About the Editor
Ben Johnson, CFA, is director of global ETF research for Morningstar. Before assuming his current role in 2012, he was director of ETF research for Europe and Asia. He also previously served as a senior equity analyst, covering the agriculture and chemicals industries. Before joining Morningstar in 2006, he worked as a financial advisor for Morgan Stanley.

Johnson holds a bachelor's degree in economics from the University of Wisconsin. He also holds the Chartered Financial Analyst® designation. In 2015, Fund Directions and Fund Action named Johnson among the 2015 Rising Stars of Mutual Funds.

Investment Strategy
Morningstar ETFInvestor scans the globe for value and improving fundamentals across virtually all asset classes. Editor Ben Johnson draws upon academic and practitioner research — including Morningstar's sizeable bench of stock, bond and fund analysts — to find reliable drivers of outperformance.

Morningstar ETFInvestor features two real-money portfolios.

The ETF Income Portfolio assembles a high-quality collection of income-generating ETFs with the goal of earning 5% in excess of the 30-day T-bill rate over a full business cycle. The portfolio adheres to a benchmark-agnostic strategy in its search for absolute returns.

The ETF Global Asset Allocation Portfolio, on the other hand, is more benchmark sensitive. It seeks undervalued asset classes with improving fundamentals. The strategy seeks to beat the 60/40 MSCI ACWI/Barclays US Aggregate benchmark over a full business cycle, with the least risk possible.

May 04, 2016
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Ben Johnson, CFA,
Director, Global ETF Research and Editor
Ben Johnson, CFA, is director of global ETF research for Morningstar. Before assuming his current role in 2012, he was director of ETF research for Europe and Asia. He also previously served
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ETFInvestor Weekly Update - April 29, 2016

Takeaways from Our Visit with Vanguard

I’d like to thank those of you who sent me your questions for Vanguard’s leadership last week. Virtually all of them hit on some common themes that my colleagues and I were also interested in digging into. Here, I’ll weave the responses we received into a discussion of some of the topics we covered during our visit.

What will stop Vanguard?

The question is a difficult one to answer. The firm is in a rare position. It has risen to the top of its league and continues to experience above-average organic growth. It is now bringing in roughly $1 billion per business day in new investor money on a run rate basis. More and more investors are entrusting their hard-earned money to Vanguard. One of the few things I could see reversing this trend would be a breach of trust. That is an awfully difficult scenario for me to imagine. The firm’s ownership structure is designed to minimize virtually all of the most common misalignments of interest that breed distrust and create bad incentives for stewards of shareholders’ capital.

Furthermore, Vanguard has stiff secular tailwinds at its back. The move towards fee-based advice, the growth in target date funds, the expanding ranks of underserved mass affluent households in need of financial guidance—all of these trends have propelled the firm forward at a steady clip in recent years and show no signs of abating.

Based on our conversations with management, it is clear that they are not resting on their laurels. Vanguard’s Chairman and CEO, Bill McNabb, told us that if they continue to do the same things that have worked for them over the past ten years, they won’t be able to replicate their success. But while the company continues to evolve, its core principles remain intact. The firm continues to return the benefits of scale to its shareholders in the form of lower fees. In fact, Wednesday morning it announced another round of expense ratio reductions for a number of funds, including the world’s two largest, Vanguard Total Stock Market Index and Vanguard Total Bond Market Index. That said, the larger Vanguard gets and the lower fees go, the more money it takes to move the needle. The company estimates that a one basis point (0.01%) firm-wide reduction in its expense ratio now requires approximately $560 billion in net new assets.

What isn’t being passed back to shareholders is getting reinvested into the business. Much of this reinvestment is being directed towards enhancing the firm’s service offering with the aim of galvanizing client loyalty and expanding its client base. Recent examples include a refresh of the firm’s online brokerage portal and the introduction of Vanguard’s Personal Advisor Services, which had 42,000 clients and $36 billion in assets under management as of the end of March.

Vanguard is also expanding overseas. The firm’s ex-U.S. funds now have approximately $250 billion in assets under management. Its London operation has grown from one man with a laptop to nearly 300 employees in recent years. The firm’s presence in the UK has grown rapidly, thanks in part to the introduction of regulation that has banned commissions outright in some advice channels. Also, the firm has built out a local trading footprint to be able to plug into local markets during local hours with local talent. This ultimately benefits not just investors in the firm’s European-domiciled funds, but also investors in the international portfolios within its U.S. lineup. While Vanguard has been relatively late and slow to expand its overseas footprint versus many of its peers, early signs are promising that its funds’ shareholders will reap a decent long-term return on their investment.

