Vanguard’s UK foray to spark price war

News that Vanguard, the low-cost US fund manager, is to offer its products in the UK is set to spark a pricing war – forcing other fund managers to compete by cutting their fees on index and actively-managed funds.

The firm’s move has therefore been welcomed by long-suffering investors and fee-based financial advisers.

“There is little doubt that its entrance will shake up the industry,” claims Jason Butler, an adviser with Bloomsbury, the financial planning group.

The difference in the level of fees charged by Vanguard compared with other fund managers is substantial. Annual charges on the average Vanguard index fund are just 0.15 per cent while charges on UK index funds can reach 0.7 per cent to 1 per cent, according to Morningstar. Similarly, Vanguard’s average annual expense ratio for all its funds is 0.2 per cent, compared with an average fee of 1.5 per cent for actively-managed funds in the UK.

Founded by John Bogle in 1974, the US group pioneered passive index tracking and offers a large sweep of funds that replicate the
holdings of more than 200 market indices including the FTSE 100, MSCI Japan Index, Dow Jones, Nasdaq and Standard & Poor’s 500, through the use of derivatives. It also offers money market and actively-managed funds.

This approach has seen Vanguard become the biggest-selling fund company in the US. Investors poured $84bn in new money into its funds last year.

The group has not yet revealed details about its UK launch but it is understood that the firm – which already offers a line of funds domiciled in Dublin – will offer a simple range of index-trackers later this year if regulators approve the launch.

Bogle still claims that index funds are preferable to actively-managed ones as fees are about a third lower and their performance records more robust on average in the long-term.

“It’s just a far more impartial investment,” he says. “Indexing comes at a lower cost and it eliminates the risks of bias and failure that managers introduce when they start to run your money.”

Over the five years ending in June 2008, almost 70 per cent of actively-managed large-cap funds failed to beat the S&P 500. Measured against mid-cap and small-cap benchmarks, active funds did even worse.

The pitfall of index investing, however, is that thesuccess of your investment tends to vary from one year to the next. And while they are usually excellent investments in a bull market, they are guaranteed to perform poorly in a bear market as their performance is pulled down by plunging prices. Also, they tend to underpeform during unusual periods in the market. In the technology bubble of
the 1990s, for example, actively-managed funds outperformed index funds.

“Although statistics can show that trackers outperform a large percentage of active managers, it is often forgotten that investors and
advisors don’t seek out average performing active funds – they look for the
better ones,” points out Tim Cockerill, head of research at Rowan, the advisory firm.

Investors should also be wary of dubious index funds that charge high fees up front.

As computers, rather than managers, do most of the work, most index funds should berelatively cheap. If they are not, the gap in performance between the fund and the index it tracks can make for an uneconomic investment.

Because of high fees, Legal & General’s UK 100 tracker for example, has only returned 62 per cent since early 1995 while the FTSE has gained almost twice that, reporting a 122 per cent return over the same period, according to Analytics, the fund tracker.

It is also advisable to examine a fund’s total expense ratio (TER) as it takes into account hidden costs tacked on for say, marketing or legal work. Vanguard’s TERs tend to be quite low. Its European Stock Index Investor fund has a TER of 0.50 per cent while its US 500 Stock Index Investor’s TER is just 0.38 per cent.

Only exchange traded funds (ETFs) – stock market-listed trackers – can get close to this level of charges. “DIY” investors as well as active managers looking to gain exposure to an asset class are now increasingly taking these up, lured by their low costs.

A standard ETF that tracks the UK All Share index has a total expense ratio (TER) of about 0.40 per cent, while the TER of an open-ended investment company (oeic) tracking the same index ranges from 0.55 to 0.90 per cent.

While most financial advisers welcome Vanguard’s arrival in the UK, some believe that the firm will have difficulty gaining traction in a crowded market, especially during the current downturn.

“It’s a brave step,” says Rowan’s Cockerill. “I hope they have a long-term business plan. Many US mutual fund managers have a poor record of staying the course in the UK.”

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