Sometime before 2001, when the Vanguard Group was still mulling the idea of offering exchange-traded funds (ETFs), there were a lot more questions than answers. How would ETFs impact Vanguard's mutual fund business? Would ETFs go against Vanguard's philosophy of long-term investing? And how would investors react to Vanguard ETFs? Would they embrace them or reject them?
Fast-forward to today and many of these questions have found an answer.
Both retail investors and financial advisors have indeed embraced Vanguard's ETFs. Assets ended June at $33 billion, an increase of 47 percent from year-end 2006. In July alone, Vanguard attracted $1.5 billion in ETF assets, bringing year-to-date cash flow to $9.4 billion and ranking the company second among all ETF providers. In other words, Vanguard ETFs are enjoying their best year ever.
"We've seen particularly strong interest in our broad market offerings, including Vanguard Total Stock Market ETF (VTI), Vanguard European ETF (VEA), Vanguard Total Bond Market ETF (BND) and the Vanguard Emerging Markets ETF (VWO)," explains Martha Papariello, principal of Vanguard's advisor services unit. Assets are congregating to these funds because they substantially lower expense ratios versus corresponding ETFs.
As of mid-summer, the Valley Forge, PA-based firm offered 33 ETFs in a broad swath of asset classes.
Taking Aim at RivalsEarlier in the year, Vanguard took a significant step by adding fixed-income ETFs to its product menu. This was a particularly bold move since the bond category over the past few years has been dominated by rival Barclays Global Investors, manager of the iShares. Vanguard didn't just launch bond ETFs based upon key Lehman indexes; it did so with expense ratios of 0.11 percent, practically half the cost of competing bond ETFs.
Likewise, the Vanguard Europe Pacific ETF (VEA), which follows a popular measure of international stocks, the MSCI EAFE Index, competes with an identical offering from iShares (EFA), but VEA invests in about 25 percent more securities than the competing product and has an expense ratio of 0.15 percent, or less than half the cost of EFA.
"The lowest of low expenses are seldom the deciding factor, but if you couple it with a competitive alternative ETF, then the nod goes to Vanguard," says Katie B. Weigel, a planner at LongPoint Financial Planning in Concord, Mass.
Interestingly, Vanguard's approach to the ETF marketplace is strikingly similar to its recipe for success in the index mutual fund business: Offer a core group of index funds in multiple asset classes with rock bottom expenses. As the asset growth indicates, the strategy seems to be working.
Privileges of ConvertingMany investors hold Vanguard index mutual funds in a company-sponsored 401(k) plan. An individual with $1 million in an retirement plan split between the Vanguard Total Stock Market Index Fund (VTSMX) and the Vanguard Total Bond Market Index Fund (VBMFX) will pay $1,950 in fees, but by owning the equivalent ETFs, expenses drop to $900 a year.
For a one-time fee of $50 per fund, Vanguard will allow your client to convert their index funds to the ETF share class. In this case, it would mean switching to the Vanguard Total Stock Market ETF (VTI) and the Vanguard Total Bond Market ETF (BND). Even though the ticker symbols change, the investment strategy remains the same. While $1,050 may seem like chump change today, it adds up to a hefty amount when compounded over decades.
It's worth noting that Vanguard investment accounts with at least $1 million can convert to ETF shares without incurring conversion fees. And for taxable investment accounts, conversion is not considered a liquidation or taxable event.
Reaching Out In the past, Vanguard seemed driven to compete with financial professionals, but in recent years, the company has emphasized the important role advisors play in the investment decisions their clients make.
Last December, the company introduced a practice management center within its dedicated advisor Web site (advisors.vanguard.com).
"We created this to help advisors develop their practice to meet the changing needs of their clients, to identify new clients, and to stay on top of industry developments, financial trends, and continuing education requirements," states Papariello.
Ron DeLegge is the San Diego-based editor of www.etfguide.com.