Rich Powers

The Art of Product Management at Vanguard

Vanguard had a dramatic year for new ETFs. The firm’s head of ETF product management, Rich Powers, talks about what’s behind those product launches, as well as the firm’s new commission-free platform.

Vanguard has a vast exchange traded funds business here in the U.S., accounting for about a quarter of industry ETF market share. The firm captures about 30 percent of the cash flows.

And it has been a pretty dramatic year for product launches, with 10 new ETFs introduced in the last 12 months, including six new factor funds, which are actively managed; two fixed income ETFs of ETFs; and two ESG funds. But that’s an anomaly for the firm; Vanguard has a total 80 funds here in the U.S. with $900 billion client assets. And it doesn’t plan on growing that number significantly.

“I wouldn't want you to walk away with any impression that we’re going to have anywhere near the large number of products that some of our competitors have,” said Rich Powers, head of ETF product management. “We’re at 80 today, and that’ll grow over time. But it won’t be 200 or 300. That’s not who we are.”

Powers’ team is responsible for ETF industry analysis, supporting ETF education initiatives and meeting with clients to discuss Vanguard’s ETF initiatives.

Earlier this summer, the firm made a splash when it announced it was increasing the number of ETFs offered commission-free to nearly 1,800, including many sold by its competitors. The move followed a decision last year by TD Ameritrade to stop offering Vanguard’s ETFs on its own commission-free platform. That happened because Vanguard refused—as per its usual practice—to pay distribution fees for its funds.

Powers recently talked to about the firm’s recent ETF launches, its big move to eliminate commissions on most ETFs and what products could be in its future. What was behind Vanguard’s decision to eliminate commissions on most ETFs?

Rich Powers: For a number of years, Vanguard ETFs for our direct retail clients have been commission-free. It’s really taking one of the key decision criteria for investors—is there a commission or not—off the table, allowing them to focus on things like what’s the exposure of the ETF, what’s the expense ratio and how well does it track. So it’s simplifying the process and improving the experience for our investors.

There are a handful of ETFs that are excluded from those—inverse, leverage—types of products. Our investment philosophy is one of long-term investing and those types of products don’t necessarily align with that. In the case of inverse and leverage products, given the way they reset and are structured, they’re not necessarily long-term investment vehicles. They’re vehicles that investors would hold, probably in their best interest, for a short-term period of time.

WM: You launched the most recent ETF of ETFs in September. What’s behind that launch?

RP: In the case of what we’re doing here with Vanguard Total Corporate and Vanguard Total World Bond, it’s taking existing portfolios in the market that provide very specific exposures and are inexpensive on their own and trade very well, and packaging them in such a way that an investor can get single ticker exposure to an area in the market.

I'll just use Total Corporate as an example. So, we’ve had a short, intermediate and long-term corporate ETF in the marketplace for a long time, they’re one of the largest in the industry and they’re very inexpensive. Some investors like to choose certain parts of the yield curve within the corporate market to allocate their capital; but they don’t want to make that decision. They actually want to be exposed to a corporate credit premium, but don’t want to make a duration call. And so putting together a Total Corporate by market cap weighting the three underlying holdings allows that investor to allocate to the corporate market as they want and not have to worry about making a duration bet on short, intermediate, or long. Same applies here in terms of the Total World Bond ETF that launched a couple weeks ago. It combines our Total Bond Market fund, which is U.S. investment grade bonds, with our Total International Bond, which is ex-U.S. investment grade bonds. It market cap weights those two portfolios to allow someone to buy, for 9 basis points, 10,000 investment grade bonds and not have to worry about the rebalancing of U.S. versus non-U.S. as a global bond portfolio in one.

You’re able to take advantage of the scale in the existing portfolios if you have products that are already 7bps or 9bps points in the expense ratio. It has spreads penny-wide and that have broad exposure to the universe of bonds you’re trying to capture. So on day one, a buyer of Total World Bond or Total Corporate is going to have really good tracking, really good diversification and really low cost.

