What’s Ahead for Vanguard in 2023

Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. When investors think of Vanguard, they probably think of two things: low costs and indexing. But there’s a lot going on at the firm today that individual investors should know about. Here with me to discuss Vanguard’s core capabilities and new developments at the firm is Alec Lucas. Alec is director of manager research and, among many other roles, Morningstar’s lead analyst on Vanguard.

Thanks for being here today, Alec.

Alec Lucas: Thanks for having me.

Vanguard, BlackRock, and iShares

Dziubinski: Good to see you. At this year’s Morningstar Investment Conference, you and your colleague Bryan Armour are going to be sitting down and having a conversation about Vanguard and BlackRock and iShares, which are of course two of the largest asset managers and two of the most popular asset managers when it comes to mutual funds and ETFs. How did this conversation come about?

Lucas: The conversation came about because the two firms really dominate the industry in terms of new money flows because they’re leaders in what’s become increasingly the vehicle of choice, which is exchange-traded funds. And we thought it would be really interesting to talk about the two firms, not only because they’re alike in the ways I just mentioned, but also because they’re quite dissimilar. So, BlackRock, for example, is publicly traded. Vanguard is famous for being mutually owned. It’s owned by its U.S. funds and indirectly U.S. investors. BlackRock is still led by its founder. Vanguard is on its fourth generation of leadership. Vanguard takes what you might call a paternalistic approach to investing, whereas BlackRock is more likely to allow investors to slice and dice the market into kind of narrow segments. So, there’s ways in which comparing the two firms will be mutually illuminating for both.

Is Vanguard Still a Low-Cost Provider?

Dziubinski: Interesting. Now, as I mentioned at the top of the segment, Vanguard is perhaps best known for those two things of low costs and indexing. So, let’s talk a little bit about those two things. Now, as competition for investor dollars has of course heated up, especially in the last decade, we’ve seen fund fees fall across the industry as investors are seeking out those lower-cost choices. So, how does Vanguard look on the expense front comparatively speaking these days? Does it still really deserve that reputation as the low-cost provider?

Lucas: So, if you look across the board across the lineup, answer is definitely. If you look at individual options, the answer is, it’s pretty competitive. But what Vanguard has essentially done in finance lingo is it’s democratized beta. Vanguard has given investors very cheap access to broad diversified funds. And its biggest competitors—so, think BlackRock’s iShares business, think Fidelity, think Schwab—they’ve either matched or, in some cases, undercut Vanguard on fees. Fidelity has a free index fund. If you look at individual options, you might beat Vanguard. But across the board, Vanguard is, I think, still the low-cost provider. Its U.S. average fund-weighted expense ratio is 8 basis points. By contrast, the industry average is 47 basis points. One of the things Vanguard likes to do is it compares how much has it saved investors based on its monthly, say, average assets over 2022 relative to the industry average. And if you do that calculation, it saved investors collectively about $26 billion in 2022. So, across the board, and if you add in advice, it is still incredibly competitive.

Vanguard’s Top Funds

Dziubinski: Let’s talk a little bit about now the lineup of index funds and ETFs. Now, it seems like, as you alluded to, a very comprehensive lineup, and a significant number of those index funds and ETFs earn Morningstar’s highest rating of Gold. So, why do their index products rate so well when it comes to how Morningstar is evaluating these products?

Lucas: They’re inexpensive, they’re tax-efficient, they track their indexes closely. Vanguard stays on top of the indexes that its passive funds track and will change them when it thinks a better one is available. The other thing they do that’s really distinctive is they make money through securities lending, and then they funnel that money back to their investors. So, Vanguard’s Total Stock Market Index Fund VTI made about 2 basis points on average back of its expense ratio in its last fiscal year. So, it costs 3 basis points. It made a little more than 2 basis points back. So, the all-in cost for investors was just under a basis point.

Dziubinski: Wow. OK. Now, we’ve talked about this before in prior conversations, Alec, but it bears repeating. Although Vanguard is perhaps best known for its index funds, it actually has a pretty strong stable of actively managed funds. For those viewers who may be less familiar with how Vanguard structures those, talk a little bit about the structure and perhaps name-drop a couple of the actively managed funds that Morningstar rates particularly highly.

Lucas: So, Vanguard built its business off of Vanguard Wellington VWENX, which is an actively managed balanced fund. The Vanguard 500 VFIAX that tracks the S&P 500 was sort of slow to grow. So, its business was really built on Vanguard Wellington, Vanguard Wellesley VWIAX, Vanguard Windsor VWNEX, those types of funds. Currently we rate 60 actively managed Vanguard funds. Fifty-seven of them are Morningstar Medalists of either Gold, Silver, or Bronze, and one is Under Review. So, there’s only two that are Neutral.

