The ‘Secret’ Behind Vanguard’s Record Year: Get Low!

by Dan Wiener and Jeff DeMaso | December 13, 2012 9:33 am

Businessweek’s almost breathless reporting[1] of Vanguard’s asset-gathering success in 2012 — more than $130 billion in net new assets through November — is anything but earth-shattering news.

It’s merely a reflection of something we’ve talked about for a long, long time: Costs matter. And in a low-yield, low-return environment, shaving pennies from fund costs gets investors’ attention. The winner isn’t Vanguard — it’s us. We are the beneficiaries of the fee wars that have been a regular staple of the business news this year, whether it was fee cuts at Charles Schwab (NYSE:SCHW[2]), BlackRock’s (NYSE:BLK[3]) iShares unit, Vanguard or even — as reported just this week[4] — Fidelity Investments.

The only reason to care is that competition between low-cost mutual fund and ETF providers means investors will come out on top, whether you’re investing in index funds or actively managed ones.

Whether or not they admit it, Vanguard has been feeling the heat on costs as competitors got religion and started their own race to the bottom on expenses.

Vanguard wasn’t going to let go of its claim to fame of being the low-cost provider without a fight.

Its biggest counter-attack came in October, when the fund complex announced a sweeping reorganization of its index products[5], with changes to index bogeys on almost two dozen different products — almost entirely in an effort to further reduce costs. Vanguard’s index fund and ETF investors are going to be going through a life change (another one, actually) in the first half of 2013.

In sum, after less than a decade, Vanguard dropped MSCI Inc. (NYSE:MSCI[6]) as the index provider for myriad domestic and international index funds, and adopted a host of new benchmarks for signature funds including Total Stock Market (MUTF:VTSMX[7]) and Emerging Markets Index (MUTF:VEIEX[8]).

Vanguard has made it very clear that its motivation for the change is simple: to cut costs. The expense of licensing an index has risen over the years, and in a recent webinar, index chief Gus Sauter explained that Vanguard had identified an area to save “tens, if not hundreds of millions of dollars over time.”

In addition to negotiating lower fees, Sauter explained that Vanguard had signed long-term contracts providing price certainty so the reduced fees will flow steadily through to lower expense ratios.

So while Vanguard has just set a nominal record, it’s not like the earth has suddenly shifted. Vanguard has been cutting costs from day one, and in recent years the company has cut operating expenses on its international index funds, offered commission-free trading programs and waived expenses on some of its money market funds to keep yields in the black.

It’s no surprise that as investors figured out that costs matter, money would flow to Vanguard. The difference now is that, thanks to its success, Vanguard is so big that it might have the upper hand in negotiations with managers and index providers to keep pushing costs lower.

And whether you believe in indexing or active management, that means you’re getting a good deal with Vanguard’s funds.

Editor Dan Wiener and Research Director Jeffrey DeMaso publish The Independent Adviser for Vanguard Investors[9], a monthly newsletter that keeps abreast of recent developments at Vanguard, and the annual FFSA Independent Guide to the Vanguard Funds.

  1. almost breathless reporting:
  2. SCHW:
  3. BLK:
  4. as reported just this week:
  5. sweeping reorganization of its index products:
  6. MSCI:
  7. VTSMX:
  8. VEIEX:
  9. The Independent Adviser for Vanguard Investors:

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