(NOTE from Vanguard founder John C. Bogle added 11/29, bottom): Vanguard Group, the Malvern-based investment giant that manages close to $5 trillion in clients' money, said Tuesday that it has registered a plan with the Securities and Exchange Commission to sell its first actively managed U.S. exchange-traded funds, starting next year. The funds will be targeted to "factors," or investing trends, such as recent high share prices (a "Momentum" ETF) and strong financial results ("Quality").
As stocks, exchange-traded funds are easier to buy and sell quickly than mutual funds, one reason Vanguard founder John Bogle, who preached a buy-for-the-long-term philosophy, initially resisted ETFs.
So the latest Vanguard step, given the company's past culture, "is huge. It's the equivalent of Dylan going electric," cracked Eric Balchunas, fund analyst for Bloomberg Intelligence, in a social-media post.
"The active ETF could be the end of mutual funds," said Matthew Topley, chief investment officer at Fortis Management, a King of Prussia investment adviser. "Anything a portfolio manager wants to express in a fund, can become wrapped into an ETF, at lower cost and much greater tax efficiency," because ETF sales don't trigger mutual fund-style underlying asset sales that could leave an investor liable for capital gains.
Given Vanguard's low fees and its success at raising $1 billion a day in customer funds, often from competitors, in the last year, "good luck to everyone else," said Josh Brown, chief executive of Ritholtz Wealth Management, a $600 million-asset New York firm that sells Vanguard ETFs, among other investments, to its clients.
The funds will give brokers new product to sell, but "Vanguard isn't pushing these new products onto individual investors," Dan Wiener, publisher of the Independent Adviser for Vanguard Investors newsletter, noted in a report to clients. Pointing out that most of the ETFs mirror existing Vanguard fund strategies, he said such "quantitative funds" have generally trailed Vanguard's own MidCap Index, Value Index, and other "basic benchmark" funds' returns.
The company already sells low-fee index-based stock and bond ETFs — which are stocks consisting of shares in other companies — in competition with BlackRock, Barclays, and other industry pioneers, as well as active ETFs in Canada and Britain. The company manages about $710 billion in stock ETFs and $148 billion in bond ETFs.
While ETF sales are growing fast, Vanguard's major product is mutual funds, both "active" funds, whose managers pick stocks, as well as "passive" funds tied to such indexes as the Standard & Poor's 500, which have become the company's best-known products. Vanguard was founded in the 1970s as a vehicle to sell actively managed Wellington Management Co. mutual funds, such as the Wellington and Windsor funds, which it continues to market (along with those managed in-house and by other firms) along with the indexed funds. (11/29: SEE NOTE FROM JOHN C. BOGLE BELOW)
Vanguard has designed the new ETFs to be sold to institutional investors and by financial advisers such as the Ritholtz firm. Vanguard promised the funds will adhere to "rules-based quantitative" buying and selling by the fund managers at Vanguard Quantitative Equity Group, which currently manages $35 billion in Vanguard "factor funds" that buy and sell stocks based on measurable performance "rules."
The new funds will be an "extension of our low-cost active lineup," Greg Davis, Vanguard's chief investment officer, said in a statement.
The funds, most of which are similar to existing Vanguard mutual funds, all "seek to provide long-term capital appreciation" by investing in U.S. stocks that show these "factors" compared with other U.S. stocks:
Vanguard U.S. Minimum Volatility ETF, "lower volatility" stocks.
Vanguard U.S. Value Factor ETF, "relatively lower share prices" compared with companies' "fundamental value."
Vanguard U.S. Momentum Factor ETF, "strong recent performance."
Vanguard U.S. Liquidity Factor ETF, "lower measures of trading liquidity."
Vanguard U.S. Quality Factor ETF, "strong fundamentals."
Vanguard U.S. Multifactor ETF, "relatively strong recent performance, strong fundamentals, and low prices relative to fundamentals."
Vanguard also is adding a U.S. Multifactor mutual fund (minimum investment: $50,000 for Admiral shares) because, unlike with the other ETFs, it doesn't already have one.
How much will these cost? Vanguard says "the five single factor-based ETFs will have an estimated expense ratio of 0.13 percent; the Multifactor ETF and Multifactor Fund will have an estimated expense ratio of 0.18 percent," below industry averages, according to data collected by Morningstar Inc.
(NOTE ADDED 11/29: John C. Bogle is concerned that my brief account in this story will leave readers with an over-simplified view of Vanguard's early relationship to his previous employer, Wellington Management Co., which remains a manager of some of Vanguard's active funds. Below, I'm posting his note in its entirety:)
"Hi, Joe: Very revealing story this morning. Nice work!
"I have no comment about Vanguard's ETF strategy (that won't surprise you!), but I do need to correct your understanding of Vanguard's formation.
"In September 1974, I created to Vanguard to administer the affairs of the former Wellington funds — executive, financial, shareholder recordkeeping, and legal and compliance, etc., duties formerly performed by Wellington Management Company — as well as overseeing and appraising Wellington's investment performance for our funds, their distribution results, and the fees the funds paid to Wellington. We were barred from engaging in investment management and distribution and marketing of fund shares.
"Of course my goal was to engage in both of these board-prohibited activities. I was able to 'get around' them, first, by bringing out and managing, as it were, First Index Investment Trust in August 1976, and then by eliminating all sales commissions in February 1977, and thus abandoning the broker-dealer network that had served the funds for nearly half a century. (Going "no-load.") Result: within three years of our founding as an administrator, we had become the full-fledged fund complex that we remain today. Dare I say that it worked out well for investors?
"But it wasn't easy. Indeed the SEC fought the distribution decision until 1981, when it gracefully conceded, and saluted our departure from the typical industry structure in which the money managers control the funds.
"You have to love a good fight — I do — to change the investment world. Best, Jack"