For the world's largest mutual fund company, the key to success has been in doing everything just a little bit differently.
From Vanguard Group Inc.'s head office in the borough of Malvern, PA to its unusual ownership structure, the firm, with $2.8-trillion in assets under management around the world, does very little by the book.
It starts with the way the company has been run since indexing pioneer John Bogle founded the firm in 1975. Vanguard doesn't answer to shareholders in a traditional sense, with a corporate structure akin to a co-operative company. It is owned by its funds, and by extension, the investors in the funds.
"Our corporate structure drives the way we think about everything," said Bill McNabb, chief executive of Vanguard, on a recent trip to the Toronto office. Mr. McNabb has been with the company since 1986 and is its third CEO.
The global company is perhaps best known for low-cost index funds. By getting market average returns with a very low cost, you're an above average investor by definition, Mr. McNabb says. Loyal investors brought their friends to Vanguard, and the company grew organically to achieve economies of scale that reduces costs further.
It's a strategy Vanguard brought to Canada in the from of a suite of exchange traded funds (ETFs) in 2011, at a time when low-cost index funds have increasingly popularity with investors. While Vanguard Investments Canada's share of the ETF market is small – less than 3 per cent – its assets grew by 277 per cent to more than $1.7-billion in the year to Dec. 2013.
Mr. McNabb attributes some of Vanguard's ability to grow steadily to things the company has said "no" to.
"In the late 1990s there was this absolute belief that if you weren't a financial supermarket you weren't going to be successful," Mr. McNabb said. The idea of offering banking services floated around, but the company ruled out the business because nobody was passionate about it and management didn't think Vanguard could be the best in the world at it. "And it would not drive our economic engine the way what we're doing in Canada might," Mr. McNabb said.
He modestly pointed out that Vanguard wasn't the only company with the bright idea to focus on its core strengths. In the mid-1990s American Express profitably divested several business line, such as its retail brokerage and asset management business.
In both the U.S. and Canada the battle for the aging boomer's wealth and asset management business is fierce. Toronto-Dominion Bank's chief executive Ed Clark recently said that banks are trying to "own every part of the customer," by building out many business lines.
But Mr. McNabb isn't worried about consumers consolidating their assets away from Vanguard, saying that kind of thinking underestimates consumer intelligence. "If people are given a better value proposition they will eventually make their way to it," he said. "It's pretty easy to have multiple relationships. Just think about how people's shopping habits have changed in the last decade."
Another change Vanguard is watching is the move towards fee-based investment advice. Vanguard doesn't pay a trailer fee on any of its funds, making them less attractive to advisers whose compensation is based on mutual fund commissions. In a fee-based advice relationship, where the adviser is paid out of the client's returns, rather than by the mutual funds that pay commissions to the advisers who sell them, the adviser is no longer incentivized to put mutual fund commissions they might receive before the client's needs.
The move to fee-based advice has accelerated in the last six or seven years and now accounts for more than 60 per cent of the U.S. market. Canada is a few years behind, and fee-based advisers accounting for just 20 to 30 per cent of assets managed. Although that market share is increasing steadily, according to Investor Economics.
"I'm guessing there will be a tipping point [in Canada]," Mr. McNabb said. "And we don't know when that will be, but we're certainly paying attention."
The company has also heightened its interest in ETFs globally, since they have become bigger than anyone expected, Mr. McNabb said.
Vanguard launched its first ETF in 2001 as a "toe in the water" and a "little bit of a hedge." But it wasn't until 2009 that Vanguard realized how great the appetite for these investments could be. "We really decided to put a strong point of emphasis on it," Mr. McNabb said. The asset class has grown from $40-billion in assets to nearly $350-billion in the U.S. in those few short years.
Mr. McNabb says the company's greatest challenge now is maintaining its reputation, which it has built on organic growth and scarcely any advertising.
"At the end of the day there's no way to value Vanguard because of the ownership structure, but we're probably worth a lot and it's all goodwill. That goodwill is made up of reputation," Mr McNabb said. "I think we're held to a higher standard … it's never far from our minds at the end of the day."