Understanding What Makes Vanguard So Successful
Low costs help, but that’s only part of the explanation.
Bloomberg, October 12, 2017
There’s never been a money-management business like Vanguard Group Inc. Any time it enters a new market, competitors see their margins demolished via the so-called Vanguard effect. No other firm controls costs the way it does. And since the financial crisis, no other firm has attracted more assets more quickly. Since 2009, Vanguard has expanded from about $1 trillion in assets under management to almost $5 trillion.
Only Blackrock Inc. has more assets under management, but it has only doubled in size during the same time period. Assuming current growth rates hold, Vanguard should pass Blackrock in size.
You might guess that the success of the Malvern, Pennsylvania-based company would be closely studied by many interested parties. Academics should be cranking out white papers by the thousands; competitors should be imitating their every move; business school case studies should be ubiquitous. 1
Nor have competitors come to grips with what makes Vanguard unique. The reasons for its success are many and varied. Those who shrug it off as the result of low fees and passive funds have missed the bigger picture. If price were the sole reason for success, then Econ 101 tells us that competitors would have simply cut their fees in order to recapture lost market share. But this hasn’t happened; if anything, Vanguard’s share has increased, and as the New York Times reported, Vanguard is growing faster than all its competitor combined.
Thus, we must conclude this phenomenon is much more than merely price-driven.
I would posit I am at least as familiar with Vanguard’s core philosophy and approach as anyone outside of its C-suite. 2 I break down its core strengths into a few key areas:
Philosophy: Vanguard’s three core beliefs were set out by founder Jack Bogle four decades ago. First, the firm holds clients’ interest as paramount. The firm is organized as a mutual, meaning its investors are also the owners. This is key as it removes the usual conflicts of interests that riddle so many Wall Street firms; it also means there is no fiduciary obligation to maximize profits on behalf of shareholders. Second, the focus on low costs allows clients to keep more of their investing gains. Every academic study shows that costs are a compounding drag on long-term performance. And last, its emphasis on indexing mitigates self-destructive investor behavior.
Contrarianism: How is a giant indexer also a contrarian? Recall when Bogle started Vanguard in 1975, the company was called “un-American” and the index was ridiculed as “Bogle’s folly.” Building its headquarters in the suburbs of Philadelphia was another contrarian idea, all in the interest of cost containment versus a flashy financial-district edifice.
Psychology: Passive indexing is built on an approach that has a superior behavioral strategy at its core. Very often, those who chase market-outperforming alpha end up forsaking market-matching betas. Giving up expensive and mostly fruitless attempts at beating the market tends to lead to better performance for most investors. This behavioral aspect was the key point in my recent debate with Bloomberg Gadfly columnist Nir Kaissar.
Balance: One of the huge advantages the firm has is its balanced approach to not only investing but business and life. None of the typical Wall Street excesses are present; there are no giant bonuses, outside salaries or massive stock grants. The firm is rarely in the news, except for the recent news on its gains in assets under management. It is a no-drama sort of firm that quietly pursues the stewardship of its investors’ capital.
No firm is flawless, and Vanguard is no exception. It remains way behind competitors such as Blackrock in exchange-traded fund issuance; it missed the move into factor investing, sometime known as smart beta; it has but one single product in the environmental, social and governance (ESG) style of investing. And considering how big and successful it has been, the firm has less presence in overseas markets than many of its competitors.
I suspect Vanguard will eventually figure those things out. This is a firm built for competition, and it is only going to get more competitive during the next decade. It will be very interesting to watch.
1. Every time I write about Vanguard I feel compelled to disclose my interests and biases: My personal investments (and my wife’s 403b), as well as the clients of Ritholtz Wealth Management, contain numerous Vanguard funds. I was also the subject of a very nice interview by Vanguard’s Advisor group: “From millennials to retirees, investment pro Barry Ritholtz offers deep insights.”
2. My past columns on Vanguard include:
Past Masters in Business podcasts include:
Originally: Understanding What Makes Vanguard So Successful