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Weekend reading: Is Vanguard going to kill off the managed fund industry?

Weekend reading

Good reads from around the Web.

The behemoth of low-cost investing is having a great year, reports Bloomberg’s Businessweek:

Vanguard is not just having its best year ever. (It shattered that record in September.) The $130.4 billion in deposits in mutual funds and exchange-traded funds that Vanguard has taken in through November is the most ever for the industry, according to data from Strategic Insight.

That beats the $129.6 billion that JPMorgan clocked, mostly for money market funds, in 2008. This year’s not over.

The article is peppered with interesting quotes about the advance of Vanguard’s business, and the rise of passive funds and ETFs in general.

But consider this section:

It’s asymmetric warfare, as Vanguard’s sole ownership and constituency is its fundholders, the savings it wrings from its buying power are passed on to them, not to shareholders or partners.

As Vanguard grows from niche player to one of the biggest beasts in the investing jungle, I think this practice of redeploying money towards its customers might enable an unbeatable feedback loop.

The Robin Hood of the fund world

Consider how much Wall Street and The City has syphoned off returns over the past few decades. Now imagine more of that vast amount of money going to lowering Vanguard’s already tiny fees on its passive products, and you see the power of the model here.

Customers owning the company would be a template for a new kind of capitalism if it worked everywhere, but it doesn’t. Usually self-interest allied to the profit principle works better. The pursuit of self-interest produces innovations and superior results at the expense of lazier competitors. That in turn generates superior profits, driving out weak competitors while making the winning companies even stronger.

But I think financial services might be different – and Vanguard able to exploit that difference – because historically it’s been the case that superior marketing – if you include the very idea that active funds beat the market – is what has generated superior profits, as opposed to superior performance being duly rewarded.

After all, in aggregate, active management can’t outperform passive funds, after fees. That is the whole point of index investing.

Passive index funds are cheaper, so will deliver better profits for most investors over time. Yet while index funds are on the rise, they don’t yet attract the lion’s share of money their performance should theoretically deserve.

The worm that turned

Because of superior marketing – which we might define to include everything from a more compelling story to established and trusted brand names – active fund management still attracts investment ahead of passive funds.

Indeed, hugely expensive hedge funds can potentially net their promoters the best profits of all – despite these funds in aggregate failing to beat a 60/40 balanced tracker portfolio!

Yet this is a zero-sum, largely zero-skill game, after costs1, which is what makes cheap passive investing so attractive.

In the past, the excess profits generated by the myth of active fund management has gone to enriching the employees and shareholders of City companies.

But because it reinvests the profits that most of the rest of the industry hives off, Vanguard is different. In its case it’s the fundholders that are going to be enriched. The more record-breaking fund flows it attracts, the more its customers will benefit through better (i.e. cheaper) performance.

Will there be a tipping point where ‘everyone knows’ that passive investing is the mainstream choice for greater returns over the long-term?

Or will active fund managers always be able to sell short-term outperformance as a more exciting long-term prospect?

Place your bets, and pick your funds!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The physical gold provider Bullion Vault has beefed up its silver offerings in recent weeks, so you can now buy and hold both gold and silver in its New York, London, and Zurich vaults.

Mainstream media money

Note: Some links are to Google search results – these enable you to click through to read the piece without you being a paid subscriber of the site

Passive investing

Active investing

Other stuff worth reading

  • How to build ‘money for life’ – CBS
  • Time: Your best bet to beat a ‘rigged market’ – Wall Street Journal
  • Amazon’s zero-profit business strategy – Slate
  • Why do TV scriptwriters hate entrepreneurs? – Slate
  • Could the next BoE governor be moving the goalposts? – FT
  • Is it cheaper to be a man or a woman? – The Guardian
  • Key statistics from the 2011 census – ONS
  • What it’s like to live on $1 a day – Business Insider

Book of the week: Four Pillars author William Bernstein has a new £2 Kindle book out: Skating Where the Puck Was. Aimed at professional investors, it argues that yesterday’s alternative assets (gold, hedge funds) are tomorrow’s correlated ones, as dumb money piles in and loads up.

