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How does Vanguard pick an active manager?
FOR PROFESSIONAL OR INSTITUTIONAL INVESTORS ONLY. CAPITAL AT RISK.
Despite being a pioneer of index funds, Vanguard’s heritage in active management dates back to 1975 and today is one of the world’s largest active managers, running $1.8trn globally. For UK investors, there are 10 active strategies – spanning equities and fixed income – to choose from, eight of which are sub-advised to different fund management firms.
In this Active in Five we talk to Andrew Surrey, active distribution lead at Vanguard, to look at the guiding principles of the active team when partnering with these firms.
The firm
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The people
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The philosophy
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The process
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The outcome
IMPORTANT INFORMATION
Source: Vanguard, as at 31 July 2024.
Surrey says one of the major advantages of the sub-advised process is that Vanguard can find active talent anywhere in the world, not just those based in the UK. “Active fund management is a people business and firms are the economic units that attract, motivate and retain talented investors,” he says. “We seek firms whose incentives are clearly aligned with the long-term interests of their clients in generating excellent performance, not gathering assets.” Judging firms on a three-to-five-year basis, he adds they should have the resources, brand and culture to attract and retain a deep pool of talent. While a range of ownership structures can be helpful to achieve this, Surrey says having “skin in the game” – namely employee ownership – tends to correlate with better firm profitability and growth.
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In today’s hyper-competitive markets, Surrey says Vanguard strives to partner with the most impressive teams it can find in terms of not only academic credentials but also diversity of thought. “On average all active managers, before fees, won’t generate a return,” he says. “In this zero-sum game, the smart money should outperform and our process for evaluating the calibre of teams we encounter follows a simple equation: collective ability equals individual ability and diversity.” As a result, Surrey says Vanguard’s selection process aims to go a level deeper, encompassing multiple engagements over time, with not just the named portfolio managers or firm leadership, but also key members of the supporting analyst team. Overall he says the Vanguard Oversight and Manager Search team interviews more than 200 prospective fund managers a year. The end result within their manager selection process is both the use of large, diversified investment firms as well as boutique fund managers, each with diverse teams.
Within the active management world, Surrey says one consequence of the explosion in computing power and the democratisation of data is the difficulty of outperforming based upon predicting short-term data points, such as quarterly earnings and analyst revisions. As a result one question Vanguard asks all investment firms is what is their active edge? “Both our own experience in selecting managers over decades and numerous academic studies suggest that fundamental active managers are better served by taking a long-term, low-turnover approach,” he adds. At the same time, Surrey says not only is it essential that the investment philosophy is clear and articulated – namely understood by everyone on the team – but that the team is also aligned with the firm they work with.
According to Surrey, increased competition and shifts in the nature of the economy have made it difficult to outperform using simple headline financial metrics such as book value or reported earnings per share (EPS). At the same time, he adds, a compelling body of research suggests that the stock market tends to underappreciate information that is nuanced or complex and requires “looking under the hood” to properly calibrate. “Active managers with the discipline and willingness to delve into the fine print and the details buried in company disclosures have a real opportunity to add alpha,” he says. When examining a firm’s investment process, focus is placed on whether it is both proven and repeatable, while at the same being enduring for decades to come. Costs are then the final piece of the jigsaw, with high costs well known for their ability to hurt performance. “It is essential we are able to deliver active funds at low fees,” he says. This is part of Vanguard’s DNA, and one of its guiding investment principles.
Source: Vanguard, as at 30 June 2024. Past performance is not an indicator of future performance. Source: Vanguard, as at 31 August 2024. Past performance is not an indicator of future performance.
Within the 10 active funds in the UK that Vanguard manages, Surrey says the aim is for the portfolios to be balanced and diversified across industries, and across multiple asset classes in the case of the multi-asset funds. In terms of track record, over the last 10 years Surrey notes that 90% of the active funds have outperformed their peer groups. “This is the result of all the principles we have discussed: assessing the firm, the philosophy and the process and making sure all of these are enduring,” he says. Globally, Vanguard currently outsources to 22 sub-advisers and Surrey notes the average tenure is 15 years.
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