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Vanguard’s Frank Kolimago on democratising investing

Frank Kolimago is Managing Director of Vanguard Australia. Previously, he was Principal at Vanguard’s Personal Advisor Services. He has been with Vanguard for 23 years.

 

GH: Many of our readers would be unsure what Vanguard’s 'mutual' structure means, and how it influences your business decisions. Could you explain it, please?

FK: Vanguard has a unique ownership model that goes back to our founding in 1975 by Jack Bogle. A typical asset management firm is either owned by public shareholders or privately by a family office or individuals. Vanguard is owned by our mutual funds and ETFs which are in turn owned by the investors in those funds in the US. Jack Bogle believed it was a better way to align the interests of the firm with investors rather than having a tension where business decisions are made on behalf of outside owners versus investors. We have a clearer client alignment.

GH: Can you give an example of how it might influence your decision-making compared with say a listed company?

FK: The biggest proof point is the fund and ETF expense ratios have declined through history. Our weighted average expense ratio is now about 10 basis points (0.10%) for close to A$7 trillion of investments globally. In Australia, we've had a history of delivering fee cuts. The bigger Vanguard gets, the more we look to pass economies of scale to our investors. At the same time, it's not just about low cost, we want to deliver a world-class service experience.

GH: At your recent 10th anniversary of ETFs in Australia, you talked about ‘democratising investing’. What does that mean?

FK: Democratising is giving investors the best chance of success. ETFs are a good example because they require low minimums to invest and at a low fee. A retail investor can get global diversification in a single trade. A few decades ago, such a solution was only available to an institutional pension fund. Now, mom and pop investors get the same benefits.

GH: Given Jack Bogle’s pioneering role in index investing, how do you reconcile that with offering active funds?

FK: When Vanguard was established in 1975, our initial suite of investments was 11 actively-managed funds. So while the growth of indexing has commanded a lot of attention in recent years, active has always been an important complement. Vanguard manages about US$1.5 trillion in active strategies, or about 25% of our global investment base.

We think of it as a low-cost investing philosophy as opposed to a binary active versus passive choice. Some investors see the benefits of active to seek outperformance, but also an appreciation that active can have periods of underperformance. That's part of that trade off.

We also use ‘sub advisory’ (Ed, external fund managers) relationships when we think they have talent and a track record in their processes and philosophies. We partner with them and they get access to our broad distribution. Vanguard also runs portfolios in-house, for example, on the fixed income side. So it’s not a source of any inner turmoil and we've been both active and passive throughout our history.

GH: Why hasn’t Vanguard joined the move into active ETFs in Australia?

FK: Well, a technical point is we do have three active ETFs in Australia, in the form of ‘factor-based’ ETFs. We have a value-oriented, a minimum volatility and multifactors. It’s a more quantitative approach but technically it’s active.

In our product development agenda in the 23 years we've been in Australia, our roots were passive and managed funds in the first decade. In the second decade, we’ve built out the ETFs with newer structures, like ESG, in both ETF and managed funds forms. We don’t rule out more active ETFs over time.

GH: Can you explain how you manage a global fund during the Australian time zone, where the underlying investments are not traded here but you issue and redeem ETFs during the Australian trading day?

FK: We have three trading hubs. One based in Melbourne, one in London and one in our headquarters in suburban Philadelphia, a town called Malvern. They give capabilities in the major regions when markets are open. The trading day begins in Australia, covering Asia Pac, then we hand off to our teams in the UK, and they pass positions to North America. We have the same processes, the same systems, the same structures, in those three markets as we ‘follow the sun’.

GH: What happens if, say, a global fund owns Apple, Microsoft, Google, etc, which are not trading in this time zone?

FK: The pricing intraday on the local exchange is done by market makers who cover our ETF lineup, including global funds. Each day, Vanguard advises the market makers of the basket of securities used to price each ETF. The market makers take the end of day Net Asset Value (NAV) in US dollars after the US market closes. At the start of the day in Australia, the market maker converts that US NAV into Aussie dollars at the current spot prices. From there, they adjust the value of the underlying securities using the movement of S&P500 futures which trades 24 hours a day. The market maker posts bids and offers throughout the Aussie trading day.

