Vanguard CEO: “We want to drive costs even lower”

We are not done on the cost side . . . We think we need to keep raising the bar on that.”

So says Bill McNabb, CEO and Chairman of the Vanguard Group. The firm, managing over $3.1 trillion dollars in client monies, has long been known for its obsessive focus on keeping costs low.

In a wide-ranging 2-hour interview, McNabb noted the institutional advantages Vanguard enjoys, and why he intends to keep pushing costs lower: The firm is a mutual, owned by its investors, and not beholden to shareholders. McNabb maintains this unusual corporate structure gives them a 30-40 per cent price advantage over publicly traded competitors. He says the firm’s relentless focus on costs have “resonated at a level with investors” that even McNabb is surprised by. Quote Intel co-founder Andy Grove, McNabb states “You cannot get complacent.”

The phenomenon has become known as “the Vanguard effect.” Any time the investing giant enters a new market, costs to investors decline. McNabb add that competitors are “getting smarter” about cutting fees sooner, rather than “losing market share” to Vanguard.

F. William McNabb III joined he Vanguard Group in 1986. At the time, the firm ran a mere $20 billion dollars. At different times, he managed each of Vanguard’s client facing divisions. He rose through the ranks, eventually taking over the top job from Jack Brennan, a mentor of his. He became the firm’s 3rd chief executive, after Brennan and legendary Vanguard founder, John Bogle. His immediate previous job was managing director of the institutional and international businesses.

A story that has become legend around Vanguard involves McNabb’s ascension to CEO. When the firm began its internal search for Jack Brennan’s replacement, many of their managing directors were interviewed for the job. At the end of the interview, the candidates were all asked the same question: “If you were not CEO, who would you like to see running the company?” Just about all of them suggested McNabb.

No Layoffs for Vanguard Employees During Great Financial Crisis

The timing of McNabb’s start was auspicious: he began in August 2008, just 2 weeks before Lehman and AIG imploded, and the great financial crisis entered a new phase.

During the crisis, the firm had three priorities: maintaining well-positioned portfolios of safe securities, keeping their investors from panicking, and assuring the Vanguard’s 12,500 employees that the firm was stable.

McNabb thought the company was well positioned to ride out the financial crisis. Their exposure to the kinds of structured products that were causing issues at most iBanks was minimal. However, following the Lehman Brother bankruptcy filing, signs of investor panic were rising. Most notably, Vanguard’s call volume began to spike dramatically during the crisis. In order to prevent their fund holders from doing something they might later regret, in October of 2008 McNabb posted a webcast explaining why panicking into market turmoil was not an especially good idea. It was downloaded 100,000 times in the first 24 hours.

Despite the call volume, investors transactions were lower than normal. Investors were hungry for calm and rational information, and this was a salve.

Another concern was the message employees – “crew” at Vanguard, and yes, everything there has a nautical theme – might be subconsciously sending to investors. The sheer volume of Wall Street layoffs had put many on edge, and McNabb revealed that Vanguard instituted a new policy in the midst of the financial collapse. While much of Wall Street was laying people off, the Malvern, Pennsylvania firm handled market stress differently. The new CEO announced a “No-Layoff” policy. “We said to our people ‘Don’t worry about your jobs – You all have jobs, and you are here to serve the client. Stop worrying, no one is going to lose their jobs over [the financial crisis]; We want you focused on being here for the client.”

It had the intended effect. Inside of Vanguard, that tone helped with the client interactions. “People had confidence when they were talking to clients” McNabb added. Since the crisis ended, Vanguard has since added 2000 new employees.

Active Manager Selection criteria  

Although the firm is well known for its indexing – it accounts for about 65 percent of their assets – they also manage about $1 trillion dollars in active portfolios. McNabb described the way they seek out and select managers to run these monies. Some of the criteria are surprising.

We want to find firms that have “great talent retention, low employee turnover and excellent succession planning.” Even though none of these attributes speak directly to the investing process, it reflects a specific firm culture that is readily translatable into better performance numbers.