High Parent Pillar Rating

Dziubinski: OK. Wow. Morningstar assigns also asset managers what we call our Parent ratings, and Parent ratings really represent how well a fund group aligns its interests with those of its fundholders. Now, Vanguard is one of the few fund families that we assign Parent ratings to that earns our highest rating of High. So, let’s talk a little bit about why the firm rates so well according to our rating system for parents and what it does better, perhaps, than other families who don’t rate quite as highly.

Lucas: I’d point to its purpose and its structure. Its purpose is to take a stand for all investors, treat them fairly, and give them the best chance for investment success. And that’s more than marketing speak to Vanguard. When you talk to the people there and talk to them over multiple years as I have, it’s clear that that is their purpose. It’s what motivates them to work there. And its structure, of course, as I mentioned previously, is it’s owned by its U.S. mutual funds. So, indirectly, it’s owned by its U.S. investors, and then it extends that ownership culture to its non-U.S. investors. And if you think about sort of the standard industry player in the asset-management industry, it’s trying to make money for its investors, sure, but it’s also really trying to make money off of them. Vanguard is trying and exclusively focusing much more on making money for them.

Opportunities for Growth

Dziubinski: Alec, let’s move on and talk a little bit about some growth areas for Vanguard. You alluded to earlier a little bit about Vanguard’s advice business. Talk a little bit about it, what it’s doing in the advice space, and what this might mean for individual investors.

Lucas: What’s really interesting about Vanguard is, it’s got its start as a no-load shop. So, back in the day when Vanguard started in the mid-70s, the way that you got advice was you paid a load, and that’s how advice was given, and it famously started by sort of bypassing the advice structure at the time. Actually, that was early on. It did initially actually have a load to correct myself. But it’s reentered the advice business. It started that in the 1990s, but that’s really amped up in recent years with the launch of Vanguard Personal Advisor Services as well as Vanguard Digital Advisor. So, if you have as little as $3,000, you can for an all-in cost, including advice and fund fees, 20 basis points, so $20 for every $10,000 invested, you can have a diversified global portfolio tailored to your own goals. So, it’s a really compelling offer.

And as your financial life gets more complicated, at $50,000, you can get access to a human advisor; at $500,000, you can get a dedicated certified financial planner. And for those high-net-worth individuals who are more than $5 million, they can get personal trust services, access to private equity. So, in entering Vanguard’s ecosystem advice, you not only get access to their funds—and they’ve in recent years launched very compelling actively managed funds that are part of that advice package; they’re kind of high alpha or high-conviction strategies that are part of this advice package that are actually only available in certain cases to advice customers, so that those advisors can help investors sort of stay the course when they might be otherwise prone to bail. It is really a compelling offer that they have and has really extended, I think, their leadership in the United States.

International Growth and U.S. Investors

Dziubinski: Now, let’s talk a little bit what you alluded to: It does have leadership here in the U.S., but it sort of has modest non-U.S. assets. So, what is the firm doing to amp up its growth internationally and what, if anything, does that mean for an investor here in the U.S.?

Lucas: So, Vanguard had about $550 billion in non-U.S. assets at year-end 2020 and at the end of last year, it was about $530 billion in assets. Part of that drop was the market. Another part of it was Vanguard has sort of refocused its international operations in recent years, and what it did is, previously it had certain relationships with institutional payers where it would be giving them a fairly low-cost access to investment options, and those investment options were then being passed on to the end investor with a surcharge added, essentially. So, Vanguard pulled away from those relationships. This happened in Asia, for example. So, it actually withdrew some of the AUM that it had. It purposely shrunk its business to focus on financial advisors and to focus on individual investors. Historically, in growing its overseas assets, it’s sought to lead with index products, exchange-traded funds, and now more recently, advice.

There’s been some fits and starts. It launched an advice offer in the United Kingdom a couple years ago, I actually think it was April 2022. And it just recently in this first quarter decided to close that business, which was a bit of a surprise. When I asked them about that, they said, they launched an offer that was really geared toward retirees and got quite a bit of interest but from more younger investors, and they thought that they could improve the business. And I think Vanguard’s goal is to play the long game. When I talked to them about their non-U.S. business, they cited a study of Italian investors that are paying, I think the figure was 206 basis points all-in for advice plus fund fees. Contrast that with what U.S. investors can pay as little as 20 basis points. So, your average Italian investor is paying 10 times more than what’s available to a U.S. investor. So, Vanguard thinks that it has the long-term advantage in terms of its competitive low-cost positioning in terms of growing its non-U.S. business. But it has had some setbacks. It’s made some major changes, for example, in what it’s done in China. So, it remains to be seen. I think if we look back 10 years from now, this next decade, the next 20 years is going to be about the growth of Vanguard’s non-U.S. business.

Active Fixed-Income Strategies

Dziubinski: We talked a little bit earlier in our conversation about some of Vanguard’s successful active funds. And as far as future growth goes, the firm is branching out into active fixed-income strategies. Tell us about that.