Like these links? Subscribe to get them every week!

  1. It is not that active fund managers are not hard working and clever that is the problem. It is that they are ALL hard working and clever, as well as competing against each other. In aggregate across the fund universe there is no out-performance in returns – there is only seepage to fees and expenses. []
{ 27 comments… add one }
  • 1 Passive Investor December 15, 2012, 2:28 pm

    Thought your post on Vanguard was interesting and it made me think of a question I have never seen the answer too.

    The passive investing industry can’t exist with out active investors. The day all investors decide to become passive will be the day that market capitalisations and share prices become set in aspic. Now clearly this would never happen for long as the active investment opportunities such a situation would offer would be too attractive to ignore (even for an evangelical passive investor such as me).

    Nevertheless I am interested to know your thoughts on two related points.

    First is there a critical level at which the passive investment interest actually hinders market efficiency? For example if 50% of the market was passive money would that be a problem and if not what about 90% or 99%?

    Secondly but relatedly what proportion of the market is made up of private investors (in pension funds / mutual funds / investment trusts / individual shares) etc? If all this money ‘went passive’ what proportion of the market would it constitute.

    Interested to know what you think.

  • 2 Rob December 15, 2012, 6:32 pm

    The assumption you make is that all passive investing uses mkt cap as the measure for constructing portfolios. At the moment you are correct and that is why mkt cap passive funds can only exist in symbiosis with active funds and hedge funds. Indeed, passive funds encourage this by lending stock to hedge funds that then correct the mis-valuation by shorting the stock.

    The way round this is alternative beat strategies, sometimes hubristically known as smart-beta, that use different measures to construct a portfolio. This removes the positive feed-back loop you get with mkt cap based strategies.

    Of course if 99% of the mkt uses price to determine portfolio weight the 1% who don’t might have to wait a long time before being vindicated.

    However, they do not need to work in a partnership of the devil with hedge funds.

  • 3 Alex December 15, 2012, 6:37 pm

    Vanguard should hurry up and list more equity ETFs on the London Stock Exchange: there’s still only four. I’ve been waiting patiently…

  • 4 Alex December 15, 2012, 6:50 pm


    Sorry for repeat posting: unintentional. Your website seemed to freeze both times when I submitted the comment. I wasn’t sure what was happening (or not). Please delete one – and this, too. Thanks.

  • 5 Retirement Investing Today December 15, 2012, 7:17 pm

    In answer to the question in the title. I hope so as that will be the day that the masses have finally realised the damaged fund expenses wreak on a portfolio.

  • 6 The Investor December 15, 2012, 8:13 pm

    @Alex — Yes, this is something that I have been seeing, and that I was asking about on the Monevator Facebook page today.

    The site has been freezing on and off for me for weeks now.

    Is anyone else seeing these freezes recently? Please do say if so. 🙂

  • 7 john December 15, 2012, 8:15 pm

    Using the trustnet charting tool Scottish Mortgage and Temple Bar Investment Trusts seem to beat Vanguard’s FTSE UK All Share and 80/20 Life Strategy OEIC’S and their All World ETF for performance. With ongoing charges reasonable for the i.t’s mentioned, could it be that those two active funds represent a viable alternative to passive investing?

  • 8 Greg December 16, 2012, 1:31 am

    One obvious advantage of cap-weighted trackers is that they don’t need to rebalance except when the components of the index change. However, to me it isn’t obvious that cap-weighting is ideal – good for an index, but that’s not the same as good for making money!

    @John – Just because they have done in the past, doesn’t mean they will keep doing so! (Note that is isn’t fair to compare SMT with the FTSE) There are that have not done so well. Having said that, I like ITs and have a mix of passives and an assortment of various ITs. Note that SMT and TMPL are both extremely cheap ITs!

  • 9 Michael December 16, 2012, 7:19 pm

    I seriously doubt that Vanguard (or anyone else) will bring an end to active management. The siren song of outperformance is just too much for many people to resist, no matter how impossible it is to achieve on a consistent basis.

