Buckley: We can always do a better job helping retirees, and advice will play a huge role in that, and the price of it. Technology is going to help drop the price of advice and its accessibility and quality.
Every retiree has different needs, and technology will also help with customization of the answers as well. When people talk about a “crisis,” people talk about savings and accumulation, and there have been huge strides in that.
What the target date fund has done as a qualifying default has been phenomenal—the cash flow we’ve seen into that! When you default into a money market fund, there’s a crisis.
But when you default into a target date fund, you’re getting a better answer and you’re in a better position going into the future.
How do you see advice evolving at Vanguard?
Buckley: Expect us to invest more and more in advice. We’ve been after advice since 1995. I’ve been involved with many of the efforts and many of the failures.
We’ve learned a lot. If you look at our current advice offering, our Personal Advisor Services (PAS), it’s growing 70% a year.
It has been incredibly successful because we’ve been able to combine advisors with technology to come up with a low-cost answer at 0.30%. Expect us to expand that work.
The technology behind that is largely digital, there’s a lot we can do with that, both in helping plans and also in helping advisors. Advisors ask all the time for the PAS technology, and we’re building that module so that it can actually be used by advisors.
We’re here to help clients, whether they come directly to Vanguard or through an advisor. If we can lower the cost of advice, we’ll do that. We don’t have a revenue model for it yet [or additional details], but we’re building it so it can be used outside the walls of Vanguard.
What’s the internal debate at Vanguard on mutual fund versus ETF fees?
Buckley: Both are rock bottom prices, but we had the debate to say ETFs is where most of the growth has been, and it’s a lower-cost vehicle for us to run. So, we try to reflect that. If it’s lower cost to run, then we should offer it at a lower price. But whether you’re using the fund or the ETF, they’re both very low cost.
When we talk to people, the conversation is more about when you would use the ETF versus the mutual fund. When you’re in an advice program, the ETF may be more advantageous for things like tax loss harvesting. For a lot of fee-based platforms, the ETF is better. It really depends on what your platform is.
Thoughts on nontransparent ETFs and direct indexing?
Buckley: First, on active ETFs, if you took at the traditional active fund and put it in an ETF, you have one big problem: You can’t close an ETF. The thing with active management is that alpha is scarce. If you’re a great portfolio manager, you eventually may say, “I’m at capacity.” And if you have an active ETF as your strategy, what do you do? You can’t close it. Whenever we roll out an ETF, we first make sure we have plenty of capacity for that strategy.
We’ve had many debates, for example, in muni ETFs on whether there’s enough capacity in that market, let alone in an active one. I worry about that on ETFs. On direct indexing, that’s a technology to watch, and is there a trend there? It has to be low cost.
The power of mutual funds is you’re pulling assets together and you’re getting scale and really low pricing. Now you have to have the technology to bring the assets together, trade in similar price; do people want the customization that would bring? Maybe they do, maybe they don’t. These are things you don’t dismiss, but is it a better answer?
What’s driving Vanguard’s growth?
Buckley: If you look at our growth over the last 10 years, two-thirds of our growth has come from two spots: target date funds and ETFs. We’ve been able to ride two trends of disruption: ETFs in the advisor space; and target -date funds in the 401(k) retirement plans.
Is indexing's growth getting too big?
Buckley: First, let’s define “indexing getting big.” It’s not big enough!
Right now, if you look at cash flows, yes, index funds dominate them. If you look at assets in mutual funds, less than 40% of assets in mutual funds are indexed—most still in active. If you look at equity markets, indexing is 15% of equity markets; of daily trading, it’s 5%.
It’s tough to say there’s disruption in capital markets from indexing. From an ownership perspective, we are at that 15%, so we’re going to have a few firms owning that 15% representing individuals who didn’t have a voice before.
Mutual funds actually vote their proxies. So mutual funds are the voice of the individual, maximizing the return of that individual, taking the long view. Is that something you’d want to lose? We invite regulation and we invite the debate, but mutual funds [indexing] are improving governance and companies.
Can it get too big? At this point, it’s a theoretical concern. There’s some point on the trading side where the number [of players] somewhere gets too small and the market isn’t efficient anymore. That number is a ways away because indexing is such a small part.
Is passive management always better than active?
Buckley: We’re big active managers, actually, and we want to see active have a resurgence. But the only way it will happen is if pricing comes down.
Active management is a zero-sum game. People often think it’s active versus passive, but it’s not—it’s active versus active. Passive is market return. But active managers find excess return by taking it from another active manager. Your gain is their loss.
Over time, it’s become very competitive—80% of the assets are now professionally managed. It’s tough to find excess return. Distribution of excess return has come in by two-thirds, but costs have not come down. The numbers are terrible.
If active managers bring prices down, they can outperform. We’ve done it. Active can work. We have $5.4 trillion in total assets, and yes, most of it—$4.4 trillion—is in passive, but $1 trillion is in active. We believe in active management, just not in high-cost active management.
We exist to take a stand for investors and make sure they hit their goals. High-cost active is not helping them. Why do we care? You don’t want to be the best house in a condemned block; you want everyone to be doing well.
What’s the magic number for active fees to be competitive?
Buckley: Twenty-seven basis points (or 0.27%). That’s where we are on average. I can tell you that the number works. You have to lower enough so when you get an excess return, it counts.
If I, the manager, get 100 basis points in excess returns and charge 80 in expenses, there isn’t much wiggle room there.
But if I take 30 and you get 70, you’re probably going to be better off [than market returns] in the long run. If I do better than 100 points, even better. Smart managers are starting to lower their prices.
What’s your view on ESG?
Buckley: We’ve had a lot of debate about those strategies.
Demand varies by where you are. It’s stronger in California than it is in Texas. It’s stronger in the Netherlands than it is in the U.S.
It’s bigger in New Zealand than in Australia, but they’re both big there.
Some people see this as how they want to invest.
In the past, people saw ESG as a give-up. It can be if it becomes too exclusionary, and not for economic reasons. Strategies are getting better now, thinking much more about finding companies that are going to do well in environmental and societal scores, that have great governance, good companies, companies of the future.
It’s an area that we’ll continue to develop, and it will continue to be debated. But it’s here to stay.