GH: So there are traders during the Australian and Asian day who are trading S&P500 futures, and the market makers do not trade in the individual stocks in the ETF?

FK: Yes, S&P500 futures is highly liquid and market makers have all the trading automated, and they make their money on the bid and offer spread. They may use other hedging techniques. We want to see our products at tight spreads with lots of liquidity so we encourage competition. The mom and pop retail investors coming in and out of our ETFs don't need to be concerned about the hedging complexity.

GH: One of your Australian team told me he used to work for an investment bank on Wall Street, and he said it’s a relief to work in the Australian operation of Vanguard. You have worked in many places around the world, do you see cultural differences between these locations?

FK: I’ve worked in four locations with Vanguard: Japan and Australia outside the US plus domestic sites at our headquarters plus our Western Region Service Centre in Phoenix, Arizona. I'm always amazed by the level of consistency in culture across Vanguard. When I started, we had about 2,000 crew members back in 1996. Today, there are over 18,000.

You need to maintain that culture. It’s in the way we recruit, the way we onboard, the things we reinforce, client-focused alignment, a strong focus on ethics and values. The strong level of consistency includes things like respect and collaboration. But whether you're in Malvern, Pennsylvania, or Melbourne, Australia, it essentially feels like the same organisation.

GH: And what do you think about the differences between investment banking cultures and Vanguard?

FK: We sometimes use the phrase in the US, ‘Wall Street sophistication with Main Street values’  I'm not sure if that resonates with Australians, but we make sure of our ability to handle complexity while old-fashioned ways of doing things shouldn't go out of style.

GH: You ran the Vanguard Personal Advisor business in the US. I'm not sure what generic term you call it such as robo-advice or digital investing, but can you explain how that model works.

FK: Sure, we're excited about Personal Advisor. Vanguard had a legacy advice business dating back over 20 years. It was a traditional model with a human adviser but essentially telephone-based built in the early days of the internet. It was a bit of a niche offering, but then we saw rising demand from our clients. Many had built their wealth in a do-it-yourself capacity and they were asking for high-quality, affordable advice. The big driver was demographic, an ageing population with lots of wealth. Vanguard was helping with low-fee investing and education and guidance, but clients were facing more complex retirement decisions. Like do I have enough to retire? How do I preserve my assets? Will they last over a long retirement? How do I cover health care costs at the back end?

Based on that need, we researched how could we scale to meet the demand in a way that would be affordable with a high-quality interaction. We settled on a hybrid model that sits in the middle with robo-like technology but a human adviser is a key component. We call it a hybrid, which is not as glamorous as robo, but it now has about US$145 billion under management since May 2015. The interaction is virtual, telephone and video-based with an adviser who participates. We have a couple of interactions upfront to do the consultation, the collecting of the information, then there's a structuring of a plan for the client. If the client accepts that plan, they get enrolled, and then they have an ongoing relationship with the adviser.

A lot of the focus has been on the pre- and in-retirement audience, with 85% of the clients aged 50 and older and half are over 65. It costs 30 basis points (0.3%) for ongoing advisory, and the weighted average investment cost is under 10 basis points (0.1%). So it’s advice plus investment with a human adviser and great technology when the traditional price for advisory fees alone in the US was over 1%.

GH: Does a client ring up a call centre and talk to whoever answers the phone, or do they receive a more personal relationship that develops over time?

FK: The initial engagement would probably start with the website, although they could consult with one of our contact centre reps. They would be directed to licensed advisers who have CFP and specialised skills. We use a team-based model for US$50,000 up to half a million but at US$500,000 and above, clients work continuously with the same dedicated adviser who brought them onboard.

GH: US$145 billion in four years is an extraordinary number in an Australian context. How much is new and how much came from other parts of Vanguard?

