Active Managers May Soon Have Another Enemy

Vanguard’s low-cost index funds have taken market share from active managers over the past few years. Now the fund giant is muscling further in on their turf as it expands its low-cost active line.

Illustration by II

Illustration by II

Active management has been under siege for a decade as investors have abandoned active funds for low-cost index strategies. Now active managers are facing a new threat: a push into low-cost actively managed funds by passive fund giant Vanguard.

The firm’s effort to build out its actively managed fixed income and equity funds business is part of CEO Tim Buckley’s strategy to ensure that the $5.3 trillion manager doesn’t get complacent now that it is one of the biggest money management firms in the world.

Buckley, who will become chairman at the beginning of next year, succeeded Bill McNabb as CEO on January 1st. McNabb had been CEO since 2008.

Vanguard now has more than $1 trillion in actively managed equity and fixed income funds, which would make it one of the biggest asset managers in the world if its active business were a standalone company. Active, however, now represents about one-quarter of the firm’s total assets, as investors have flocked to its index funds over the past decade. As a result, Vanguard’s actively managed funds have been overshadowed in recent years by the growth of its passive funds.

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“Ten years ago, Vanguard’s assets were split fifty-fifty between active and passive,” Matthew Brancato, a principal who leads Vanguard’s global product group, told Institutional Investor. “Five years ago active was one-third of our assets. As we’ve talked to our clients, we see there is more opportunity to emphasize active.”

Although the firm won’t get back to a fifty-fifty split, it does want to have a better balance between active and index, he added.

Brancato — whose team is responsible for overseeing Vanguard’s 400-plus mutual funds, ETFs, and their advisors — said the firm thinks active strategies can generate benchmark-beating returns, but those excess returns won’t accrue to the investor if a fund charges high fees.

Vanguard, founded by Jack Bogle, is best known for its index funds. But the firm’s philosophy has always been to emphasize low-cost investing, rather than index funds per se. In addition, the firm — whose funds are owned by shareholders — has been quick to close funds as they’ve reached their capacity limits, as research shows that managing too much money is one of the biggest impediments to good returns.

Vanguard has relationships with 27 subadvisors, who oversee most of the firm’s equity funds. The firm also manages all of its active fixed income funds, factor-based funds, and some other products internally.

Active funds will be a priority for Vanguard’s international business as well, the firm said. As Vanguard has entered markets outside the U.S., its index funds have been quickly adopted, as fund expenses are far higher internationally than in the U.S. For example, Vanguard recently launched funds in Canada, which has the highest average fund fees in the developed world.

Last year the firm launched global versions of its active Wellington and Wellesley funds. It also has a global credit fund in registration with the Securities and Exchange Commission.