WM: How do the fees work on that structure?

RP: The expense ratio for those products is the weighted average expense ratio of the underlyings. There is no additional fee that we layer on top.

WM: Have you thought about doing that for equities ETFs too?

RP: It could work just as easily in the case of equities. We’ve got a broad spectrum to the pieces in place, so less of an opportunity for us to do it there, but I wouldn't write if off entirely.

WM: What’s the next thing for you guys in terms of product development on the ETF side?

RP: Places where investors are interested in hearing and seeing more from us; I would say in the non-U.S. equity space. We have a nice offering there, but investors are curious if we would build that out farther.

Our bond lineup is substantive and growing, but certainly there are pockets of opportunity there. And then there are places like balanced ETFs—the classic 60 percent stocks/40 percent bonds—that don’t really have much of a space in the ETF market today, but certainly you can make the case that balanced portfolios are often core to any investor’s portfolio.

We have a product development process where we think about things like the investment efficacy of a product. Is there a buyer for the product we’re investigating? Do we have the capabilities to do it well and can we offer it at a low cost? If you check those boxes then we’ll have a product.

But I wouldn’t want you to walk away with any impression that we’re going to have anywhere near the large number of products that some of our competitors have. We’re at 80 today, and that’ll grow over time. But it won’t be 200 or 300. That’s not who we are.

WM: Why balanced ETFs?

RP: There are investors who say, “I’m looking for a solution. I don’t have the time, inclination or interest in choosing this value ETF or this international ETF. Give me something that’s broadly diversified, either as the only holding, or the core holding in my portfolio.” We’re trying to serve the needs of the entire stretch of investors.

WM: What percentage of your ETF assets are advisor-directed versus self-directed?

RP: We estimate about three-quarters to 80 percent of our assets are through some type of advisory relationship, whether that be an RIA, a broker/dealer or a bank wealth management. About $100 billion, so about 10 percent, is through direct retail investors. And then the balance would be with institutions, like insurance companies, pensions, endowments and foundations.

WM: What do you see in terms of how advisors are using ETFs and any sort of changes you’ve seen over the last couple years?

RP: Certainly, the investor and the advisors are using ETFs as strategic, long-term holdings and building portfolios. There’s this myth out there that ETFs are wildly traded, and there’s a high level of turnover and tactical investment happening in pockets, but that’s the exception rather than the rule.

In terms of advisors, the use of model portfolios is becoming much more prevalent. Whether it’s broker/dealer home office models that are being used, or different firms, even Vanguard, we have our ETF strategic models that are available on different platforms. I think that’s something that reflects as advisors saying, “I’m going to outsource the portfolio management function and focus on some of the higher value-added activities.”

WM: Last year, TD Ameritrade stopped offering Vanguard’s ETFs on its own commission-free platform. What happened?

RP: We don't pay for distribution for our ETFs, and so there’s a misalignment there in terms of what we do and what their expectations were. As you might expect for certain advisors, the lack of commission or the presence of commission, where there wasn't one before, caused them to take action and choose other products or re-allocate assets elsewhere, and we saw that in terms of flows. That dissipated pretty quickly though; there was this kind of immediate reaction to that, and those investors who were highly sensitive to it made those decisions late last year or early this year. But then subsequent to that, things kind of leveled out.

We continue to have a pretty strong presence and success on that platform. Changing investment strategies for advisors in a relatively short period of time from one sponsor to another isn’t taken lightly.

For some, commission-free is a highly sensitive point, and it’ll catalyze change. For most of the people we talk to it didn’t change the calculus.

WM: In February, the firm launched six factor-based ETFs—its first actively managed ETFs in the U.S. What prompted that launch?

RP: What we heard time and time again is that investors who prefer the ETF vehicle wanted access to the Vanguard active capabilities, and we thought about what types of strategies would fit really well into the ETF structure. Those that are kind of systematic and rules-based felt to us to be the most appropriate to start our active lineup with.

This interview has been edited for length and clarity.

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