  • 10 Snowman December 16, 2012, 10:59 pm

    One of the interesting effects of Vanguard’s appearance in the UK is the way it has seemed to have brought down tracker charges of some other managers competing to be amongst the cheapest trackers.

    When HSBC reduced the amc on its tracker range in 2009 that was widely put down to the Vanguard effect.

    It now appears that Fidelity are introducing a Fidelity Moneybuilder World Index tracker with an OCF of 0.3% tracking the MSCI world index (to add to their recently introduced American tracker) . I wonder if this is to compete with the Vanguard FTSE Developed World ex UK tracker fund which has a TER of 0.3% also.

  • 11 john December 17, 2012, 9:01 am

    I guess one has also got to factor in the platform fee and any other costs involved with holding i.t’s and etf’s especially on lowish investment contributions when compared with any trackers that might not attract any extra drag on returns.

  • 12 john December 21, 2012, 9:16 am

    FTSE V MSCI. Any preference? Also, would you say the real alternative to a Vanguard Life Strategy with some bond exposure is something like Personal Assets?

  • 13 The Investor December 21, 2012, 12:15 pm

    @john — Well, Personal Assets Trust is a very different kettle of fish to a normal equity investment trust, let alone a tracker fund. With Personal Assets, like with all active funds, you’re betting on someone being smarter than the market when you buy into it. They are also very focused on downside protection (they hold a lot of gold, for instance) so you benefit from that without having to hold your own gold et cetera. On the other hand you’re paying a higher annual charge, and potentially your returns will deviate from a simple equity / index portfolio, perhaps meaningfully.

    I think for some investors Personal Assets might be a good choice. As an ultra-active, unconventional ‘conviction’ active fund it’s the diametric opposite to Vanguard Lifestrategy though. It’s the alternative in a similar way to Batman being the alternative to The Joker, as opposed to marmalade being another take on jam, if you see what I mean. 🙂

  • 14 john December 21, 2012, 2:00 pm

    “It’s the alternative in a similar way to Batman being the alternative to The Joker…”. Brilliant.

  • 15 john December 26, 2012, 9:02 pm

    Don’t you think the Vanguard LifeStrategy funds are a bit lowly weighted emerging markets wise and conversely a bit heavily vested in the u.s index?
    Any ideas on a counter balance to an 80/20? I’m a bit stretched so numbers of funds would have to be kept low hence the LifeStrategy route thinking.

  • 16 Passive Investor December 27, 2012, 12:32 pm

    Hi John


    The above link doesn’t address your question directly but does have a lot of useful information. (The Vanguard advisers site has quite a bit of relevant Life strategy asset allocation information which doesn’t appear on the Vanguard individual investor site)

    I am very interested in your question as I invest in the 80 / 20 fund now and asked myself the same question a while back.

    I eventually decided to take a bit of a mid cap home tilt by investing in a FTSE 250 tracker too. By keeping some iShares Emerging Mkts ETF which I already had I also took a bit of a tilt towards emerging markets. Trouble is to maintain an 80 / 20 allocation then I had to keep some separate bond funds I already had…..

    Having done all the above I realised I had lost some of the benefit of the automatic rebalancing of the 80 / 20 Life-strategy allocation fund. (The part of my portfolio that isn’t Lifestrategy will gradual drift away from 80 / 20 and will need rebalancing, though probably only every 5 years or so).

    For what it is worth my aim is to have about 80% of my portfolio in the 80 / 20 fund with the other 20% roughly made up as (5% Emerging Markets, 11% FTSE 250 and 4% inflation linked bonds).

    According to my otherwise strict passive investor philosophy these tilts are a bit illogical perhaps, but my rationale is as follows:

    1) FTSE 250 because the FTSE 100 is too concentrated in the top 10 big stocks which also happen to be very international. I also believe that there may may be a mid /small cap premium. Finally I wanted a bigger home tilt because I remain a bit concerned about exchange rate risk

    2) Emerging markets because I believe that demographics, relatively low debt and economic benefits of a growing consumer middle class favour economic growth in these economies. (I accept that by tilting to emerging markets I am claiming to be able to predict future investment returns better than the world capital markets. This is a claim I can’t rationally justify of course.)

