Sometime this quarter (likely sometime in February) fans of exchange-traded funds (ETFs) and/or mutual funds are going to be introduced to something they’ve never quite seen before. That is, fund giant Vanguard — yes, the same Vanguard that has made “indexing” a brilliant investment strategy — is making a foray into the world of active investing.
It’s launching six actively managed ETFs, each with its own specific “factor,” or theme, that makes it more than a mere index fund.
The move into waters the company has avoided until now has prompted plenty of opinions … some encouraging, and some not as stoked. Founder and former CEO of Vanguard Funds John Bogle has pretty well proven that the passiveness of investing in an index as opposed to individual stock-picking actually bears more fruit for the vast majority of investors. The unveiling of a small handful of exchange-traded funds is a move in the opposite direction.
The thing is, Bogle may well be on to a budding paradigm shift in the world’s belief in what is and isn’t likely when it comes to plugging into the stock market.
New (and Unusual) Vanguard Funds
For the record, five of the six funds in question will either employ a strategy that focuses on minimum volatility, value, momentum, liquidity or quality (presumably of earnings). The sixth exchange-traded fund will combine those five elements; the multifactor ETF will also be offered in a traditional mutual fund version.
It is, calling a spade a spade, very un-Vanguard-like. The company became the biggest mutual fund company in the world largely because Bogle has successfully proven to the masses that over time, it’s almost impossible to beat the market. Bogle provided the simple solution of matching the market’s broad performance at the lowest cost possible.
It should be noted that while “active” and “passive” investing are largely viewed as two different ideas, there are various degrees of what “active” can mean.
Where the new funds will lie on that spectrum remains to be seen. But, given the company’s modest dabbling in actively managed waters via its rollout of the Vanguard Global Minimum Volatility ETF (TSE:VVO), Vanguard Global Value Factor ETF (TSE:VVL), Vanguard Global Momentum Factor ETF (TSE:VMO) and Vanguard Global Liquidity Factor ETF (TSE:VLQ) in the United Kingdom and Canada over the past couple of years, we probably have a good idea of what to expect.
As Morningstar’s Ben Johnson recently opined of those four funds:
“While definitionally, yes, they will be actively managed funds, what we see in those funds listed outside the U.S. is that they’re just ever-so-barely ‘active.’ They follow a very systematic approach to security selection and portfolio construction that looks an awful lot like an index-based strategy, but the active element is the fact that they retain a degree of discretion over how to trade the portfolio, how to modify the process, and the strategy at any point in the market cycle if they discover that there are certain refinements that might improve the overall performance profile.”
To that end, a closer look at any of Vanguard’s funds that might also qualify as an actively managed fund (though nearly all are still index funds by most any other use of the term) determines that, on average, Vanguard isn’t beating its respective benchmarks with its pared-down version of “actively” managed funds.
Indexing Isn’t What it Used to Be
So why bother?
It was a mostly overlooked idea put forth by Bogle in the middle of last year, but the Vanguard Funds Chairman warned then that the growing attraction to indexing as a strategy could eventually cause the equity market to stop functioning altogether.
It was a hyperbolic assessment to be clear, made more for effect than as a caution. The point was well taken though. Given the current trajectory of investor willingness to stop trying to beat the market and only trying to mirror it removes more and more of the buying and selling that make it a lively, thriving business. If everybody is just holding and nobody’s selling or buying, there is no net movement or an auction process that forever changes stock prices.
Or, as Bloomberg Gadlfy reporter Stephen Gandel put it so perfectly last week, “Even the best investment strategies tend to work only when few know about them.” He added, “Now that passive investing has become the most crowded trade on the planet, its performance should sputter at some point, and it may already be happening.”
And yet, who can blame investors for not doing what they’ve been told not to do for years now?
Bottom Line the New Vanguard Funds
It remains to be seen just how much of an impact the new funds from Vanguard might make on the fund and ETF market. They’re not index funds in the sense that they mirror a specific basket of stocks, but they’re not exactly managed funds in that their underlying stocks are picked based on specific criteria rather than hand-picked.
The pros are split on the matter. Todd Rosenbluth, director of ETF and mutual fund research for CFRA, thinks the lack of options on this front is the only thing holding this potential arm of the fund market back though. He commented, “It’s easier for them [investment managers] to not participate now because the pool of assets in active ETFs is small and you can say, ‘Well there’s isn’t yet client demand.’ If Vanguard proves there’s client demand — and we think they will — it’s an easier decision to make.”
In other words, look for more of the same if Vanguard develops the market. That’s a very big “if” right now, but it’s certainly a story worth watching develop in the very near future.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.