Brennan (cont'd): The second is indexing, which was a pure curiosity when we got into the business in 1975. If you're the advisor, it fits beautifully with what you think you can do and provide to your clients, with the aim of being the highest-value advisor you can be. So you get a confluence of things that happen. And then you get a force like Vanguard that comes in and enters the advisor space, largely with ETFs. There are a lot of things that led to broad adoption of ETFs. None of it would be true, by the way, if it wasn’t simply a great product.
IU: Let’s talk briefly about Vanguard’s VIPERs. What exactly was the thinking when that started? Weren’t those really ETFs?
Brennan: They're actually the same product, just a different name. We initially branded them VIPER, which stood for Vanguard Index Participation Equity Receipts. And then, after a couple of years, we said, “When we talk to people, we say, ‘These are Vanguard ETFs.” So it was probably a misadventure on our part from a branding standpoint, although it has enduring value. But they're the same products.
The important part of VIPERs, when they came out, was this structure that allowed you to launch a bond ETF off the portfolio of a $50 billion existing index fund. And it’s why we, not uniquely, but aggressively, say, “These are index funds, just another form of indexing, where other people still want to create a sense of exoticness about them.” And advisors liked it better when they became the Vanguard ETFs, because it had explicit brand value.
IU: Are there too many ETFs?
Brennan: I've always believed there's a big difference between innovation and proliferation. And we have had both. Proliferation is a bad thing, in my view. And, yes, there are too many ETFs. Now it doesn’t mean there can't be new ones that will be valuable. But, when you look at the list of new products that have come out, you question the enduring value of many of them. That said, I think the fact that closures are occurring is a good thing, because the market is saying, “No. That’s not credible.”
I worry that too much proliferation can dilute the overall message of the power and the value of the ETF itself. This is a concern for all participants in the market. You end up with things that are so niche-y, they go against the principles of indexing. They're not low cost, and they're not diversified.
At the end of the day, the real ETF has to be scale-driven and cost-driven. Don’t forget that there are 35 or 40 ETF sponsors. You probably have too many sponsors producing similar products that can't reach scale and thus can't be low cost.
IU: How do ETFs get into the 401(k) space?
Brennan: I think that, in some ways, there is a less compelling need for ETFs in the 401(k) space than there is in other places, because the sponsor should have access to similarly priced index portfolios. For example, buying Vanguard Total Stock Market in the Vanguard 401(k) plan is functionally just as good as having VTI in the 401(k) plan. So, the question I would ask would be just a little different. How do we get correctly priced index options—ETF or not—to be more prevalent in 401(k) plans, large and small?