    3) Extra Inflation linked bonds because I want some protection from the tail risk of much higher than the market-expected inflation. Because current prices are unfavourable there is a likelihood that inflation-linked bonds will return less than actual future inflation. I view the ‘risk’ of poor returns (if there turns out to be market or lower than market expected inflation) as an insurance premium worth paying to maximise wealth preservation if inflation gets out of control. If I was 30 rather than 50 I probably wouldn’t take the same view!

    Interested to know what you think.

    PS All these tilts can be executed with tracker funds (rather than ETFs) and therefore low dealing charges.

  • 17 Passive Investor December 27, 2012, 12:41 pm

    PS to avoid confusion I am just a self taught private investor. I use the pseudonym Passive Investor for commenting on investing blogs (Although I have several decades of investment experience and learnt about passive investing the hard way, I don’t claim the same authority as Monevator’s The Investor & The Accumulator! ). Adrian

  • 18 john December 28, 2012, 5:01 pm

    Maybe a whole host of tilts aren’t necessary. I was just thinking that the E.M portion of the Vanguard LifeStrategy was low. Maybe I’m thinking about it too much. I guess the only tilt I might go with is the F&C Global Small Comps that I took out in my daughter’s name with her ctf voucher.

  • 19 Passive Investor December 28, 2012, 9:12 pm

    I think you are right that the tilts aren’t really necessary and there is a lt to be said for just going with the Vanguard LS fund that suits your risk appetite and age.

    My only other comments are first that in the current unusual investment landscape there is a lot to be said for going for the 100% equities LS fund and using cash as the fixed income part of your portfolio.

    Secondly personally I would steer very clear of the F & C global smaller companies fund

    1 it is partly a fund of funds so costs are high – it seems 1% TER PLUS expenses of 2% in some of the subsidiary funds. Add in turnover costs and I guess annual expenses could be north of 3%. OUCH!

    2 I wonder how small small cap is – I see some of the companies are more medium cap really

    3 As a closed end investment trust (I think this I right) you are exposing yourself to discount / premium risks which will increase volatility.


  • 20 The Investor December 28, 2012, 11:47 pm

    @Passive Investor and all — The Accumulator is the best man with the mindset for this, but for what it’s worth I don’t see a problem from a pure investing standpoint with tweaking LifeStrategy to suit with other funds.

    It’s important to realise that there is no perfect asset allocation that you (or I) could be expected to hit upon right now. Even if eventually your EM allocation turns out to add value, or if it turns out that you would have been better sticking purely to Vanguard’s take on global equity — that’s hindsight, and is currently unknowable as a *fact*.

    For this reason, I say do what you want to do based on your best guesses and hunches. For passive investors, the best guess is that you don’t know better than the market, so you should probably go with pure trackers. But from a psychological perspective, you may find it easier to commit to investing if you also back your hunches a little, and I don’t see adding a small cap / EM tilt as violating this (if done cheaply, passively, etc).

    The main reason *not* to do these though is the more you add, the more you get away from the very real simplicity benefits of passive investing. You also open the door to future tweaks and deviations, and before you know it you’re meddling and racking up costs, and potentially doing worse (and/or increasing risk).

    I think home bias is a really interesting subject — but I don’t blame you for over-weighting Sterling markets, given that’s where you’ll eventually need to spend your currency! I think this can get slightly lost in the ‘replicate global allocations’ debate… if Sterling soars and your portfolio halves in relative terms, it may be cold comfort that you’ve correctly tracked global markets… Again, another difficult one in practice, but I am comfortable being very overweight UK versus the global benchmarks. But again, I’m not a pure passive investor by any stretch.

    Merry Christmas all! 🙂

  • 21 john December 29, 2012, 9:17 am

    Hi Passive and not so passive,

    The old overnight test is always a good one. I guess the tilts are a personal preference but the more dabbling is done the more potential for going askew I suppose.

