A look at fund costs and their role in overall fund performance

Vanguard principal Daniel Wallick and product manager Hugh Watters explain fund costs and the significant role they play in a fund’s overall performance.


Emily Farrell: Ann asked us a great question. It really gets back to the cost discussion, which is so crucial. She asked, “Please discuss all the types of fees, management, commissions, sales charge, load, operating expenses, and taxes.” So we only have a certain amount of time, but, Hugh, could you talk a little bit about what should an investor be thinking about when they’re thinking about cost?

Hugh Watters: Yeah, I mean I think there’s two key components, right? There’s the cost in which we’re paying the actual manager to run this, so that talent piece that I mentioned. Right, there’s a cost involved with securing world class talent that we think can outperform over the longer term period. And that can be, in the case of Vanguard, there’s generally a variable cost as well, based on the performance of a particular manager. And there’s obviously the Vanguard piece, right, the economies of scale that we bring to the table that as the funds get larger, you know, we inherently have this mechanism to lower the fees over time, given our sort of unique ownership structure.

Emily Farrell: Right.

Hugh Watters: So I think you just need to be aware of how much other managers’ taking of that overall fee and is that worth really the performance that they’ve been able to deliver over a longer-term period.

Emily Farrell: Yeah, I would imagine it’s a little confusing though because at the end of the day if I’m the investor sitting there with my fund information, what should I be focusing on?

Daniel Wallick: So there’s two things, and I think she raises those questions. One is expense ratio, which is what Hugh was identifying there; and that should be disclosed for every fund, and you can find out what that number is as a fee. So you want to look at that.

If you’re buying that directly, perhaps from Vanguard or somebody else, you’re not paying any of the marketing fees or any of those. But then the other issue would be taxes, and I think she raises that, and that’s an important thing to address.

Emily Farrell: Yes, exactly.

Daniel Wallick: So if I could, right, we did run some research that tried to look- In academic terms, it’s called ex ante, which is, is there anything that signals us ahead of time to indicate future success? And Hugh mentioned this a little bit.

And so we looked at everything. We looked at fund size, we looked at past performance—looked exactly at what Dave had suggested there—we looked at fund size, age of the funds, concentration of the funds—either they have a little bit of stock or a lot of stocks—number of stocks. And the only thing we found that was predictive of future success was cost. So more expensive funds underperformed lower cost funds. That was the only thing that was statistically significant. Right, so that’s the only thing that mattered ultimately.*

*Source: Daniel W. Wallick, Brian R. Wimmer, CFA®, and James J. Balsamo, M.Sc. 2015. Shopping for alpha: You get what you don’t pay for. Valley Forge, PA: The Vanguard Group.

Daniel Wallick: And Vanguard active is actually incredibly low cost. It’s about 37 basis points. That’s cheaper than 99% of our competitors and 70% of the indexes that are out there. So although some people sometimes use the shorthand of active is more expensive than indexing, it’s actually not always the case. But we do think cost is something for everybody to be cognizant of.*

*Sources: Douglas Grim and Daniel W. Wallick. 2017. The role of active management in portfolio construction. Valley Forge, Pa: The Vanguard Group.
Brian R. Wimmer, CFA and Daniel W. Wallick. 2013. Analyzing multi-manger funds: Does management structure affect performance? Valley Forge, Pa: The Vanguard Group.

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