Kurtosys caught up with Rich Powers, head of US ETF product management at Vanguard. Based in the US, he is largely responsible for promoting Vanguard’s own offering and also communicating the broader ETF story, honing a comprehensive understanding of the competitive marketplace and shaping the group’s product development and innovation. His team, effectively represents the voice of Vanguard ETFs in the United States.
With around 100 providers of ETFs, but only three (BlackRock, State Street and Vanguard) accounting for 80% of the assets, Vanguard is clearly one of the winners in this space. Why would another provider want to join that party?
I think what you would find is that many of the new products that come to market today end up being more satellite or complementary positions, that an investor might use.
It’s likely to be a more narrowly defined strategy in a segment of the market or a different way to deliver that strategy, such as through an active approach. In contrast, most ETFs today are in index-based strategies.
But interestingly, there are still gaps in the broad market that weren’t covered by the conventional insurers. For instance, last September, we launched the first global bond index ETF available in the marketplace. I find it fascinating that, the global bond market being as large as it is, yet there was no ETF providing investors an opportunity to invest, so we closed that gap last year with the new product.
The ‘race to the bottom’ on ETF charges seems to have been happening for quite some time now and now we’ve reached single basis point products in some cases. How sustainable is that direction of travel?
The Vanguard story is one where we ascribe costs based upon what it actually costs us to run the organisation and so as our products gain scale, as more and more investors adopt them, that allows us to lower costs and return value to shareholders in the form of a lower total expense ratio.
Scale is a very important component for Vanguard’s ETFs being able to reach very low-cost levels.
Other organisations might play to that as well and that my very well be true but in a number of instances they also look at low costs as a mechanism to a marketing spend, in bringing investors to their product and allowing them to capture some share, while having higher costs in the rest of their line-up.
At Vanguard all of our products are low cost; that is a key differentiator in our offer relative to other firms that are doing low cost today. In a number of categories, we are at a low single-digit basis points and we think that is incredible; it’s great value.
Taking the cost much lower than that, a difference of a basis point or so from where we are today, isn’t going to make as much impact as if you’re going from 50 basis points to 5 basis points.
We have encouraged investors to think about things beyond just cost as a way to decide whether a product is good for them or not, such as looking at tracking error, tax efficiency, or the actual exposure offered by the index.
I think a lot of investors remain invested in very high-cost products, and so even though we’re talking about the competition on that low single-digit basis point level, there’s still a huge opportunity for investors who are paying way too much for their investments. They can move from that 100bps product to a 50, 10 or a 5bps product.
What about flows? Is your sense that the money is coming into your strategies from the passive end and seeking enhanced performance, or from active funds where investors are seeking the same outcomes but via a lower-cost product?
Most cash flows into ETFs are coming into broadly-based market-cap weighted index ETFs. If you connect the dots between outflows from active mutual funds and the inflows to index ETFs, it would be fair to conclude most of the cash flows to ETFs is coming from active funds. In terms of flows into factor ETFs, based on the conversations that my colleagues and I have had on the topic, it feels as though investors are looking at factor-type strategies as substitutes to high-cost active, rather than replacements for market cap weighted index funds. I’m sure some of that is happening but our sense is that it’s mostly substituting for high-cost active.
You mentioned your global bond ETF launch last year, and broadly speaking fixed income is significantly behind the curve of equity products, but traction is starting to pick up a little bit in that. What challenges still exist and how are they being addressed?
I think one of the key reasons why you see fixed income ETFs representing only about 20% of the overall ETF ‘pie’, even though fixed income as an asset class is more than half of the global capital market has a lot to do with the starting point; fixed income ETFs started 10 years after equity ETFs and so there is a bit of a ‘head-start’ in equities.
Second, there are some doubts among different pockets of investors on how you can have second-by-second liquidity in fixed income ETFs when the underlying bonds don’t necessarily offer that. But that is the beauty of the ETF wrapper; it’s the packaging of those bonds where they don’t necessarily have to be bought and sold very frequently. In fact, roughly 90% of the time, the portfolio manager never has to buy or sell the bond. Half of trading in fixed income ETFs is one investor selling their exposure to the global bond market and another buying that exposure, effectively pairing it off at stock exchange level.
I think people got comfortable with those ideas but you’ve certainly seen a huge uptake in cashflows and the fixed income ETFs in the last couple of years and there is every reason to believe that more of that will happen in the future.
Do you see different appetite for different types of products within the strata of clients that Vanguard has?
Financial advisers have been the early adopters of ETFs since they’ve been buyers of products across the different categories, being equities or fixed income, US or international.
I think many investors are on a journey where they are moving away from home-country bias in terms of portfolio construction and as a result, we are seeing more use of non-US equity ETFs or non-US fixed income ETFs more prevalently among advisers. But the individual investor is still very much in the early days of ETF adoption.
What about the rise of quant and robo-models? To what extent are more automated processes working hand-in-hand with human intervention?
Where we have seen a lot of success is in this hybrid model that we offer, which is a combination of having an individual helping you build your plan but a lot of the automation in terms of the scalable function with the advice – the rebalancing engine, recommendations around portfolios, and then ultimately the choice of ETFs – is growing in a pretty significant way in terms of being the preferred vehicle to use.
I think there is adoption of ETFs across the entire spectrum there and I think robos are largely ETF-orientated. The individual ‘adviser on the corner’ is probably moving more towards ETFs and then the hybrid type of offers of an adviser and the robo- are also migrating more towards ETFs. I see a lot of tailwinds for ETF adoption.
Two dominant areas of focus right now seem to be ESG and sustainable investing and how to target the next generation of clients. To what extent can ETFs provide part of the solutions with both of those objectives?
ESG has evolved over the last 20 or so years where mutual funds were generally the way in which they are delivered and usually in an active structure. However, given the prevalence and preference for ETFs and indexing you’ve seen a lot of new ESG ETFs launched in the last couple of years. While there is not a huge amount of assets there yet – just less than $10bn – but the acceleration of adoption has been pretty meaningful.
Take our own products as an example: we launched two ESG ETFs last September and in around seven months’ time they had a collective asset base of just over $600m. These are new, broad products covering the common ESG criteria in a very low-cost ETF wrapper, and we are seeing a lot of resonance with investors as a result.
With regard to younger investors, we see that individuals tend to prefer ETFs over say investors that are a little bit older, given the entry point into ETFs is usually just simply the price of a single share which could be $100 or $200 versus a $3,000 minimum investment level.
Lastly, if you were launching as an ETF provider today, what might you do differently, or what do you wish you’d known before launching as a learning, given your experience?
I think we’ve done quite well actually; taking advantage of the existing index fund expertise and scale that we had available to be able to bring our ETFs to market at a very low cost and at a very diverse size and great tracking experience.
Perhaps one thing would be to espouse the benefits of ETFs to more clients earlier on – there are so many investors who don’t have the access to inexpensive index mutual funds on their brokers’ platform because of factors that are outside of both their, and our, control whereas an ETF is available on any broker platform and they could have taken advantage of low cost and indexing maybe earlier on than say just in the last couple of years.