Lucas: Yes. So, they launched an emerging-markets bond fund in 2016. It became available for investors in late 2017. They’ve launched a core-plus multisector bond fund. There’s a high-yield fund. On Aug. 29, about a third of its assets went to an internal team managed by Vanguard. So, if we step back, what’s happened here is that Vanguard’s CIO Greg Davis used to head up their fixed-income group, and he saw an opportunity a few years back to bolster Vanguard’s in-house fixed-income capabilities. They’ve made some key external hires. One I’d would point to is Sara Devereux. She joined Vanguard in October 2019 from Goldman Sachs. She’d worked there for about 20 years. She was originally head of rates at Vanguard and then took over the fixed-income group on July 1, 2021, when John Hollyer retired. And so, she has really, I think, helped key efforts for Vanguard to compete with best-in-class fixed-income products, and we’ve seen a number of funds launched, the ones I mentioned.

Dziubinski: Interesting. The last growth area for Vanguard—at least the last one we’re going to talk about—relates to the firm’s efforts around environmental, social, and governance investing, or ESG. BlackRock has leaned pretty heavily into ESG as a key pillar for its business. What’s Vanguard doing here?

Lucas: Vanguard is committed to its indexing business. And so, in that respect, it is trying to vote its proxies responsibly for its indexing business, and it has a whole team, a stewardship team, devoted to doing that. At the same time, it’s ramped up its efforts to increase ESG offers. So, it has a head of global ESG product that was named a few years back. I think that happened in 2020. And then, it’s launched some funds. It’s adopted, in one case, a Baillie Gifford positive impact fund. It partnered with a new subadvisor that was originally founded in 1991, hence the name of the firm is Ninety One. It was founded in Cape Town, South Africa. And so, it launched a global high-conviction fund that’s only investing in companies that are committed to reducing carbon and/or facilitating positive environmental change. It invests in about 25 companies. What Vanguard is trying to do is give investors choice. If you think back to its purpose, is to take a stand for all investors. So, it’s trying to take a stand for investors who just want to index their assets and not think about other things. It’s also trying to take a stand for investors who care deeply about the environment and want their values expressed in the way they invest, and it’s trying to give them options to do that, and it’s launched a number of funds to help them do that in recent years.

Vanguard’s Customer Service

Dziubinski: And then last question, Alec. I attended the Bogleheads Conference here in Chicago last fall, and attendees were expressing their frustration with Vanguard’s customer service. Can you tell us a little bit of about what’s been going on there and what Vanguard has been doing to improve on this front?

Lucas: Customer service complaints have always been sort of a feature of Vanguard’s history. If you go back to the days when Bogle led the firm—this is a point that I made at that conference—there were lots of complaints over the years about Vanguard’s customer service. I like to compare Vanguard to, say, those of you who shop at Aldi. If you go to Aldi, you have your quarter, you get your grocery cart, you bring your own bags or you put it in boxes. I would say Vanguard has got more customer service ethos than that, but it is something where it’s not necessarily been known for high-touch customer service. And it is trying to become a leader in customer service and to really improve its technological offer.

So, what Vanguard is trying to do is, because it has experienced over the course of its history and continues even in this first quarter, experienced such asset growth, it’s trying to enable investors to do as much as they can as simply as they can online, so without talking to a human advisor. And they’ve really made investments in technology. They’ve modernized their technology platform, and they’ve seen increased resiliency and increased customer service scores.

The big snafu they made in 2020 was—this is Vanguard, they’re always thinking about investor assets and costs and trying to save money on behalf of investors—so, in 2020, when the market turned down, they stepped back and they looked and they saw that historically when the market falls, client communications sort of fall off a cliff. So, they actually slowed their hiring of customer service representatives right at a time when—in fact, what happened with the lowering of interest rates is that investor demand shot up and that caused, I think, significant wait times and lots of frustration. They have normalized that, and I think are committed to sort of being a little bit more, call it, I don’t know if cautious is the right word, but they’re going to be more prone to overspend and I think on what they expect they will need to try and improve customer service. In talking with Vanguard leadership, they feel like they’ve heard that and they’re trying to become known for best-in-class customer service. That is a goal of theirs, and they say they’ve made progress in that. It remains to be seen. We hear a lot of comments from that here at Morningstar. But the big thing always to keep in mind is that Vanguard serves a lot of customers. So, you’d expect that some of them would be frustrated. And I’ve heard both success stories and stories of frustration, and we’ll see if the stories of frustration are minimized over the coming years.

Dziubinski: Well, Alec, thank you so much for your time today. I really enjoy talking to you usually about once a year about Vanguard because there’s so much going on there, and Vanguard is so popular with our viewers. We appreciate your time.

Lucas: Always delighted to do it.

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