The folks at Wealthfront posted an entry on their blog a while back about why they were going to use Vanguard’s exchange-traded funds going forward rather than those offered by BlackRock. As you may know, Wealthfront is a “robo-advisor” that uses algorithms to diversify the money it manages for people across a number of ETFs. Wealthfront is not large, but it has the potential be large someday, so whose ETFs they use is a matter of some importance.
Here is the relevant section:
Vanguard is essentially a non-profit, because it is owned by the investors in its funds. Therefore any profits it earns are returned to the investors in its fund in the form of lower fees. In contrast, Blackrock is a for-profit publicly traded company. It remains highly dependent on management fees from ETFs, which were the source of roughly a third of its $11.1 billion in revenue in 2016. Cutting fees on all their ETFs to Vanguard prices (not just their new “core” share classes) would cost Blackrock over $500 million in profits, which would be an almost 20% hit to their earnings …
In essence, Wealthfront is implying that clients may be better served if the financial services industry adopts a non-profit business model. But what in the name of all that is holy is wrong with making a profit? Last I checked, there are a lot of successful businesses with great products and satisfied customers that make obscene profits. Also, the U.S. is allegedly a capitalist country, so, you see, this is what grinds people’s gears about the whole movement in low-cost, passive-style index funds and why people go around equating them to communism.
Time to ask some questions. If being a “nonprofit” is so good in the asset management industry, then why don’t we see it elsewhere, like in the retail industry or the auto industry or the mobile phone industry? More philosophically, why are we fighting to retain (or eliminate) profit in the health care industry by forcing down drug prices? We could have a longer discussion here about the role of profit in society, but there are plenty of places on the internet to find that.
Vanguard isn’t a non-profit in the strictest definition of the term. Vanguard is more or less owned by its shareholders, but it does have to pay employees. And, as you know, people in the securities industry get paid pretty well, even on the low end. Vanguard has to compete — in a free market — to employ these people. The remarkable thing about Vanguard is that it manages to get its few thousand employees to “buy in” to making less money than they otherwise would, but how much less? My guess is they are still doing pretty well. Nobody is going to go to Valley Forge, Pennsylvania, and live an ascetic life in the name of low operating expenses and then struggle to put their kids through college. In fact, I’d bet that the salaries of key employees (like the manager of the $250 billion flagship Vanguard 500 Index Fund) are actually quite high, relatively speaking.
So, while Vanguard does not seek to maximize profits, what about the self-interested Vanguard employee? And does that create an agency problem, or rather a conflict of interest between Vanguard and its employees? At a traditional asset manager, everyone’s interests are more or less aligned, from the CEO on down. The firm succeeds if clients succeed or grow assets under management. Vanguard is different because all it cares about is lowering fees and assumes that client success will follow.
So maybe asset management as a non-profit works because, despite making less money, people are still pretty highly compensated compared with a lot of folks and have a pretty good quality of life. There is not a lot of stress about missing your benchmark. The market closes, you get to go home.