Vanguard manoeuvres to open up Europe
The Jonathan Davis column
Saturday 04 April 1998
It is in the process of getting final regulatory approvals to market a series of offshore funds, based in Dublin. Initially, its aim is to try to win a chunk of the growing institutional pension fund market in the UK, Netherlands and Belgium.
Well, you may say, so what? The firm has no immediate plans to launch a unit trust or Oeic in the UK, although it will be surprising if they do not do so before long. And it expects to take several years to establish a meaningful presence in the pension fund market, which is notoriously conservative.
Nevertheless, the news is interesting on several counts. For a start, Vanguard is one of the genuine heavy hitters in the global fund management scene, ranking second only to Fidelity as the world's largest mutual fund company.
Just as interesting is the way it operates. No other fund management company has quite the same ethos. As Vanguard has no shareholders, but is owned by the funds it manages, investors get the firm's service at cost. As a matter of policy, it pays no sales commission to intermediaries, and prides itself on having the lowest expense ratio of any fund management company. The company describes itself as the only mutually owned fund management business in the US.
The other thing that marks Vanguard out is that it was one of the pioneers of passively managed funds - that is, funds which aim to track the market indices. Tracker funds are the lowest cost funds you can buy and are particularly well-suited to pension fund planning. The firm has been a leading promoter and beneficiary of the growing awareness that most actively managed funds are simply not worth the handsome performance fees they charge.
If you accept that point, it follows that most managed equity funds should be regarded as a commodity rather than a specialist product. The lesson of Vanguard's success is that low cost does not have to be incompatible with quality.
The facts certainly seem to bear out Vanguard's boast that its mutual funds are the cheapest in the industry. Its average expense ratio last year (ie how much of its investors' funds were absorbed by management costs) was 0.28 per cent, less than a quarter of the industry average. If you look at total costs, including the impact of sales commission, it claims an even greater cost advantage - 0.5 per cent per annum against an industry average of 1.5 to 2.0 per cent a year. Note that these are US averages: the comparable UK figures are at least as high, if not higher, once you factor in the bid/offer spread.
As I have noted before, in a low inflation world modest percentages can make a huge impact on long-term returns, thanks to the power of compound interest. For example, suppose you pay pounds 6,000 a year (the current PEP limit) into an equity-based pension fund for 25 years. Suppose also you expect the fund to grow on average at 9 per cent per annum over that period, in line with the long-run real return on equities. How much difference does it make if you pay the equivalent of 2 per cent a year in fees rather than 0.5 per cent over that time?
Answer: a hell of a lot. The value of the fund, according to my maths, on the first basis will be: pounds 94,279 after 10 years, pounds 249,385 after 20 years and pounds 366,906 after 25 years. Factor in the lower fees and the sums come out as pounds 104,281, pounds 305,171 and pounds 474,719. In broad terms, the value of your fund will be 29 per cent - or pounds 107,000 - greater after 25 years. Put another way, your fund manager has to consistently outperform the market by around 1.65 per cent per annum to earn back the cost of his higher fees.
While I have no idea whether Vanguard will succeed in Europe, I do know that if they think the European market is full of overpriced, poor value funds, as they clearly do, then everyone else in the industry is going to have to take notice. Call me a hopeless optimist, but I see it as further evidence that smarter consumers, willing to shop around, are starting to win the war against cosy oligopoly providers.
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