Asset Allocation Strategies

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>>> Why Investors Are Pulling Money From Vanguard’s Index Funds


Barron's

By Leslie P. Norton

Oct. 22, 2020


https://www.barrons.com/articles/why-investors-are-pulling-money-from-vanguards-index-funds-51603390832?siteid=yhoof2


Vanguard Group gets a lot of credit for the massive inflows into its exchange-traded funds. For good reason—for years it has been vacuuming up money, and, in some periods, has even taken in more than the rest of the ETF industry put together. But that edge may be slowing, and a closer look at the numbers reveals that its industry lead isn’t quite as exceptional as it might seem.

The news is certainly good for Vanguard. Investors added $134.3 billion to Vanguard ETFs in the first nine months of the year, according to ETFGI, up 73% from a year earlier. That’s a wide lead over rival BlackRock (ticker: BLK), which took in $106.3 billion, State Street Global Advisors, which saw inflows of $21 billion, and Invesco (IVZ), which took in $19.4 billion.

For Vanguard, the haul from the first nine months of the year is much greater than the $119.3 billion in ETF inflows it saw in 2019. Freddy Martino, a Vanguard spokesman, says that Vanguard maintains its lead in ETFs.

But a significant portion of those ETF inflows aren’t money that’s new to the firm. Vanguard has a unique structure: Its ETFs are actually a share class of its index mutual funds. Roughly 17% of Vanguard’s ETF flows so far this year, or $22.8 billion, came from people moving money out of a mutual fund and into the ETF version.

Back those flows out, and Vanguard’s ETF inflows for the nine months were $111.5 billion—still ahead of BlackRock, but less comfortably. It also suggests that inflows into Vanguard’s index funds—both mutual funds and ETFs—were sharply lower than last year. For the first nine months of this year Vanguard took in $60.3 billion, or just 47% of what it did in the same period last year.

“Vanguard has been taking money out of one pocket and putting it into another,” says Ben Johnson, director of ETF research at Morningstar. Vanguard has encouraged investors to swap out of its index mutual funds to ETFs in recent years, dropping expense ratios for the ETF versions of many core funds below those of the Admiral share class for mutual funds. (Admiral shares require a $3,000 minimum investment and feature lower expense ratios than standard Vanguard investor shares.)

For example, the Vanguard Total Stock Market Index fund’s Admiral shares (VTSAX), has an expense ratio of 0.04%. The ETF version, with a ticker symbol of VTI, has an expense ratio of 0.03%. That made the migration “inevitable,” Johnson says.

This is the first year in more than a decade in which more Vanguard index mutual funds have seen redemptions than purchases, with outflows totaling some $71 billion in the first nine months of the year, according to an analysis by Morningstar. Since $22.8 billion of that went into ETFs, $48 billion actually exited.

The trend began, like so much of what’s happened in 2020, in March. When the market cratered, investors withdrew $16.4 billion from Vanguard’s index mutual funds.

What accounts for remaining index mutual fund outflows? Johnson says it could be clients pulling out money because they’re retiring, or because they’re negatively affected by the pandemic. Perhaps some are opting for active management as the markets become more volatile. Some might have gotten so wealthy that they’re taking money out and putting it into, say, private-equity funds, which Vanguard started offering this year.

Dan Wiener, an investment manager who is also editor of the Independent Adviser for Vanguard Investors, notes that mutual funds are still more important to Vanguard than ETFs. Vanguard has $1.4 trillion in its ETFs, but it has $6.4 trillion in total assets, including $1.6 trillion in actively managed funds.

“I would not categorically say that the ETFs have been a resounding success except within the ETF market,” says Wiener. For instance, he points to the Vanguard Small-Cap ETF (VB), which has $13 billion in assets, while the four share classes of the open-end mutual fund have $61 billion. “For the typical Vanguard investor who grew up with open-ends, and even for many institutions, in a lot of cases the open-ends win.”

Still, this marks a continuing cultural change at Vanguard, whose low-cost advantage is being eroded by advances in technology, industry consolidation, and heightened competition. The firm’s clients have changed too: To compensate, it has pushed to make inroads with financial intermediaries as well as into ETFs. “Vanguard is evolving to become more marketing-oriented,” Wiener says.

Investors still need mutual funds for their 401(k) retirement plans, most of which don’t have ETFs because it’s too hard to account for investments that trade more than once a day. ETFs also don’t allow for fractional share purchases, which complicates employee purchases. That could help stem the trend.

Indeed, Vanguard’s Martino points out that the percentage of 401(k) plans offering index funds and target-date funds has increased steadily over the past decade, while the percentage of participants that use target-date funds—a key source of demand for index mutual funds—has also steadily increased.

“Ultimately, it comes down to the investment vehicle that meets investor needs in the best possible way,” he says. “It’s right in line with the Vanguard core tenets.”

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