“The Vanguard Effect” has been cited in the media in both the United States and abroad to describe the tendency for investment providers to lower mutual fund and ETF expense ratios when Vanguard enters a new market. The positive result is, obviously, lower investment costs for investors. While flattering, I believe it may overlook a very important partner in this trend: advisors.
After all, unless the benefits and value of low cost investing had been well understood by advisors, Vanguard funds and ETFs would not have likely found their way into investors’ portfolios in the first place. Hence, we also have “The Advisor Effect”—the growing tendency for financial intermediaries to invest their clients’ assets in low-cost products.
As our research has shown, cash-flow trends have heavily favored low-cost mutual funds and ETFs. It’s also not just a U.S. phenomenon, as our research from the United Kingdom shows, albeit with a shorter observation period. In other words, wherever lower-cost funds and ETFs have been made available, cash flows suggest investors have embraced them.
To be clear, two other dynamics are at work here lowering the “cost experience”, for investors. The first is “The Plan Sponsor Effect,” the trend for sponsors of defined contribution plans to offer more low-cost fund options to participants, especially low-cost default options, such as target-date funds. The second is “The Mom and Pop Effect.” That is, individual investors have increasingly recognized that costs matter and enjoy ready access to cost information and tools via the internet to make cost-conscious investment decisions.
The role of advisors
Advisors play an important role in constructing portfolios and selecting investments on behalf of their clients. A recent survey reports that 65% of investors use an advisor and that those who do entrust nearly 75% of their assets to an advisor.¹ As such, it is logical to conclude that advisors are one of the driving forces behind lowering investors’ costs.
As the “all funds” chart below shows, expense ratios have been declining for some time for U.S. stock funds. However, the chart also illustrates an important point that is too frequently overlooked by industry critics: While the average expense ratio for U.S. stock funds was 1.20% at the end of 2014, the asset-weighted expense ratio was 0.58%.²
Since the asset-weighted expense ratio is lower—much lower—than the simple average expense ratio that is so often cited, it means that a very large percentage of investors’ U.S. stock fund assets are invested (or have been invested for them by advisors) in lower-cost funds. It also means that investors are paying less than half of the stated industry average to have their U.S. stock fund assets managed for them.
While it may be tempting to credit the lower average expense ratio trend to the many new index funds and ETFs that have entered the market over the past few years, the other charts show that the average expense ratios for index funds and ETFs have tended to be rather stable, or even slightly higher, over the recent period.
This makes sense because many of these newer index funds and ETFs have tended to be niche products with expense ratios that are higher than those for broad-market, capitalization-weighted index funds and ETFs. It is only when you examine the asset-weighted expense ratios that you see the downward cost trend that mimics the trend shown in the “all funds” data.
The data supporting The Advisor Effect is both compelling and encouraging. Simply stated, more investors are being placed in lower-cost products, which will ultimately give them a better chance of investment success over the long term.
Author’s note: Let me take this opportunity as Vanguard celebrates its 40th anniversary to reflect briefly on our past and our future. In the early days, Vanguard primarily focused on serving individual investors directly and plan participants through corporate-sponsored 401(k) plans. While we continue to serve these clients, more recently it has been our partnership with the advisor community that has contributed to extraordinarily strong cash flows into Vanguard. In fact, our Financial Advisor Services division recently crossed the $1 trillion milestone, representing nearly one-third of our total assets under management. Our growing partnership with advisor clients, combined with The Vanguard Effect and The Advisor Effect, has been a contributing factor to the significantly lower asset-weighted expense ratios that investors are paying for professionally managed funds.
I’d like to thank Don Bennyhoff and John Woerth for their invaluable contributions to this blog.
1 Cogent Wealth Reports, 2014. Investor Brandscape. Livonia, Mich.: Market Strategies International.
2 Source: Morningstar, Inc. Morningstar categorizes U.S. stock funds as traditional open-ended index and actively managed funds, as well as ETFs. Asset-weighted expense ratios are represented as a percentage of net assets.
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