The investment fund management industry is facing mounting pressure on fees, driven by low returns and growing competition for the assets of increasingly fee-conscious investors, William McNabb, chairman and CEO of U.S. -based Vanguard Group Inc., told the Morningstar Investment Conference in Toronto Wednesday.
“Investors are asking what they are getting for what they are paying, and they want lower costs,” McNabb said. “It’s much higher on their radar than previously.”
McNabb estimates that a balanced portfolio of fixed-income and equity funds might achieve a return of 5% to 6% during the next decade. If you subtract uncontrollable elements such as inflation of at least 2%, taxes, and a high fund management fee, there is little on the table for the investor, he said.
“There’s no magic, it’s all arithmetic at the end of the day,” he said. “Costs are one factor you can control in an era of lower returns.”
One of the consequences of the search for lower costs is the growing popularity of exchange-traded funds, McNabb said. Vanguard entered the Canadian market late last year with the launch of six ETFs, and in six months has garnered about $225 million in assets. Its most popular products are the Vanguard MSCI Canada Index ETF, with a management fee of 9 basis points, and the Vanguard MSCI Emerging Markets Index ETF, with a management fee of 49 bps.
Vanguard is currently in the “product planning” stage and expects to add to its Canadian ETF lineup before year end, possibly in the fixed-income area or key subsectors of the Toronto Stock Exchange. Vanguard’s ETFs are based on traditional market indices weighted by the market capitalization of the underlying securities.
“From a strategic standpoint, we believe in staying focused,” McNabb said. “Narrow and deep is important. It is not our philosophy to introduce actively-managed funds in Canada or other fund structures.”
McNabb says there is a huge opportunity for advisors to add value in an era of volatility and low returns. It is important to build trust with clients and create a financial plan that removes emotion from the process. Advisors can help clients choose an appropriate suite of investments, monitor risk, rebalance when appropriate and maximize tax efficiency, he said.
“Advisors need to stop searching for alpha in the product and provide the alpha themselves,” he said. “Instead of trying to find the next hot performer, they need to pay attention to basics such as whether clients are saving enough, and hold their hands during tough times. They need to help clients set a course and stay with it. It takes tremendous discipline and that’s where the advisors can add value.”
Although Vanguard is focusing solely on launching ETFs in Canada, it offers both actively-managed and index-based products globally, with its US$2 trillion in global assets split fairly evenly between the two groups. But McNabb said that the cost-effectiveness of index-based strategies, whether through mutual funds or ETFs, is leading to rapid growth in passive investing. About 26% of U.S. equity fund assets are indexed in some form, he said, compared to virtually nothing in 1994. In 2001, the ratio of ETFs to mutual fund assets was $1 to $90; today, it is currently $1 to $16.
“What we hear from investors around the globe is that they want plain talk, simplicity, trust and lower costs,” he said. “With higher fees you’re fighting a huge headwind.”