    Aside, as an alternative to a 100% Vanguard Life Strategy perhaps a global index tracker, not sure which, and a uk index linked gilts tracker or cash account for now is an answer.

    One other thing, I took out a F&C Global Small Comps with my daughter’s ctf voucher but haven’t added any more to it.
    I thought the charges were curtailed to 1% max? Is there a better alternative investment vehicle for a child trust fund? No JISA option now that we are in a ctf.

  • 22 Passive Investor December 29, 2012, 9:37 am

    Hi Accumulator & John

    Accumulator expressed exactly what I thought about home bias (ie more in favour of it than current fashion would have).

    With regard to the CTF charges I am no expert. I am guessing that the 1% cap applies only to the administrator final wrapper charge. I can’t see how it could apply to portfolio turnover and other internal costs. Would be worth checking with an expert though.

    I don’t know of any ‘properly’ (ie not misnamed mid cap) small cap world tracker fund but would be interested if there was one.

    FYI There is a short duration ishares gilt exchange traded fund (2.5 yrs from memory). The yield is terrible at present obviously but there would be relatively good capital protection if interest rates rise quickly. (I don’t use it but have thought about doing so).

    All best Adrian

  • 23 The Investor December 29, 2012, 1:29 pm

    (Hi Adrian — Just to note that this is “The Investor” here — the other Monevator writer! The Accumulator is up to his eyeballs in Christmas pudding I think. 🙂 )

  • 24 john December 29, 2012, 7:43 pm

    Re: F&C Global Smaller Companies as a 5% tilt to a potential 100% Vanguard LifeStrategy (is there a comparable global index tracker?) and 10% cash.

    Is there a better alternative investment vehicle for a child trust fund? Perhaps Foreign & Colonials investment trust is more cost effective for smallish contributions? Maybe I should just transfer to a cash account?
    I have no JISA option now that we are in a child trust fund.

  • 25 john December 29, 2012, 8:26 pm

    Incidentally my partners ‘frozen’ company pension, worth about 8k, is presently vested as such;
    40% L&G UK Equity Index
    45% L&G World (Ex-UK) Equity Index
    5% L&G World Emerging Markets Equity Index
    10% L&G Corporate Bond
    She is 46 and was wondering if there is any reason to move to their moderate growth option available which is;
    30% L&G UK Equity Index
    46.25% L&G World (Ex-UK) Equity Index
    3.75% L&G World Emerging Markets Equity Index
    6.667% L&G AAA_AA_A Corporate Bond Index
    6.667% L&G Over 15 Years Gilts Index
    6.667% L&G Over 5 Year Index Linked Gilts Index

  • 26 Passive Investor December 30, 2012, 12:00 am

    Hi John – don’t think it’s really possible (or perhaps legal for a non-financial adviser) to give you a detailed answer regarding your partners pension. To state the obvious the decision regarding her asset allocation is very personal and will depend on her time horizon (is she planning to leave the pension for 20 years) any other assets including pensions she may have and her appetite for risk.

    A few general observations though. First costs are likely to be OK with L&G trackers. Secondly rather than worrying about where the equity part of her portfolio is invested she really needs to consider the equity / bond ratio which appears to be 90% but still near 80% in the more cautious option. The third consideration is that even if she wants to be more cautious (have more bonds) over the medium term then because of ultra low bond yields now might be a very bad time indeed to make the move to bonds. I guess one common sense option might be to plan to move to more bonds some time in the next 10 years assuming retirement is 20 years away.

    I learnt a lot from a very good section on bond / equity allocation in Bond Investing for Dummies. Rick Ferris Asset Allocation is also good on this.

    Good luck Adrian

  • 27 john December 31, 2012, 9:33 pm


    No scope for greater flexibility within investment options for m&s pension.

    Will view holistically and see what’s what.

    Maybe a gilts retreat is on hold for now.

    Hope everyone has a prosperous new year!

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