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Manager underperformance: Vanguard thinks you should pay less

Emma Rapaport  |  19 Mar 2021Text size  Decrease  Increase  |  
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Should you pay less if an active manager underperforms? Vanguard thinks so. The US fund giant's first actively managed Australian fund has hit the market with an Australia-first fee structure which fluctuates to reflect performance.

The base fee charged to investors is 0.6 per cent. If the manager outperforms the MSCI ACWI Index (All Country World) the fee can jump up to 0.6825 per cent (+9 per cent, capped). But, if they underperform, the fee can drop as low as 0.5175 per cent (-9 per cent).

Vanguard Australia active sales development manager Ian Boater says its aim is for both the fund and the end investors to share in the pleasure and the pain of performance.

"I think is really important for us that the investment manager also shares in any pain of underperformance, which we hope there isn't any," he says.

"It's fairer for the investor as well."

Vanguard Active graphic

Source: Vanguard Investments Australia

Fees charged by active managers typically take this format. A manager may charge 1 per cent a year in ongoing fees but may also receive as much as 20 per cent if they beat the index. The fee charged by Vanguard forces a “symmetric penalty” or reward on to the management fee as a performance fee.

Boater says that while this style of sliding performance-fee structure is used in the US and the UK, that he's unaware of any fund exploring it in Australia. Boater wouldn’t be drawn on whether more active managers should adopt this sliding scale of fees. His focus, he says, is on the end investor.

"We're really happy having brought this structure to the market," he says.

"We try and make sure that our fees are low, that they align with the end investor.

"Others may choose to follow suit, I'm not sure, but I think this structure is more client friendly."

Active managers, particularly those in the global equity arena, have historically struggled to outperform the index while charging higher fees. The investor is left to ask: shouldn't I just go with the cheaper passive fund?

Research conducted by former Morningstar senior analyst Andrew Miles shows global equity active managers have trailed their passive peers since the 1990s. This is true irrespective of style. Global blend, growth and value all underperformed the MSCI World Index to December 2019.

The Vanguard Active Global Growth (43445) fund has outperformed the MSCI ACWI Index in its short history in Australia. Since inception in September 2019, the fund returned 26.50 per cent compared to the benchmark return of 10.25 per cent. A client in the fund at the end of February 2021 would have paid a fee of about 0.64 per cent at the end of the period.

Vanguard Active Global Growth—returns

Chart

Source: Morningstar Direct

Boater accepts that Vanguard is primarily known among Australian investors as a passive giant. Its Vanguard Australian Shares ETF (ASX:VAS) is the largest on the ASX. He says that while Vanguard US has always offered active funds there's work to be done to introduce the brand to the market as an active and passive player.

"We're trying to give clients to best chance of investment success by keeping fees as low as possible," he says.

"Indexing has done that to a degree where costs have come down, but I think still close to 80 per cent of all the assets in Australia are active and majority of them are still 1 per cent or more in terms of their fees. This [fund] allows an option that's low costs, from an institutional, quality manager, but using our scale to provide a low cost for investor."

Morningstar fund analyst Edward Huynh says in comparison to other performance fee strategies, Vanguard's is particularly appealing.

"Given that performance fees are capped and even at the max payable fee (0.6 per cent), it represents exceptional value," Huynh says.

The average fee charged as self-reported by managers for Australia World Value, Blend, Growth and Hedged and has an analyst rating is 1.05%.

Fund snapshot

The Vanguard Active Global Growth fund invests growth companies falling into four growth buckets: rapid growth, latent growth, cyclical growth, and growth stalwarts.

  • Stalwarts—durable franchises with robust profitability and competitive advantages;
  • Rapid growth—early-stage businesses with vast growth opportunities;
  • Cyclical growers—firms subjected to macroeconomic and capital cycles; and
  • Latent growers—companies where earning growth accelerate over time

The resulting portfolio consists of 70-120 stocks (currently 106).

The fund is underweight technology, consumer defensive and utilities compared to the index. Overweight positions are in combinations services, consumer cyclicals and financial services.

Vanguard Active Global Growth—portfolio holdings

chart

Source: Morningstar Direct

The fund's performance fee calculated on a rolling three-year period. Boater says this is done to ensure that short-term attitudes don't creep into the portfolio.

"We feel that the longer the period, the less likely the manager will take on extra risk to try and reach the performance fee figure. When managers charge [performance fees] on a 12-month basis, short-termism can appear."

Example

If the Fund’s total net performance over the Performance Period (rolling 3 years) is 14.25 per cent and the Benchmark performance for the same period is 12.0 per cent, then the performance variance would be +2.25 per cent.

The Performance Fee component of the management fee would be +0.0207 per cent p.a. (+2.25 multiplied by 0.0092). The management fee would be 0.6207 per cent p.a (compromised of 0.60 per cent p.a. (Base Fee) plus 0.0207 per cent (Performance Fee)

Source: Vanguard Active Global Growth Product Disclosure Statement

is an editor for Morningstar.com.au

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