Jack Bogle, founder of Vanguard Investments has built a somewhat cultish following with his prophecies of the advantages of index investing. His loyal band of followers, labelling themselves ‘Bogleheads’ spruik the merits of index investing, citing the benefits of their low cost, high levels of diversification and the fact that many active fund managers fail to outperform over the long term.
Many Bogleheads may be surprised that Vanguard actually has a range of active ETFs. They’ve recently launched two of them as ETFs on the Australian market, Vanguard Global Value Equity Active ETF (VVLU) and Vanguard Global Minimum Volatility Active ETF (VMIN). Today we take a look at these two funds.
One of the biggest costs a fund manager must bear is the cost of human capital. Investment managers regularly come in behind only medical specialists as Australia’s highest paying jobs. This is one of the reasons why active management does not come cheap, with the average management cost of actively managed ETFs in Australia at 0.83% per annum, and LICs higher again at 1.06% (plus performance fees).
It’s these high fees that the Bogleheads will say is one of the key reasons active funds do not outperform over the long term, the additional return (also called ‘alpha’) that they create is eaten up by their high fees.
With VMIN and VVLU, Vanguard have employed quantitative rules based active management, allowing Vanguard to develop a set of rules to choose the universe of underlying stocks to invest in and have the computer models do the hard work, rather than a team of analysts individually handpicking stocks. This aligns VMIN and VVLU closer to Smart Beta or ‘factor’ based ETFs, who employ similar techniques.
We asked Michael Roach, head of Vanguard’s Australian Quantitative Equity Group to explain how VMIN and VVLU differ from a ‘Smart Beta' ETF. He explains below:
“Although there is no consensus on a definition for smart beta, generally speaking these products target factor exposures by deviating from traditional market-cap weighted processes that have been common with passively managed strategies. For example, smart beta products often track an alternatively weighted index - revenue weighted, equal weighted, fundamentally weighted etc.”
“Despite this step away from market-cap weighting, many of the initial products in the marketplace still focused on an index-based implementation of what should be regarded as an active approach. In these cases the active decisions are part of the index construction rather than directly part of the portfolio management process. Regardless of the implementation approach, active or passive, these products are taking bets against the broad market, so they are very different than a traditional market cap-weighted product. Investors should be aware of those differences and evaluate these products as active products.
“We believe that because these strategies step away from a market cap-weighted framework there are benefits to implementing factors actively rather than following an index. This means our factor funds have a more flexible rebalancing schedule enabling our portfolio managers to maintain a consistent exposure over time, managing the trade-off between exposures and rebalancing costs, while still providing all the benefits that investors expect with a Vanguard ETF – a rules-based investment process, transparency in holdings and in methodology, and low costs. Secondly, the active approach enables us to refine and enhance our strategies over time. Additionally, our products are very well diversified, with each of the portfolios holding hundreds of shares.
“Removing one of the most persistent headwinds to active outperformance, our ETFs are the lowest cost factor offerings in the market (active or index), which has a direct and measurable impact on after cost performance.”
With their Quantitative investment approach, VMIN and VVLU are available for just 0.28% per annum, around 1/3 of the cost of traditional active ETFs.
First we take a look at VVLU, developed as a global equity fund. VVLU channels value investing pioneers Benjamin Graham and Warren Buffett, by applying rules to select stocks based on value characteristics. Value investors seek to buy shares that are trading at a discount to their market value and VVLU applies some of the common value investor criteria such as price to earnings (P/E) ratios, price to future earnings ratio and price to operating cash flow to quantitatively determine which companies to invest in.
VVLU targets large, mid and small cap securities and currently holds a total of 1,189 companies. VVLU is currently overweight financials, utilities and basic materials compared to its benchmark FTSE Developed All Cap Index and underweight technology and health care.
Whilst most investors like the upside that comes with investing in shares, many do not enjoy the wild swings along the way. VMIN attempts to tamper this volatility by considering the risk and diversification characteristics of funds it invests in and hedges the majority of currency exposure back to Australian dollars.
VMIN currently holds 201 companies and is overweight consumer services, utilities and telecommunications, and underweight technology, health care and oil stocks compared to the FTSE Global All Cap Index (AUD Hedged).
We’ve long said that we think the next big development in ETFs will be the emergence of a growing range of Active ETFs, due to their transparency and ease of trading on the ASX. Vanguard has provided many of the benefits of Active ETFs with the costs of a passive ETF with their Quantitative approach to active management. We’ll be keeping an eye on VVLU and VMIN and see how their perform over the longer term.