But track records matter less than process verified by data. Prior to hiring a new manager, they look for easily explainable investing process that is consistent, backed up an intense “portfolio attribution analysis.” Consistency between the explanation of the investing process and the results is a key aspect.

Advice for Millenials

McNabb also had some advice for Millenials, and others starting out their career: Live below your means, save early, and get exposure to diversified global portfolio.

The interview broadcast this weekend on Bloomberg radio. The full 2 hour podcast can be found on iTunes and at Bloomberg.com.

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Discussions found on the web:
  1. theexpertisin commented on May 15

    Between Vanguard and Schwab for a basic portfolio construction, why go anywhere else?

  2. rd commented on May 15

    I can see Vanguard doing a 0.20% and 0.20% hedge fund.

  3. corpgov commented on May 15

    I like the low cost of Vanguard but wish they had a better proxy voting track record. See http://proxydemocracy.org/data/funds/63

    I hold very little in mutual funds, preferring stock. I think many people can do better on their own as long as they spread their investments out to at least 25 companies to be diversified.

    An example of this strategy on an institutional basis can be found in the Voya Corporate Leaders Trust Fund, now run by a unit of Voya Financial Inc. They bought equal amounts of stock in 30 major U.S. corporations in 1935 and haven’t picked a new stock since. See http://mobile.reuters.com/article/idUSL5N0VY58B20150227?irpc=932

    I buy stocks in promising companies and not only vote my proxies (only 30% of retail shares are voted) but I agitate for changes I think will improve long-term value.

    I find many small companies haven’t a clue on some fundamental issues. Last year, one of my companies said in the proxy that it took a majority of votes for directors to be elected. They pay the non family members of their board practically nothing and at least a couple don’t own stock in the company. As a result of my posts, one of the directors “lost” but it turns out they didn’t know their own bylaws only required a plurality. This year, maybe I’ll file a proposal to move to majority requirements.

    I say invest in only a few companies and watch them like a hawk. You’ll learn while you earn.

    • Liquidity Trader commented on May 16

      I hold very little in mutual funds, preferring stock. I think many people can do better on their own as long as they spread their investments out to at least 25 companies to be diversified.

      The data overwhelmingly suggests otherwise . . .

  4. farmera1 commented on May 15

    Been with Vanguard for decades. Always get a fair deal with good to excellent service. Never a problem with Vanguard. My only “concern” is the numbers as in growth they have putting up the last few years. Almost seems too much. So far no real signs from my perspective of problems. But I’m watching. Lots of people I know have figured out Vanguard is a good place for their money. Lots of truck loads of cash going to Vanguard. We’ll see how they handle all of this rapid growth.

  5. intlacct commented on May 15

    “At the end of the interview, the candidates were all asked the same question: “If you were not CEO, who would you like to see running the company?” Just about all of them suggested McNabb.”

    Standard technique. When someone is trying to sell you something – a company, an idea, employment or partnership with them – say, “I know you are the best. Who’s number 2?” I have use this several times.

  6. intlacct commented on May 15

    Mr. McNabb and Vanguard fed the austerity trolls at the worst possible time by calling for a balanced budget plan. Admittedly there was no time frame, and would love for someone to disabuse me as I have everything not employed in my version of a hedge fund at Vanguard), but I recall it came out about the same time as the now much discredited open letter from the Club for Growth (pro cancer?). Still, it is a comparatively exquisitely run organization.

    When will someone (besides me) recognize Bogle’s severing of the conflict of interest between the fund management company and the fund shareholders as the fundamental innovation? Once he did that, indexing had to win, IMO. Totally contrary to the inequality generating policies of the last 40 years.

    • RW commented on May 16

      When I saw those comments from McNabb my first thought was I sure the hell hope he knows more about running a mutual fund company than he does about macroeconomics and national accounting; arguing that balancing the federal budget should be a priority isn’t just untimely, it is frankly unwise even during better times.

      The prepared remarks of of Mark Blyth before the Senate Budget Committee explain why.

      But my second thought was: Can McNabb really be that ignorant or is he pandering to the kind of folks (usually wealthy) who are predisposed to this sort of twaddle? No way to determine that but it wasn’t a comfortable thought.

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