IU: You just segued beautifully into the next question. You began to speak about Tim. You are the consummate number cruncher in a strict portfolio management kind of way. And, for his part, Tim is a number cruncher, but perhaps more in that sort of MBA organizational enterprisewide kind of way. Is that a fair assessment?
Sauter: Yeah, I think that’s roughly a fair characterization. Tim has tremendous management skills. He has managed two other divisions of Vanguard. In fact, I’d note he’s probably the first person in the history of the investment management industry to be CIO twice. He was originally our chief information officer. Now he’ll be our chief investment officer. And, in between times, he ran our retail investment group.
So Tim has been on senior staff for, I want to say, at least 12 years and managing several different organizations. He was extremely good running and developing our retail and information technology groups. We’re at a stage of maturity where he’ll come in and do great things in the investment management group. I certainly do not want to make light of his investment acumen. He’s been working in our portfolio review group, which is a group that oversees all of our portfolio managers, internal and external. He has great investment knowledge. He just didn’t grow up on this side of the business.
IU: Give us a sense of the arc of the history and how your tenure and Tim’s will be stitched together in the grand sweep of things.
Sauter: When I started, indexing was only 3 percent of Vanguard’s book of business. And it wasn’t anywhere near close to 1 percent of the industry. So really, we had to go about building an index industry. Until a decade ago, we were 65 percent of the index mutual fund industry year in and year out.
So it was really very different, at that point in time trying to build our capabilities, but, at the same time, contributing to promoting the concept of indexing and helping to build that industry. Indexing has a tremendous amount of momentum behind it. It’s going to be a matter of making sure you're absolutely the best at indexing to compete. You will have to have tight tracking and you're going to have to have a low cost.
That will certainly play into Tim’s capabilities. I think we have an extremely strong group of people here. And I should have said this earlier that Tim will be supported by very, very strong leaders running the different departments within our division. We have tremendous portfolio managers who know their responsibilities. The next phase is just making sure that we’re extremely efficient in what we do, that we are managing all of the risks, whether they’re investment risks or operational risks. And that we are finding ways to create additional efficiencies and pass on cost savings to investors.
IU: Gus, why do you think index investing has been embraced so warmly by retail investors?
Sauter: There were three events that were the catalysts to the growth of indexing. The first one was the tremendous out-performance of large-cap stocks in the bull market in the latter part of the ‘90s.
Interestingly, at that point in time, investors were really focused on large-cap indexing, primarily either total market indexing or S&P 500 indexing. That’s really what people thought of when they thought of indexing, or maybe in 1999, they were thinking of the Nasdaq 100. It was a market that was so dominated by large-cap performance. All of those indexes were dramatically out-performing active managers, because they had a larger cap orientation than active managers had. That was like the first real shot in the arm that indexing got, and the first spurt in growth.
The second spurt was coming out of the bursting of the tech bubble. A lot of people had loaded up on tech stocks in the latter part of the ‘90s and really had a severe ride down throughout the bursting of the bubble. They realized they needed broader diversification. The whole discussion in 2003 was, “Maintain broad diversification.” Well, indexing is diversification extraordinaire. The second shot was not only retail investors, but also many advisors, financial advisors, who recognized they needed broad diversification. They didn’t want to target smaller, more volatile segments of the market. And indexing was a great way to gain that diversification.
I think the third shot was coming out of the global-financial crisis. We had had a decade of time where the return in the equity market was zero. And I think, quite honestly, incorrectly, investors projected the past into the future. They were expecting low rates of return going forward from the equity markets, which is not what we believe. But investors, many investors have adopted that notion, so they sought low-cost exposure to the market.
The recognition of the advantage of low cost came to the front when we had a low return environment previously. Low cost is certainly a strong characteristic of indexing. So again, that pointed to yet another advantage of indexing. Each one of them promoted a different advantage of indexing: low cost, broad diversification and relatively predictable performance.