. So, a little bit higher risk/reward with that one, depending on what you want, but just based on the name, these sound like pretty broad core type bond holdings that could easily complement a very diversified portfolio at the end of the day.

Vanguard International Dividend Growth Fund

Dziubinski: Outside of these actively managed bond funds, did Vanguard launch any new mutual funds or ETFs in 2023 that you think are notable?

Sotiroff: One that just came out recently was International Dividend Growth Fund. That’s the international cousin of Dividend Growth that we were just talking about before. Peter Fisher is managing that fund, who is going to be taking over Dividend Growth from Donald Kilbride. So, you see some continuity there. I haven’t really looked into it. It just came out last month but expect a very similar process just applied to international markets there.

ETF and Mutual Fund Hybrids

Dziubinski: On the news front in 2023, Vanguard’s patent on its unique hybrid mutual fund ETF structure expired in May 2023. There was a lot of speculation in the media at that time that a bunch of fund families were just going to bust through the door and try to adopt this strategy. And I seem to remember at the time, Dimensional Fund Advisors was actually trying to do that, that they were eager to offer ETF share classes of their funds. Talk a little bit about why this structure was unique to Vanguard for as long as it was, and why is it appealing for other asset managers?

Sotiroff: Well, you kind of alluded to it, right? It was patented, so you couldn’t actually do anything with it from a legal standpoint. But now that the patent is off, we’ve seen that there is some appetite out there. I think what’s going on right now is like, Dimensional has filed for it. There was another firm very early on called PGIA that filed for it for like six or seven of their mutual funds. And then Fidelity also filed a similar filing to Dimensional to also get that structure. The play there is like, what happens is when you bolt the ETF share class onto an existing mutual fund, the mutual fund share classes inherit the tax advantages of the ETF. So, the ETF can purge those potential capital gains from the mutual fund share classes, and you get a potentially much more tax-efficient investment experience without having your investors have to actually sell out of the mutual fund and go into an ETF. So, active managers right now would be really interested in that because they’re losing money to more tax-efficient vehicles. So, this might be a way to protect some assets for them.

The tricky thing is, you’ve seen some appetite, but nobody is knocking down the door. The whole industry isn’t going after this. You do have to be careful about it because while there is that advantage of tax efficiency out there, it doesn’t really fit with every active manager. You can’t really shut down an ETF in order to, I guess, control your capacity. So, that’s long been an advantage of mutual funds. When managers seem to be taking in too much money and they start to lose their edge, they’ll shut the fund down. When you bolt on this ETF share class, that’s going to trade no matter what, and you can’t do that. So, it’s something that managers have to be very careful in assessing. So, that remains to be seen. And we should be clea: These haven’t been approved yet. These are just filings at this point. So, I think some of it is also we’re just testing the waters right now to see what the SEC thinks about this. And then, depending on what gets approved or disapproved with Dimensional and Fidelity and that other asset manager, we may see more or less depending on that outcome.

Implications for Investors

Dziubinski: If we’re talking about real-world implications for investors, if I own a mutual fund that would have this bolt-on ETF, it could be beneficial for me from a tax perspective, but maybe not it for some reason it’s a strategy where I might want my manager to shut the doors and manage the asset size, right?

Sotiroff: Correct, correct, exactly. There’s give and take. There’s benefits and disbenefits with it. So, the advantage you would get is definitely a more tax-efficient investment experience. You would have far fewer, if any, capital gains. But again, if you’re in a very high-conviction strategy, it probably doesn’t make sense.

New Fund Launches in 2024

Dziubinski: Dan, let’s turn over to 2024. Break out that crystal ball. First, let’s talk a little bit about new fund launches for Vanguard in 2024. What might be in the hopper? Where might you see them? Again, complete speculation, but where do you think they might go next?

