Retiring Vanguard CIO Gus Sauter Looks Back

December 21, 2012

Outgoing chief investment officer for Vanguard reflects on 25 years and peers over the 'fiscal cliff.'

The arc of Gus Sauter’s career at Vanguard is the story of the rise of indexing in modern financial markets. Sauter first arrived at Vanguard in October 1987, just two weeks before the “Black Monday” stock market crash. At that time, the firm had just $1.4 billion in assets in two index mutual funds, including the world’s first retail index, the Vanguard Index Trust/ 500 Portfolio.

By the time Sauter became Vanguard’s chief investment officer in 2003, the Valley Forge, Pa.-based firm’s fortunes were clearly beginning to change, and investors were waking up to the allure of low-cost indexing strategies. The company’s total assets had grown to $615 billion including $79 billion in that original fund John Bogle launched in 1976.

Now, with his retirement just days away, Sauter can boast of presiding over one of the most profound transformations in the history of finance. For one, Vanguard is now the biggest mutual fund company in the world, with $2.3 trillion in assets under management. More to the point, the ETF—the ultimate indexing vehicle—is the fastest-growing piece of Vanguard’s business, and to hear the mild-mannered Sauter tell the tale to IndexUniverse’s U.S. Editor-in-Chief Drew Voros and Managing Editor Olly Ludwig, his role in fostering the growth of Vanguard’s ETFs stands among his proudest achievements.

IndexUniverse: The big question staring at all of us right now is the fiscal cliff. Tell us what you think investors should be, one, thinking about; and two, should investors be thinking about making changes in their portfolios?

Gus Sauter: We don’t know when and what the resolution will be, but we do think that it’s important for investors to think longer-term. The big question would be, if you have some exposure to equities, do you think, for that portion of your portfolio, you can get better than equity-like returns over the extended period of time? Let’s say you’ve got a 10-year time horizon. Are you satisfied getting, let’s say, a 7, 8, 9 or 10 percent return in equities? Or do you think you can do better?

Our experience has been that investors really don’t do much better or any better than the market itself. Trying to time events, such as the impact of the fiscal cliff, invariably works against investors. By the time something happens, typically the market will have moved sufficiently to negate any potential gain. Waiting on the sidelines and then jumping onboard is going to cause you to miss the boat. We know that the market moves in spurts. And if you don’t capture those spurts, you don’t capture the market rate of return.

IU: How does an investor react to this environment of higher taxes?

Sauter: There are some tactical considerations. You certainly have to ask the questions and answer them, as opposed to ignore them. Should you realize capital gains, at this point in time in anticipation perhaps of higher capital gains taxes next year? There isn't a correct answer for all individuals. It’s a very personal thing. It depends on the nature of your portfolio, your age, the amount of your capital gains.

So certainly, investors should be considering all of these possibilities. But again, the response could be very different for two different investors. Obviously, if tax rates are higher on capital gains and/or dividends, the after-tax return is likely to be impacted in equities. I don’t think it would dramatically change how a portfolio should be put together. Over the immediate to longer term, equities will be the higher performing asset class and will likely deserve a spot in a portfolio.

IU: Can you comment on Vanguard’s recent switch to FTSE and CRSP indexes? And as a follow-up to that, there's been a pretty discernible pattern in investment flows since Oct. 2, back toward EEM notwithstanding its large expense ratio relative to Vanguard’s VWO. Do those flows concern you at all?

Sauter: So why did we make this change? Certainly, it wasn’t to benefit Vanguard. It was to benefit the investors in our funds. Because of our at-cost structure, all of the value created by cost savings falls through to the bottom line for investors. One of the fastest growing line items in our budget over the last five or 10 years is index-licensing fees. We’re always looking for ways to provide value to investors, whether that’s providing new services, whether it’s making improvements in our own processes here to gain greater efficiencies, or whether it’s identifying other ways to cut costs.

We did identify a way to really cut the costs of index licensing and provide long-term certainty of cost for index licensing. It amounts to literally hundreds of millions of dollars over time. We felt that that was certainly value-added to investors. Of course, we considered that it would raise a number of questions. The first of which is, are you sacrificing anything in quality? It wouldn’t increase value just to save money, but impact high quality.

We have worked with FTSE and with CRSP for a number of years now and are very, very satisfied that they are top-quality providers of indexes, and that they even have a couple of nuances in their construction methodology that others have not included that we liked. In the case of FTSE, South Korea is the big question. We do think it’s appropriate that South Korea is classified as a developed market. We think that FTSE has that right. It does mean that we’re going to have to transition the portfolio since the emerging-markets has South Korea in it at this point in time.

On the CRSP side, they have their packeting methodology, which slows down turnover when stocks are migrating from one style index to another. The lower turnover results in savings of transaction costs. So we feel that we’ve found an opportunity, to both significantly cut costs, and at the same time, maintain high quality indexes and even add a few whistles and bells.


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