Vanguard Thrives in a Sour Climate

Low fees draw assets as other money managers see withdrawals
McNabb has preached Vanguard's low-cost gospel to financial advisers Photograph by Christopher Leaman for Bloomberg Businessweek

A dozen years of disappointing stock returns have soured investors on professional money managers, especially ones who charge high fees for their ability to pick winning stocks. For Vanguard Group, which sells mainly index funds at one-fifth the industry’s average fee, investor angst has been a windfall. Vanguard attracted $48 billion in deposits in the first quarter, the most in its 38-year history, and roughly one-third of all the money that went into mutual funds and exchange-traded funds (ETFs). “The world is coming around to our way of doing things,” says Chief Executive Officer F. William McNabb in his office on Vanguard’s suburban campus, which looks like a no-frills community college.

Vanguard funds charge an average fee of 16¢ on every $100 invested, compared with 79¢ for the industry as a whole, data from analyst Lipper show. Stock market returns that averaged 1.2 percent a year since 2000 and ultralow interest rates have forced investors to be more aware of such fees, says Burton Greenwald, a mutual fund consultant based in Philadelphia. “These days people are looking at every crumb they can pick up,’’ he says.

While Vanguard offers actively managed funds, it has never emphasized stockpicking or promoted star managers. It is best known for its index funds, which are designed to match various market benchmarks, such as the Standard & Poor’s 500-stock index. That has helped Vanguard benefit from a general loss of confidence in the financial industry since the 2008 credit crisis, says Nancy Koehn, a historian at Harvard Business School. “Their credibility is stronger, not because they have done anything different, but because the rest of the landscape looks so dubious,” she says.

With $1.9 trillion under management, the Valley Forge (Pa.) company is the largest mutual fund manager in the U.S.—a title it wrested from Fidelity Investments in 2010. Both Fidelity and American Funds, the second- and third-largest mutual fund firms in the country, have experienced net redemptions from their funds during the past year. Vanguard has 17 percent of the U.S. ETF market, up from 6.1 percent in 2007, Morningstar data show. Its share of stock and bond funds grew to 16 percent from 13 percent over the same stretch.

The Vanguard way was laid out in founder John Bogle’s 1951 Princeton University senior thesis, in which he criticized the investment industry for putting the needs of firms ahead of those of customers. When he set up Vanguard in 1974, Bogle devised a structure in which the company was owned by its funds, which in turn were owned by the funds’ shareholders. Profits were to be used to lower costs or to improve service.

Sixteen years after he stepped down as CEO, Bogle, 83, still retains an office and influence at Vanguard, from the pictures of British warships that he picked to decorate the walls to the emphasis on low costs and diversification that were his trademark. “We have strong Kool-Aid here,” says George Sauter, the firm’s chief investment officer. “If you don’t like the taste, you have to bail out.”

McNabb, 55, is spreading the Vanguard gospel to new audiences, including financial advisers, whose assets with Vanguard have grown 80 percent in the past three years. Wayne Blanchard is a convert. A financial planner in Orlando, Blanchard recommended actively managed mutual funds to his clients for most of the last 20 years. Over time he lost faith in his ability to find funds that could beat the market. “I wasn’t doing my clients any good,” he says. Today he uses mainly Vanguard ETFs, which mimic indexes but can be traded like stocks. His motivation: “They’re cheap.”

McNabb wants to make sure the company retains the positive image it has with the investing public. To reinforce his message, he recently spoke to a group of young Vanguard employees, stressing familiar themes: keeping costs low, putting the customer first, and investing over the long term. When one of the employees described that approach as “boring,” McNabb had a ready response: “Boring works.”

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