The conversation in our industry has again turned to the “commoditization” of index investing as a handful of prominent asset managers have decided to hop on the low-cost indexing bandwagon. Whenever this comes up, it makes me think of Charlie Brown.
If you don’t remember Peanuts, Charlie Brown’s friend/antagonist Lucy would hold a football for him to kick. When he ran up and tried, she would pull the ball away, and Charlie Brown would go flying and land flat on his back. But Lucy would always set the ball up again and convince Charlie Brown that she wouldn’t pull it away this time. Another pratfall ensued.
Commoditization keeps coming back like Lucy with her football. This recent shift in strategy by some of Vanguard’s competitors has been accompanied by a bold sales and marketing effort that attempts to narrow the differences across firms and competing products to the exclusive dimension of cost.
Not surprisingly, we believe there is some additional perspective that can benefit the conversation.
Yes, fees are very important, but they are not everything. If costs were all that mattered and indexing were a true commodity, any blockhead could pick the right index provider. Just find the lowest price.
In that case, Econ 101 would tell us that Vanguard should probably have 100% market share in the index space by now. Low-cost investing—whether it be indexing or the more than $1 trillion of active strategies we manage¹—has been the ethos of Vanguard for more than 40 years. We launched the first index fund for individual investors in 1976, and we’ve been working to lower costs ever since.
But while we’ve enjoyed tremendous success and manage a significant share of indexed assets, we are by no means 100% of the market. Instead, we compete in a robust market where institutions and individuals select providers based on how firms distinguish themselves across multiple factors such as the ability to prudently track an index over the long term, providing clients with robust choices across benchmarks, the level of client service, a firm’s overall investment philosophy, and the organizational commitment to indexing. We believe Vanguard is highly differentiated from other providers across all of these dimensions and more, and we find that most investors apply this holistic lens when selecting the right index provider with which to partner.
The robots have not taken over—indexing is still a high-touch human endeavor. The delivery of many services has been automated and commoditized in recent years. When was the last time you walked into a record store, talked to a bank teller, or relied on a human being to print your boarding pass?
While it may be tempting to think that the same application of technology can displace the human element of running an index fund, we have not seen that disruption and probably never will. Indeed, people remain one of the most critical differences across providers. The portfolio managers charged with running Vanguard’s index funds have honed their craft over decades and apply their judgment, perspective, and experience to ensuring that our products are successfully implemented in a constantly changing and evolving market environment. Index fund management is an absolutely critical competency that we maintain in-house at Vanguard—it is not a discipline we farm out to third parties, as others in our industry do.
Vanguard is structured to offer low costs to investors in an enduring way. We’ve been able to offer low-cost index funds for decades because of a truly unique corporate structure. Our firm is owned by our funds, which are in turn owned by our funds’ investors. We have no outside owners, so we have no pressure to meet short-term earnings expectations and we’re free to focus on the long term, which we think is the right outlook for fund shareholders. Each fund investor’s bottom line is all that matters.
As a result, Vanguard’s commitment to low-cost investing is measured in decades. It’s not a dramatic shift in strategy or a flashy marketing campaign. It’s the essence of who we are. And given our unique ownership structure, we are confident that we will be able to continue to lower the cost of investing for decades to come.
By contrast, Vanguard’s main competitors in the index fund market do have outside owners and shareholders to consider. If those owners are not satisfied with the returns generated by offering index funds at Vanguard-like prices, profits may have to be generated elsewhere. Or, the decision to compete as a low-cost index provider could be reconsidered.
So I can’t help but feel like I’m watching Lucy set up the football. However, unlike Charlie Brown, I’m confident that she will pull it away. I am also confident that the index fund industry will continue to be a competitive and differentiated market place for years to come.
¹U.S.-domiciled assets as of May 31, 2016.
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