FK: The majority has come from existing Vanguard clients, but often they consolidate assets from outside of Vanguard, taking more into an advisory capacity. In the US, people have employer-sponsored 401k funds and they often roll them into the relationship. Our mutual model is dedicated to improving our capacity with existing clients and we have built our team to 775 advisers.

GH: It sounds like the only business model that will work for mass market in Australia under the new rules. What's the possibility of a rollout here?

FK: It’s not in our current near-term plans. Our focus is on upgrading and modernising our current retail business and enhancing its digital capabilities. It will create a foundation to extend the business over time. Technology and our learnings mean we can do things in a more cost-effective manner than in the past.

GH: Last question, Frank. Can you see any global trends either in investing or advice that will materially impact Vanguard business over, say, the next decade?

FK: Sure. Here are a few ‘lightning rounds’.

First, the accelerating pace of technology and the future without work or the future of work. Will technology automate work to a degree that will displace workers? And what will happen to portfolio management and financial advice? We think technology will help to automate many routine tasks. We already have portfolio construction and rebalancing and the creation of financial plans that's highly automated. But it gives the adviser more time to be more creative, more empathetic, and to invest more time in the relationship management. We don't think that technology will take humans out of the mix but they will focus more on a higher-order type work. We need to train people to have more of those ‘soft’ skills.

Second, the continued pressure on fees and the low-cost revolution. We've seen it on the investment product side, and we'll see it in other forms of financial services such as advice. We all need to embrace it, it's not something you can fight against, it's something that is inevitable. And developing business models that are efficient and cost effective where the value flows back to the client.

And the last thing is demographics and longevity. People retire, maybe in their mid-60s, and one member of a traditional couple could be looking at a further lifespan of 30 to 35 years. How do we structure portfolios that recognise such longevity? How do we help people who are doing different things over those decades? In the US, 10,000 Baby Boomers retire every day and we need to see that age wave coming and position ourselves to provide the best services and solutions.

 

Graham Hand is Managing Editor of Cuffelinks. This article is general information and does not consider the circumstances of any investor. Vanguard Australia is a sponsor of Cuffelinks.

For articles and papers from Vanguard Investments Australia, please click here.

 

3 Comments
Wayne
September 26, 2019

Regarding the bit about market makers - Frank says "Mom and pop retail investors coming in and out of our ETFs don't need to be concerned about the hedging complexity". But I'd be interested in knowing what happens when there is a major correction and everyone heads for the exits? Do the market makers still come out to play?

Also, given this article is predicated on passive funds exceeding actively managed funds by value in the US, I wonder what happens if this number becomes more like 75/25 in favor of passive funds? Does/will it create imbalances in markets?

Graham Hand
September 26, 2019

Hi Wayne, I have read the arguments by The Big Short's Michael Burry about redemptions from ETFs causing problems, but I don't understand why it's pointing only at ETFs or indeed passive funds. It's an issue about liquidity generally when investors panic and there are desperate sellers and far fewer buyers. It's the same for people in unlisted managed funds which need to redeem to meet redemptions, and even direct investors who want to find a buyers as the bid drops away.

I was working at CFS during the GFC, and client redemptions were so heavy that fund managers needed to sell whatever was the most liquid asset in the portfolio. It was frustrating for many managers because they could see the value, especially in fixed interest, but instead of being able to buy, they were forced to sell at whatever price the market would pay. Otherwise, funds would need to suspend redemptions which is poor for long-term reputations, but this happened in some funds with illiquid assets (such as mortgages).

So I don't see this 'major correction' argument as a pointed criticism of index funds or ETFs, but the ability of the market generally to meet liquidity needs when everyone heads for the exit.

Gary M
September 26, 2019

And I notice Michael Kitces reported this in his newsletter: "Also in the news this week is the announcement that Vanguard is preparing to launch a new “Digital Advisor” service, which will be a ‘true’ no-humans robo-advisor offering (as distinguished from its Personal Advisor Services solution with hundreds of human CFP professionals) charging just 15 basis points with a $3,000 account minimum."

No plans to bring to Australia announced, but that's a price point to worry robo advisors.


 

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