The Globe and Mail, Report on Business
Published June 10, 2011

We heard this week that Vanguard, the giant U.S. asset manager, is coming to Canada. As a permanent student of the business, I’ve been fascinated by Vanguard for many years. It’s an example of a company that grew through word of mouth. It went viral before the Internet was mature and long before Facebook and Twitter existed. Without a big advertising budget or a commission-based sales force, it now manages mutual and exchange-traded funds totalling $1.85-trillion (U.S.).

To go viral, a company needs to be unique, fill a customer need and be entrepreneurially managed. Vanguard fits the bill. On the uniqueness measure, it’s off the scale.

The company was founded by the father of indexing, John Bogle, and is headquartered in Valley Forge, Penn. It’s not owned by a family or bank, nor is it a public company. Vanguard is a co-operative. It’s owned by the unitholders and the mutual funds are run at cost. As a result, they have the lowest management expense ratios (MERs) in the business by far.

I have visited the Vanguard campus a number of times over the years, and what’s always jumped out at me is the esprit de corps. In an industry that has a tarnished image, this crew (nautical terms are used to name everyone and everything) is passionate about what it’s doing. Staffers work hard to improve client returns by providing lots of educational material while pounding away at the principles of long-term investing.

Vanguard was built on the back of the indexing trend, even though its roots were in active management (now 30 per cent of equity assets). When Mr. Bogle started the S&P 500 Index Fund in 1976 (now holding $112-billion), it took a while to get traction. When indexing eventually caught on, however, the company owned the market for a number of years.

As it enters Canada, Vanguard will be up against established players who offer a broad range of ETFs, but the market is still under-penetrated. Indexing has been much slower to catch on here due to the dominance of commission-based advisers and bank-branch sales. Indeed, until ETFs emerged in the last decade, Canadian investors had few low-cost index funds to choose from.

Set Benchmark for Fees

I expect Vanguard to lead on fees, and there will be some categories where it establishes a significant advantage. For example, one of its big sellers in the U.S., Vanguard MSCI Emerging Markets ETF, has an MER of 0.22, which is considerably cheaper than the competition.

Vanguard will also tout its strong record in tracking the indexes, where it’s rated best among the majors (i.e. smallest tracking error).

Will Vanguard have an impact on our investment landscape? I’d be surprised if it didn’t. Fees will come down. It will take away meaningful market share from existing ETF and mutual-fund players (there is already substantial pent-up demand for Vanguard funds among investors and advisers). And it will bring more of a long-term focus to the wealth-management scene through its educational efforts. In the U.S., Vanguard was late to the ETF party, but was the sales leader last year and is now No. 3, behind BlackRock (iShares) and State Street.

Skip the Advisers

If Vanguard chooses to focus on selling ETFs to advisers, as most people expect, its entry into Canada will be more evolutionary than revolutionary. In my opinion, it would have a far greater impact if it developed the other side of its U.S. model – a direct-to-client fund company that doesn’t rely on the adviser network. Without the middleman, the cost for clients would be substantially lower and Vanguard would have a bigger impact on investor behaviour.

Direct distribution makes up 20 per cent of the fund market in the U.S., with Vanguard, Fidelity, T. Rowe Price and a few others having substantial assets under management. In Canada, however, the direct market is still a niche, with only RBC Phillips, Hager & North and a few other small firms (including Steadyhand) taking it seriously.

Whichever way Vanguard chooses to approach the Canadian market, it will be a positive influence. Its culture and ownership structure put it solidly on the side of the investor and it has the heft to shake up our market’s dominant players.