photo by Wikimedia Commons user Grk1011
Vanguard’s low-cost mutual funds have many enthusiastic fans, but their number does not include many of the large financial firms whose customers are buying those funds.
The Wall Street Journal reported that companies including Fidelity Investments and Morgan Stanley have made it more costly or even impossible for their customers to invest in Vanguard’s mutual fund offerings. Vanguard, riding the wave of passive investing’s rising popularity, grew explosively over the past decade. The company managed $1.4 trillion in assets 10 years ago, but today manages $5 trillion, making it the second-largest money manager in the world.
While firms like Fidelity have supported this growth by selling Vanguard’s products to their customers, now it seems that brokerage firms and retirement-plan administrators are belatedly trying to cut off – or at least slow – the flow of cash to a company that has been both a partner and a competitor.
Fidelity made waves in the investment world when it announced that it would charge new 401(k) plan clients with $20 million or less in assets a 0.05 percent fee on any Vanguard funds the plan holds. Fidelity has argued that this move is simply about “leveling the playing field,” but many industry observers aren’t buying it. Singling out one fund manager this way is highly unusual.
Employers, rather than plan participants, will bear this extra cost. However, many companies share plan administrative costs with plan participants, so savers may bear some portion of the higher fees. While a 0.05 percent change is small, such fees can reduce long-term returns. And Fidelity surely hopes that plan administrators, investors or both will find Vanguard funds less attractive with the extra fee, or at least that they will find Fidelity’s offerings more competitive. Fidelity reduced prices on many of its own index fund offerings in 2016.
As Jim Keenehan, senior consultant for AFS 401(k) Retirement Services, told Employee Benefit News: “It is no coincidence that Fidelity lowered the fees on its own suite of passive or index funds so I think this change is also going to have an impact of opening the door a bit on the Fidelity platform for Fidelity to win back some of the market share they have been losing so rapidly to Vanguard.”
Some observers have speculated that other 401(k) record-keepers will follow Fidelity’s lead given Vanguard’s dominance in the space. Morgan Stanley has gone even further and cut Vanguard’s funds from its wealth-management platform entirely, putting it in the company of Merrill Lynch, which has long forbidden its financial advisers from selling Vanguard funds to clients.
Ultimately, such moves are misguided at best. I would expect that Fidelity’s added fee will gain the company practically nothing in marginal income, while potentially turning off prospective new clients. It would take a lot more than a few basis points to check Vanguard’s ascent at this point, when the firm is already deeply entrenched in the market, and beloved and respected by most investors. Morgan Stanley’s move risks not only infuriating customers, but also raising questions about its business model and conflicts of interest. Vanguard’s strategy is to lower the cost of investing across the board, and other firms are not in a position to do much about it.
Many of the firms pushing back against Vanguard favor active management, but that has been a losing battle for quite some time. S&P Dow Jones Indices’ most recent SPIVA Scorecard indicated that only 7 percent of U.S. large capitalization mutual funds outperformed the S&P 500 Index over the 15-year period ending in June 2017. And, as Nir Kaissar pointed out in a Bloomberg commentary, that measure does not include funds that went under during that time. Investors are growing increasingly sensitive to fees just at the time active managers increasingly struggle to justify their relatively high costs.
Eventually, something has to give. There may be a shakeout in the industry, with weaker active managers falling by the wayside. Or we may see a capitulation on fees from firms like Fidelity. The longer active managers with high fees underperform, the more difficult it will become for them to justify their fees. Whatever comes next, attempting to sucker-punch Vanguard isn’t the answer.