Kathy Bock, Vanguard
Kathy Bock, principal and head of Vanguard Canada. Photo by Jamie Hogge

When Toronto-based Vanguard Investments Canada Inc. entered the Canadian ETF market in 2011 with the launch of six passively managed ETFs, the low-fee investment manager was expected to make significant inroads. And it has.

As of March 31, 2019, Vanguard has become the third-largest ETF manager in Canada, with 39 ETFs and $19.6 billion in assets under administration, according to statistics from the Canadian ETF Association (CETFA) and Montreal-based National Bank of Canada. That gives the firm an 11.4% share of the $172.7-billion Canadian ETF market.

Kathy Bock, principal and head of Vanguard Canada, says that “given that we do not pay for distribution any place in the world, ETFs were the best place to start in Canada.” Bock, who has been with the firm since 1997 and now works primarily out of the Toronto office, took over for managing director Atul Tiwari on Jan. 1, 2019. Tiwari had led Vanguard Canada since its launch.

Having made its mark in ETFs, Vanguard jumped into the $1.5-trillion mutual fund market with the launch of four actively managed mutual funds last year: the Vanguard Global Balanced Fund, the Vanguard Global Dividend Fund, the Vanguard Windsor U.S. Value Fund and the Vanguard International Growth Fund.

Vanguard’s foray into mutual funds comes at a time of declining sales growth in the sector, compared with increasing ETF sales. But Bock, who is also head of Vanguard’s Americas business, which also includes Latin America and the Caribbean, is optimistic her firm will gain traction by offering “high-quality products at a good price point, which is very important for investors.”

Cost, she says, is the biggest hurdle to performance: “You can have great active management but if all the alpha is eaten up by high cost, it doesn’t benefit investors.”

She contends that Canadians have a long-standing preference for actively managed mutual funds – an area in which Vanguard has “strong capabilities to deliver value,” even though the firm is often perceived as a passive manager.

“Active management goes back to our founding in 1975,” Bock says, “so these new funds fit with our history and strengths as an organization.” Vanguard addresses its perception as a passive manager through “education, which plays a big role in terms of reaching out to [financial] advisors through our sales team and hosting investment symposiums.”

Tim Huver, head of product, Americas, for Vanguard in Toronto, explains that roughly one-quarter of the company’s $6 trillion in global assets is actively managed, making Vanguard the third-largest active manager in the world. The mutual funds being offered to Canadians already exist in the U.S., Huver adds.

Bock says that although there has been a pickup in ETF sales, active mutual funds will still be an important part of investors’ portfolios.

“There is a place for both ETFs and mutual funds,” Huver says.

While various surveys indicate that millennials prefer ETFs to mutual funds, Bock does not see demographic trends being a core driver of whether investors choose mutual funds or ETFs.

“There are categories of investor preferences” that drive investment decisions, Bock says. “Vanguard is relatively product agnostic and sees its ETFs and mutual funds as being complementary,” she says. As well, “some advisors may not have access to ETFs, and these mutual funds can help serve that group; so it really depends on the needs of financial advisors and their clients.”

Market trends bear this out. For example, Mackenzie Investments and Franklin Templeton Investments Corp., both traditional mutual fund companies based in Toronto, have experienced substantial success by offering ETFs as a complement to their traditional mutual funds. Last year, Mackenzie’s ETF assets grew by 127.5%, while Franklin’s Liberty Shares grew by 198.3%, according to CETFA.

In addition, the strategic alliance earlier this year between RBC Global Asset Management Inc., Canada’s largest mutual fund manager, and BlackRock Asset Management Canada Ltd., previously Canada’s largest ETF provider, is another example of companies seeking to offer investors greater choice and flexibility through a comprehensive suite of products (both firms are based in Toronto).

Unlike other mutual fund firms that have expanded into ETFs from a mutual fund base, Vanguard wants to leverage its success in the ETF space to attract mutual fund investors. Bock says that while the firm has more than $19 billion in ETF assets, Canadians currently have $33 billion invested in Vanguard funds, including U.S.-domiciled ETFs.

For Bock, this indicates the firm’s “ability to reach that many investors” and is “less so about business growth,” giving her cause for optimism that the firm’s following in Canada will translate into investing in its mutual funds.

The funds’ performance-based fee structure could drive sales. Management fees for all four funds are at their lowest during the first year of the fund, ranging from 34-40 basis points (bps). If a fund outperforms its benchmark in the second year, its management fee will rise to a ceiling of 50 bps. However, if a fund underperforms its benchmark in any year, its management fee will fall below the ceiling.

This fulcrum pricing model “aligns the interest of the investor with that of the advisor,” says Huver.

How does Vanguard offer substantially lower fund fees? Bock says it’s due to the fact that the company is owned by investors in its funds, not by shareholders. She explains that the U.S. parent, Malvern, Pa.-based Vanguard Group Inc., is owned by Vanguard’s U.S.-domiciled funds and ETFs, and those funds are owned by their investors, instead of the firm being publicly traded or owned by a private group of individuals. In turn, Vanguard Investments Canada Inc. is a wholly-owned indirect subsidiary of the Vanguard Group, which effectively translates into Canadian investors owning the Canadian arm.

Given that Vanguard does not pay for distribution, its four mutual funds are available only to retail investors in Series F versions, which are sold through fee-based advisors. The funds are also available in Series I versions for institutional investors, and on two discount brokerage platforms, Toronto-based Questrade Inc. and Qtrade Investor, owned by Toronto-based Aviso Wealth.

Although lower fees are one of Vanguard’s most attractive features, Bock says, the firm’s pricing structure “is not its core differentiation.” Rather, she points to “the firm’s track record, high-quality products and managers [who] deliver.”

Bock admits the funds’ distribution structure limits their growth, but she does not see it changing. She expects an increasing trend toward fee-based services, which will support the firm’s strategy of not paying for distribution. “The distribution model is beginning to change with more discussions about fee-based planning,” she says. Bock also anticipates that more discount platforms will place Vanguard’s mutual funds on their shelves.

Vanguard wants to attract the support of advisors through several development initiatives. Huver says the firm is providing advisors with education, practice-management training and resources to grow their businesses. “Our value proposition is to help them become involved in more holistic planning,” he says.

What’s next for Vanguard? “We hope to see greater downward pressure on mutual fund fees in Canada and hope that [our mutual] funds can help accelerate that trend,” says Bock. “While we can’t speculate about future pricing decisions, low-cost investment products are part of Vanguard’s DNA in terms of the benefit of our mutual ownership structure. As we grow in scale and size, we expect the cost of our products to continue to move lower.”