15 bps and a Cloud of Dust

October 03, 2007

Matt's 15 bps feature has been popular. The question is whether expense ratios are the only thing you should be looking at.

A couple things are striking about Matt's portfolio. One is that Vanguard is completely dominant in its representation in part because they focus on the broad diversification Matt favors, but mainly because they have completely blown all of their competition out of the water on pricing. Is that all you should be looking at, though?

The answer is—of course not. You want to see, above all, what you're getting exposure to and to make sure that this matches your investment goals and risk profile. And you want an index fund manager who knows what he's doing. So you want good indexes covering the right asset classes at a reasonable price.

The thing is, it is very difficult to find much fault even with Vanguard's index fund management, though I suppose that you could make the case that many of their ETFs are tracking mainly new and mainly untested MSCI U.S. indexes. But I guess I like my chances with those. And Gus Sauter really is legendary for the performance he has squeezed out of the index equity funds.

So if the funds are so good, why is Vanguard so far behind BGI on ETF assets?

For one, they're relatively new to the game, and when they first entered the ETF market, they seemed ambiguous about even wanting to be there. In addition, ETFs are not IT for Vanguard. Their retail fund business, in particular, and now their institutional business have also been very successful as their ETFs have ramped up. And of course their ETFs are just one fund structure of a large established fund family.

And on the other side, BGI has never wavered in its commitment to iShares. And they've put together an extremely comprehensive lineup of quality products in a way that is thorough and makes sense. And they've marketed the heck out of them and have always sold the whole package as an integrated solution. They've also often been first mover and have tended to be in all the right places at the right times ... but their growth is really about the asset allocation story, not the hot asset class. So in that way, and many others (lots of smart geeky guys running around with spreadsheets, off the beaten path of Wall Street location, academic feel), these are very similar shops and SSgA fits right in with this club.

But BGI and SSgA may not join in the race to the bottom on fees (though they've already done that in the institutional space, so we shouldn't put it past them) and Vanguard isn't going to quite crank up the marketing matching to BGI levels on the ETFs. And apparently there is room for them all, including the SSgAs and their $80 billion ETF, the PowerShares, ProShares, Rydexes, Claymores, First Trusts and the rest...

I look right at fees as the most easily controlled fund variable. I also look at where I'm at with an index, and yes, I do look at returns series. And some of these active guys (including Vanguard) are outpacing the indexes from time to time. I love the competition and finally seeing active have to play the fee game too (the less you pay in fees, the more of any alpha there is that you'll get, and ultimately the higher your returns). So I'm looking forward to seeing the active ETFs really turn things in that direction the way that Vanguard and now ETFs in general have turned attention to cost and structural efficiency. That's where we as investors want the battles to be waged.

Then maybe Matt can run a "50 bps portfolio" with 100 bps of alpha.




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