Active vs. Passive

Tom Rampulla, the head of Vanguard’s U.S. Financial Intermediaries business, recently authored a blog post on the Vanguard Blog for Advisors titled “Why we believe in active and passive—No ifs or buts”. This nicely summarizes the firm’s take on the topic. While the lion’s share of the company’s assets are now in index funds, they have a large and largely successful roster of active strategies as well. The common element amongst them? You guessed it—low costs. Low costs are just one ingredient in the recipe for successful active management as Vanguard sees it, the other two being top talent and patience. But top talent is becoming increasingly difficult to find. Dan Newhall, a principal in Vanguard’s Portfolio Review Department tasked with manager selection and oversight, told us that finding skilled active managers is more difficult than ever. According to Newhall, many top-tier managers have left the fund business or avoided it altogether, opting to work for hedge funds or striking off for Silicon Valley. Furthermore, as index funds’ fees have continued to march lower, the bar has been raised for active managers.

Strategic Beta

“Active management minus the headwinds” was the title of the slide presentation that John Ameriks, the head of Vanguard’s Quantitative Equity Group, shared with us—an apt description of factor-focused funds. Ameriks’ group represents the brains behind Vanguard’s Global Minimum Volatility Fund, which was launched in December 2013. Vanguard’s approach to factor funds is differentiated from those of most of its ever-expanding peer group in the strategic-beta arena. Firstly, they are not interested in tracking newfangled benchmarks, so these strategies are technically active—though just barely so. By retaining an element of active discretion, Ameriks’ group hopes to avoid some of the costs associated with regular re-balancing and to fine-tune its factor exposures. At the highest level, they view offering factor funds as a way to take the costs (and some of the idiosyncratic risks) out of traditional active management. The firm recently launched four actively-managed single-factor ETFs in London and has filed to list similar ones in Canada. Odds are that a U.S. bunch are forthcoming, though the regulatory hurdles the firm faces are relatively higher than those they’ve surmounted or will have to surmount outside the U.S. These funds are intended for an institutional and advisor audience. Ameriks emphasized the need for education and appropriate expectations setting when it comes to introducing investors to focused factor funds and providing them with guidance on how to best use them within their portfolios. Ameriks thinks that there are a handful of factors that have worked in the past. Also, he believes that the economic intuition that underlies them gives them reasonable odds of working in the future. That said, there are no guarantees, and given that there is a question as to whether these factors will persist, Ameriks thinks of factor funds as a new form of active management. In his book, anything with a question mark after it (i.e. Will X strategy beat the market?) is active management.

What's Next?

Vanguard has come a long way over the past 40 years and its growth has only accelerated in the past 10. Its ascendance is rooted in the trust of millions of investors—some 7 million in the U.S. and a growing number outside U.S. borders. It’s difficult for me to imagine what the firm could do to break this trust and set the virtuous cycle that has propelled it higher spinning in the opposite direction. As the firm pursues new growth opportunities some will pan out and others may flop. But this is to be expected in any enterprise of any scale. What will inevitably be Vanguard’s key differentiating feature in the future and underpin most of its growth is nothing new: it is owned by its fund shareholders and only its fund shareholders. This is a powerful competitive advantage.





From Morningstar.com

Fees are falling. The average fee paid by fund investors continued to decline in 2015, owing to a shift towards passive strategies and lower-cost share classes. Here is a link to our annual study of fund fees, authored by my colleagues Patricia Oey and Christina West.  

John Rekenthaler weighs in on why fund costs are on the decline.


Woodstock for Capitalists kicks off tomorrow morning in Omaha, Nebraska as Berkshire Hathaway BRK.B CEO Warren Buffett and his right-hand man Charlie Munger take the stage for their annual shareholder meeting. For the first time ever, you don’t have to be in Omaha to have an audience with the Oracle as the meeting will be streaming live on Yahoo! Finance. You can access the live stream here.

This week Research Affiliates’ hosted a webinar during which the firm's co-founder, Rob Arnott, discussed the findings of the controversial paper he recently co-authored with a number of his colleagues titled, “How Smart Beta Can Go Horribly Wrong”. You can access a replay of the webinar here. Arnott provides a deeper explanation of his team’s findings and directly addresses some of the criticisms of their work that have since been published by AQR’s Cliff Asness.

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