Sotiroff: It remains to be seen. It’s always a little bit of speculation, but I think fixed income is a big area. I think we touched on that before. That’s been a big area for the industry. It’s an area that I think has been overlooked in a lot of ways. There might be more value to be added there than there has been in the equity strategies. When we talked to Vanguard earlier this year, they said ETFs are definitely in the plans for their new fixed-income products, as we saw with the recent launches that are still pending. Along those lines, they did announce plans to launch an intermediate municipal-bond ETF. That’s going to be an index-tracking one. Then along the same lines, a California taxes and municipal-bond ETF. So, those were in the hopper for next year. So, clearly, they’re thinking along the fixed-income lines. We’ll see what comes out in terms of actively managed versus index-tracking. Both can be great offerings, I think, at the end of the day; Vanguard does both of them in a low-fee, broadly diversified format. So, that’s what I’m really watching for in terms of product launches.

Vanguard’s 2024 International Business Outlook

Dziubinski: Let’s talk a little bit about Vanguard’s international business. Vanguard hasn’t really been nearly as successful outside of the U.S. as it’s been here. Is there anything you’re going to be looking for on this front in 2024?

Sotiroff: Yeah, to put some context around that, they’re still managing hundreds of billions. It’s a massive business. And a lot of asset managers would love to have that asset base. But you’re right, compared to their U.S. business, it’s tiny in comparison. The things we’re really watching for are more from a business perspective. They’ve gotten into a few initiatives over the last couple of years, and they’ve backed out. This year, they left a German platform that they had created called Vanguard Invest. That was really aimed at the DIY retail investor, led with index funds. So, it was largely an index fund type platform, I believe. They launched that in February 2022 and then got out this year. So, it was a very short-lived project. Similarly, they entered China a few years ago, and then they exited China, I think late last year, and then they finally got out fully this year. They had a joint venture with the Ant Group that they ended. So, it raises some questions about how committed are they to some of these markets, I think, on one end. At the same time, it’s like maybe they saw something that wasn’t working very well there and decided, hey, we’re just going to get out and not throw bad money after good type of thing.

I’m not privy to all the details that Tim Buckley and company are talking about in the boardroom, but that’s something we’re definitely going to be watching on is how do those international projects go and what do they stick with and what do they leave by the wayside. That’s probably the biggest thing we’re watching is just how do they go about looking at new markets and new strategies.

Advice in 2024

Dziubinski: Lastly, Vanguard has made a significant push into advice here in the United States. Tell us about what the firm has done already and where you think things might be headed in 2024.

Sotiroff: The way I would frame it is they’ve got great funds. No surprise, they’ve had great funds for a really long time. And they got a great platform. They have this tiered investment platform, Digital Advisor, a $3,000 minimum, 0.15% annual fee, $50,000 minimum goes up to Personal Advisor. So, then you get a little bit more hands-on financial planning advice. The fee goes up to 0.3% per year for that. Then you go to Personal Advisor Select, which is the next tier up, and that’s if you have like a $0.5 million portfolio. Then you’re getting access to more holistic financial planning, hands-on type, actual human in the loop type stuff to help you out. So, they got a great platform and everything. The underlying investments are great. I’ll reference Amy Arnott’s research and a Robo-Advisor report that came out earlier this year. The Digital Advisor platform came out as one of the best-in-class robo-advisors out there. So, that’s all great.

When we talked to Vanguard, they even admitted that really, it’s been the client experience side of things. It’s adding that personal touch to things and developing trust with clients and that sort of thing. That’s a real challenge, I think, especially when you’re trying to do financial planning on a large scale like this. At the same time, that’s a massive opportunity. If they can figure that out, and they’ve got this great fund base, the sky is the limit for them. It could really be the next big thing for them, I think, if they can figure it out. They’re going through some growing pains. There’s been some complaints out there from some clients and stuff like that that it isn’t working as well. But they’re clearly attentive to that. They clearly realize it’s going on. They’re making some changes on the fly to adapt to it as they go. So, it’s going to be very interesting to see where that goes. I’m excited to see what they come up with because they’ve got a pretty compelling offering so far if they can figure out those little things around the edges to make it that much better.

Dziubinski: Dan, thank you so much for your time. As you know, we’re all very interested in Vanguard and big fans of the firm. It’s really great to hear from your perspective, working on their funds and looking at them every day like you do to see what you think is on the horizon.

Sotiroff: You’re very welcome.

Dziubinski: It’s good to see you. I’ll see you this time next year.

Sotiroff: Yes, we’ll be back.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “3 Great ETFs Having a Lousy 2023″ for more from Daniel Sotiroff.