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Pragmatic Capitalism

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In Defense of Vanguard

Here’s an article criticizing Vanguard. I guess we need to get used to this. As low fee indexing continues to eat the world the high fee alpha salesman are going to have to step up their game or they’ll all go out of business. But this “takedown” is particularly bad. Let me explain.

The article repeatedly refers to Vanguard as a non-profit even though the author, at one point, admits Vanguard is not a non-profit. Let’s clear this up. Vanguard is a mutual company. That is, it is mutually owned by its fund owners.¹ Vanguard is basically a big group of mutual funds with a management team that executes the mission to make those mutual funds best benefit their owners.

Now, at first glance this might not seem that much different than any other type of business. But I would argue that there are two significant elements to this structure as a financial firm:

  1. Vanguard adheres to a mission of offering low cost and simple investing strategies. They do not make “market beating” promises across their fund platform like most of the rest of the financial management industry.² Instead, they offer low cost market matching types of returns for most of their funds. As a mutual company, this is an important distinction as they can adhere to their mission to shareholders while returning profits in the form of lower costs over time without having to worry about chasing their own tails in the pursuit of market beating returns.
  2. This structure aligns the firm’s interests with its owners. Since the owners have a vested interest in the performance of the funds the management team is not pressured to generate a profit that benefits outside owners whose interests might not be aligned with the fund owners.  This is quite different from most other financial firms whose real owners are outside shareholders who rely on the firm’s ability to maximize fees in order to continually maximize profits. But it is also different from traditional mutual funds who sell the hope of market beating returns in exchange for the guarantee of high fees.

This isn’t that complex in my opinion. Vanguard basically refuses to make empty promises about what its products can deliver and reduces potential conflicts of interest by better aligning their interests with the interests of their underlying owners. If this is taking the “moral high ground” then maybe the rest of the financial services industry needs to lace up some hiking boots and find a better moral compass.

¹ – Why Ownership Matters, Vanguard

² – Vanguard does offer some “active” funds with the goal to beat the market, however, even in these cases they tend to be superior options relative to traditional active funds because they are better optimized for taxes and fees.  

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