A Sit-Down With Vanguard’s CEO

May 10, 2019

Is indexing's growth getting too big?

Buckley: First, let’s define “indexing getting big.” It’s not big enough!

Right now, if you look at cash flows, yes, index funds dominate them. If you look at assets in mutual funds, less than 40% of assets in mutual funds are indexed—most still in active. If you look at equity markets, indexing is 15% of equity markets; of daily trading, it’s 5%.

It’s tough to say there’s disruption in capital markets from indexing. From an ownership perspective, we are at that 15%, so we’re going to have a few firms owning that 15% representing individuals who didn’t have a voice before.

Mutual funds actually vote their proxies. So mutual funds are the voice of the individual, maximizing the return of that individual, taking the long view. Is that something you’d want to lose? We invite regulation and we invite the debate, but mutual funds [indexing] are improving governance and companies.

Can it get too big? At this point, it’s a theoretical concern. There’s some point on the trading side where the number [of players] somewhere gets too small and the market isn’t efficient anymore. That number is a ways away because indexing is such a small part.

Is passive management always better than active?

Buckley: We’re big active managers, actually, and we want to see active have a resurgence. But the only way it will happen is if pricing comes down.

Active management is a zero-sum game. People often think it’s active versus passive, but it’s not—it’s active versus active. Passive is market return. But active managers find excess return by taking it from another active manager. Your gain is their loss.

Over time, it’s become very competitive—80% of the assets are now professionally managed. It’s tough to find excess return. Distribution of excess return has come in by two-thirds, but costs have not come down. The numbers are terrible.

If active managers bring prices down, they can outperform. We’ve done it. Active can work. We have $5.4 trillion in total assets, and yes, most of it—$4.4 trillion—is in passive, but $1 trillion is in active. We believe in active management, just not in high cost active management.

We exist to take a stand for investors and make sure they hit their goals. High-cost active is not helping them. Why do we care? You don’t want to be the best house in a condemned block; you want everyone to be doing well.

What’s the magic number for active fees to be competitive?

Buckley: Twenty-seven basis points (or 0.27%). That’s where we are on average. I can tell you that number works. You have to lower enough so when you get excess return, it counts.

If I, the manager, get 100 basis points in excess returns, and charge 80 in expenses, there isn’t much wiggle room there. But if I take 30 and you get 70, you’re probably going to be better off [than market returns] in the long run. If I do better than 100 points, even better. Smart managers are starting to lower their prices.

What’s your view on ESG?

Buckley: We’ve had a lot of debate about those strategies. Demand varies by where you are. It’s stronger in California than it is in Texas. It’s stronger in the Netherlands than it is in the U.S. It’s bigger in New Zealand than in Australia, but they’re both big there. Some people see this as how they want to invest.

In the past, people saw ESG as a give-up. It can be if it becomes too exclusionary, and not for economic reasons. Strategies are getting better now, thinking much more about finding companies that are going to do well in environmental and societal scores, that have great governance, good companies, companies of the future.

It’s an area that we’ll continue to develop, and it will continue to be debated. But it’s here to stay.

Contact Cinthia Murphy at [email protected]

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