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Can Vanguard Pull Off Actively Managed ETFs?

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Low cost, customer service and quality: As the adage goes, you can have two out of three, but never all at once.

Industry behemoth Vanguard has built its business — now at $5 trillion of assets and counting — by offering low-cost products tied to indices and excellent customer service. Since the days of Jack Bogle, the firm carved out a niche and clearly the results speak for themselves.

But in late November, Vanguard stepped partially out of its well-established comfort zone and jumped on the actively managed ETF bandwagon here in the U.S. Whereas its index-based products are passive and don’t require significant human monitoring or intervention, the mere definition of actively managed products means the significant involvement of human brain power in the making of decisions that attempt to beat the index.

Traditionally, active management and low cost have been mutually exclusive, and for good reason. Active managers with a track record of success are like professional athletes — healthy compensation follows strong results — and investment advisory and fund management firms recruit and compete for that talent. This competition is like the free agent markets in professional sports: lucrative salaries that have to be paid for from somewhere.

The situation creates a set of goals that work against one another. Vanguard’s ability to offer low cost and well conceived and marketed funds is truly unmatched. Can active management, with the need to pay for the talent to manage those portfolios, fit into the business model where low cost is virtually synonymous with the Vanguard brand?

This situation reminds me of when the banks decided to offer mutual funds a few decades ago. They saw the writing on the wall and figured that because the bank held people’s deposits and loans, they might as well offer them investment products.

To some extent, they’ve been successful. However, they haven’t been able to squeeze out their competition that focuses solely on offering mutual funds, and I will argue that there is not anyone out there who would say that large banks’ core strengths are their mutual funds.

If Vanguard wants to be successful in offering actively managed products in the United States, it needs to be prepared to pay for the industry’s best and brightest at the helm, which means competing with other issuers to attract and retain talent. That will cost many millions, perhaps even billions, depending on how many actively managed products Vanguard plans to offer.

Again, that begs the question: Can you offer low cost and highest quality in the same package? As a white-label issuer, we know that innovation is at the core of the ETF industry. My word of advice to potential issuers is to proceed if you have a good idea, have a following among registered reps and wealth managers, and have a strategy to raise assets.

There may be too many attorneys in the world, but good ones are always in demand and well compensated. They are compensated for their intelligence and experience, and the investment industry is an apt comparison.

If you have a good track record and investment style that would appeal to a core client base, then don’t abandon your plans. You might end up competing with Vanguard, but if you feel strongly that it’s an idea that will appeal to the investing public, then you’ll find a way to forge your own path. (You don’t see advertisements comparing a Chevrolet truck to a Mercedes sedan.)

There is plenty of room in the investment world for variety and competition, especially in appealing to the particular goals of your target market. Investing does not mean “one size fits all.”

Our view is this announcement from Vanguard is validation that actively managed ETFs are the future. We predict this industry standard setter will help many firms feel the time has come to pursue their own actively managed strategy in an ETF structure.


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