Vanguard stock index ETFs are merely a newer and different share class of their original index mutual funds. But according to Vanguard, ETFs make up about 20% of assets, yet they accounted for 40% of Vanguard’s net cash flow in 2019 and 58% of cash flow so far in 2020.
There is good reason for this, and most is being driven by Vanguard itself.
For a long time, Vanguard ETFs and its Admiral Share class mutual funds had the same expense ratios.
I recommended the mutual funds because they had several advantages, such as buying fractional shares, no bid/ask spreads, always traded at net asset value (NAV), allowed for automated, dollar-cost averaging and faster dividend reinvestment.
ETF Fees Targeted
Early last year, however, Vanguard began reducing fees on ETF share classes but not on the corresponding mutual funds. I wrote about my tax-free conversion from the Total International Stock mutual fund to the ETF, which went very well.
But the gap in expense ratios has continued to increase.
|Vanguard Total Stock ETF (VTI)||0.04%||0.035%||0.03%|
|Vanguard Total Stock Admiral (VTSAX)||0.04%||0.04%||0.04%|
|Vanguard Total International Stock ETF (VXUS)||0.11%||0.09%||0.08%|
|Vanguard Total International Stock Admiral (VTIAX)||0.11%||0.11%||0.11%|
This caused me to wonder if Vanguard was de-emphasizing its ETFs over mutual funds. A Vanguard spokesperson responded:
“Vanguard is fully committed to the mutual fund product structure. At $4.7 trillion in mutual fund assets, Vanguard is the largest issuer of mutual funds. As it relates to expense ratios, the differentials reflect economies of scale resulting from Vanguard investors’ significant adoption of ETFs in recent years.”
Lower Fees, No Commissions
Vanguard’s costs are lower for funds held by outside custodians such as Schwab and Fidelity since Vanguard passes on such functions as tax reporting, record keeping and customer service.
And it seems logical that most investors would prefer to buy Vanguard ETFs over its mutual funds from these custodians since ETFs have no commissions, while the mutual funds purchased at those custodians typically do charge commissions.
So my hypothesis would be that if Vanguard can’t steer retail clients to its Personal Advisory Services, typically charging 0.30% annually, their second best option would be to have retail investors buy Vanguard ETFs at other custodians and let those custodians provide the extra services.
‘Difference Between … Night & Day’
"The difference between Fidelity's customer service and Vanguard's is night and day," says financial author William Bernstein. He also stated: “They lack a long-term vision of their services. The story of VGPMX is the poster child for their lack of fund mandate discipline.”
He is referring to Vanguard dropping the precious metals mandate for this fund, which is why I switched from Vanguard to the Van Eck Gold Miners ETF (GDX). Vanguard’s timing was terrible, as precious metals and mining stocks soared after the abandonment.
Bernstein notes other services were discontinued, like its banking Advantage accounts, concluding: “It makes you wonder what service they're going to drop next."
And Jim Dahle, founder of the Whitecoat Investor blog, echoes Bernstein’s views. He told me:
“The dilemma Vanguard faces with a strategy to concentrate on asset management and outsource its customer service like BlackRock (iShares) does is that both Schwab and Fidelity both offer at least some high-quality, low-cost ETFs that are on par with Vanguard and iShares ETFs.
While investors are grateful for the historical role Vanguard played to lower costs, put investors first, and promote passively managed investment strategies, more and more they will be asking themselves, 'What have you done for me lately?' Without improved customer service, even if it means slightly higher expense ratios, Vanguard will eventually lose its place as the default choice for investors. Many informed investors think it already has.”
There is some compelling logic that one might be better off getting superior customer service at a Schwab or Fidelity and buying Vanguard ETFs with zero commissions.
I do think the Vanguard ETFs are slightly superior, with all profits from securities lending going back to shareholders. I trust Vanguard a bit more not to raise fees, trapping money between continuing to pay the high fees or paying taxes to get out.
Vanguard might also benefit in the short run by allowing custodians like Schwab and Fidelity to take care of record keeping, tax reporting and customer service. Over the long run, however, Vanguard becoming narrower, offering fewer services and inferior customer service may backfire.
Leaning Into ETFs
I’ve written about one possibility of Schwab dominating Vanguard in a decade.
Vanguard is not going to abandon stock mutual funds, but it appears to be nudging investors toward ETFs. I expect ETFs to continue to gain share at Vanguard.
The current 0.03% expense differential between its total international stock index mutual fund and ETF amounts to $30 a year for every $100K investment. If you have stock index mutual funds at Vanguard, you can typically do a tax-free conversion, but can’t do the reverse and go back to the mutual fund.
This means you’ll pay a spread and possibly a discount over net asset value when you sell. That discount can be very large in times of panic, as I wrote about recently regarding the Vanguard Total Bond ETF (BND).
A Vanguard spokesperson said the company is committed to serving the retail investor well, stating:
“We are constantly looking for ways to enhance and create value for our investors. We are actively investing to improve the digital experience, adopt exciting and innovative technologies, and enhance our services, particularly for individual investors. Vanguard is built for—and will evolve for—our investors.”
Allan Roth is the founder of Wealth Logic LLC, an hourly based financial planning firm. He is required by law to note that his columns are not meant as specific investment advice. Roth also writes for the Wall Street Journal, AARP and Financial Planning magazine. You can reach him at [email protected], or follow him on Twitter at Allan Roth (@Dull_Investing) · Twitter.