Vanguard is an American asset manager that today manages over $3 trillion in global assets, an amount which has grown at a 20% CAGR over a 40 year period and that exceeds the total hedge fund industry . Vanguard offers 160 mutual fund options and has 20 million individual investor customers that invest in its funds through their 401(ks), IRAs, and individual investment accounts . Vanguard’s core operating statement is “strategy follows structure”.
Industry Overview and Business Model Summary
The mutual fund industry typically generates revenue through two channels – firstly, many mutual funds charge an initial fee (termed a “load”) upon purchase of the fund, and secondly, all funds charge an ongoing yearly fee associated with the expenses of running the fund, termed a “expense ratio” . Vanguard differentiates its investment offerings from those of other large asset managers by not charging a load and focusing on low cost, index funds that passively track public market benchmarks such as the S&P 500.
By focusing on index funds, Vanguard decreases the expense ratio that investors have to pay on their mutual funds. On average, a Vanguard fund has an expense ratio of 0.18% compared to an industry average of 1.02%. As shown in the chart below, assuming an initial investment of $100,000, choosing a Vanguard fund would save an investor $121,851 in fees over a 30 year period.
Vanguard has been able to amass a huge base of assets while simultaneously charging low fees and changing the way individual investors deploy capital through the alignment of their business and operating model by following the simple mantra of “strategy follows structure”.
Firstly, the value alignment starts with their corporate structure. While most asset managers are publicly traded companies that have to answer to shareholders, Vanguard has no outside owners and is owned by its funds. What this means is that its investors are its owners, thus aligning client and Vanguard interest. How this plays out in reality is that expenses like portfolio management and other services are provided at cost to funds, lowering the expense ratio. By building up a huge base of assets, Vanguard is able to amortize the fixed costs of running its funds over a broader asset base, lowering fees. Rather than pay large, egotistical fund managers large salaries that drive up fund expense ratios (as a comparison, PIMCO, a large active asset manager, paid its founder, Bill Gross, $290 million in 2013 while its flagship fund underperformed a majority of its peers ), Vanguard represents the “triumph of individual investor interests over the interest of fund managers” .
Secondly, by emphasizing low cost, passive index investing, Vanguard funds suffer less turnover and a more stable base of assets than other actively traded funds that are judged on monthly or yearly performance. Vanguard’s mission of providing low cost funds also aligns with personal investor’s goals – substantial research has been done that shows index funds generally outperform actively managed funds, while also generating substantial savings from a tax-efficiency standpoint (Vanguard’s own research shows that their passive index funds have outperformed ~90% of actively managed funds over the prior 10 year period) . Additional research has shown that individual investors who actively trade underperform passive index funds by a substantial margin . By encouraging investors to “stay the course” during bull and bear markets versus chasing actively managed fund returns, Vanguard drives investor performance while insulating itself from some of the other risks that face actively managed funds during bear markets.
Lastly, Vanguard has continued to listen to clients and innovate as a result. Vanguard was the first mutual fund company to offer index funds, and has continued this culture of innovation by being the first asset manager to provide index-linked ETFs as well as responding to new innovators such as robo-advisor startups Betterment and Wealthfront by offering a similar “robo-advising” product that uses algorithms to design an optimal portfolio based on questions the client answers online .
. “Vanguard Reaches $3 Trillion In Assets, Matching Entire Hedge-Fund Industry”, Wall Street Journal http://blogs.wsj.com/moneybeat/2014/09/18/vanguard-reaches-3-trillion-in-assets-matching-entire-hedge-fund-industry/
. Vanguard Website, https://about.vanguard.com/who-we-are/fast-facts/
. “John Bogles’ 40 Year History of Vanguard”, Philly.com http://www.philly.com/philly/blogs/inq-phillydeals/John-Bogles-40-year-history-of-Vanguard.html
. “Guess How Much Money Bill Gross Made Last Year, Bloomberg http://www.bloombergview.com/articles/2014-11-14/guess-how-much-money-bill-gross-made-last-year
. Vanguard Website, https://investor.vanguard.com/mutual-funds/index-vs-active
. “The Behavior of Individual Investors”, Brad Barber and Terrance Odean, http://faculty.haas.berkeley.edu/odean/papers%20current%20versions/behavior%20of%20individual%20investors.pdf
. “Robo Investing Craze Now Pitting Vanguard Against Fidelity”, Bloomberg http://www.bloomberg.com/news/articles/2015-06-19/robo-investing-craze-now-pitting-vanguard-against-fidelity