Vanguard’s Rampulla On The New Active Mgmt

Active management will not go away, it will just keep getting cheaper.

The name Vanguard is almost synonymous with index investing. But many overlook the fact that it quietly controls more than $1 trillion in actively managed assets. According to Tom Rampulla, head of Vanguard’s advisory business, they do so at their peril, because active investing today is more interesting and applicable than it has been in many years.

On Jan. 23, Rampulla will take the stage of the 10^th annual Inside ETFs conference to deliver the opening address (tickets are still available; register here). He recently sat down with Inside ETFs CEO Matt Hougan to talk about why active will be a key focus of that speech … and why advisors should be thinking about “the new active” in the year ahead.

Matt Hougan, CEO, Inside ETFs: You’re giving the kickoff keynote at Inside ETFs 2017. What are you planning to discuss?

Tom Rampulla, Managing Director, Head of Intermediaries Business, Vanguard: I don’t want to go too much into the speech—we’ll save that for the event—but I will say this: I want to talk a bit about active. There are lots of people asking, “Is active dead?” We’re going to say, unequivocally, “No.”

What’s traditionally been high-cost active isn’t the place to be these days, but low-cost factor and so-called smart-beta approaches are changing the game. We’re going to show how, for even the best active managers today, most of the value they add is through factor exposure, not stock selection.

So we think “high-cost active” is dead, but there is a “low-cost active” that’s looking pretty interesting.

Hougan: Is active especially relevant today? What’s your take on the current market environment?

Rampulla: We’re likely facing a lower-return environment in the future. We actually think that’s good, in a way, for most advisors. Their value proposition is strongest in a low-return environment, where you can add tremendous value through financial planning, tax location, tax-loss harvesting, discipline, rebalancing and behavioral coaching.

A low-return, high-volatility environment means behavioral coaching is more important than ever, and of course, in a low-return environment, costs are more important than ever. When you’re talking returns of 15%, what’s 50 basis points? When you’re talking returns of 3%, 50 basis points is a big deal.

So we think active can play a key role in portfolios in this environment. It just has to be low-cost active, and one way to deliver on low-cost active is through so-called smart beta and factor exposure.

Hougan: When you say active has a place in portfolios, what is that place? Is it at the core of a portfolio? Is it in the satellite? Is it about creating a behavioral outcome?

Rampulla: It could be all of the above. Advisors have different strategies, and we’re not going to tell them how to manage individual portfolios. But when you think about a factor like minimum volatility, it could be core or it could be noncore. 

If I have a client in retirement who’s drawing down their portfolio, I may want to get equity exposure, but with less risk; in that case, minimum volatility can be a great position at the core. In other portfolios, it could be a satellite addition to a portfolio. These are just tools for advisors to use.

Hougan: You mentioned advisor alpha and the behavior gap. One of my concerns is that the behavior gap will amplify in smart-beta portfolios. Do you think smart-beta strategies will make the behavior gap better or worse, or will it not matter?

Rampulla: Whether it’s smart beta or active quant or something in between, I don’t think that’s going to drive the behavioral gap. People chase returns, and that’s where advisors can drive tremendous amounts of value. But I don’t think the product itself impacts that behavioral gap.

Hougan: One question I get from advisors about smart beta is how to evaluate smart-beta ETFs. There are so many different ETFs out there—how should investors choose?

Rampulla: We see smart beta as active management. You need to evaluate these products the way you would evaluate any other active strategy. You look at people, process and performance. For us, performance comes last.

With a smart-beta strategy, the actual portfolio manager is not as important as with a traditional active strategy. But you have to understand the quantitative strategy and how stocks are selected in the portfolio. You have to ask yourself: Will there be enduring alpha premium in any given factor?

Hougan: Let’s turn to bonds. With rates backing up, what should advisors do about the bond portions of their portfolio? Should investors still have exposure to bonds? Should they alter the mix?

Rampulla: We think bonds are a diversifier. Of course, there has been a 30+ year bull market in bonds that’s unlikely to repeat anytime soon, so you have to lower your forward expectations of returns. But bonds still have a critical role to play in portfolios.

Hougan: One more hot topic before we wrap up: What about robos? Obviously they were top of mind two years ago, and quietly, the big established robos have been vacuuming up billions in assets. What should advisors think about robos today: Are they a threat, or a tool?

Rampulla: I look at robos as similar to other disruptions in the financial services industry, like the deregulation of stock commissions. When stock commissions were deregulated, they fell from several hundred dollars per trade to nothing, and massive new businesses like Charles Schwab emerged.

Similarly, the rise of low-cost indexing cut down the costs of active management, but also gave investors new tools to build portfolios. Robo investing is in a similar vein. Robos are putting a spotlight and competitive pressure on fees, and it’s part of the maturation of the advisory industry.

That means advisors shouldn’t ignore robos. They should ask themselves: How can I take advantage of this industry trend? If I can take advantage of the technology, I can scale my practice and engage with the younger generation that’s the future of my business.

So advisors should be thinking about how to take advantage of the robo-advisory tools, while also thinking about how they articulate their value proposition versus stand-alone robos. A big part of that proposition comes down to behavioral coaching.

If I’m working with a robo and the market blows off 15% or 20%, I can ignore what the computer tells me pretty easily. But if I’m working with an advisor and they’re talking me down off the ledge, that has a tremendous amount of value. Advisors just have to be confident and clear about articulating that value.

Hougan: What other challenges do you see for advisors in 2017?

Rampulla: Beyond leveraging today’s technology and staring down a lower-return environment, I’d be thinking about the demographics of the industry over the longer term. The average advisor is in their late 50s, and the average client is probably the same. How am I engaging the next generation of clients, and how I am planning for the evaluation of my own business? 

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