Q: It doesn’t sound like managing an index fund is “passive.”
Sauter: There is an awful lot of blocking and tackling with passive management. A lot of action in the trenches – more than the average person probably realizes.
Q: What is your take on high-frequency trading [HFT]? Is it helpful or harmful to individual investors?
Sauter: The term high-frequency trading is applied to many different types of participants and strategies in the market. Market makers are high-frequency traders. We need market makers to provide liquidity and for price discovery. High-frequency trading is also used for arbitrage opportunities. We want the derivative markets to be in line with the cash markets. We want futures contracts to be in line with the underlying security. It’s the same with ETFs. Arbitrageurs use high-frequency trading to keep markets in synch with each other. Maybe at the other end of the spectrum there are people abusing the system. The SEC is trying to identify people doing that. It’s a very small percentage of high-frequency trading. Investors have benefitted from changes in the market including HFT. Transaction costs have declined precipitously the past 10 to 15 years. Net-net, we’re better off with HFT than without. Individual investors have benefitted more than institutional money managers. Spreads have narrowed dramatically. The bid and offer are thinner than they used to be; it used to be deeper. But most traders are not trading in enough size to worry about market impact. We benefit from tighter spreads but we still have to be careful.
Q: Have ETFs made the market more volatile or increased systemic risk?
Sauter: We’re in a difficult environment to invest. People are looking for something to blame, and ETFs have been successful. I think it’s unwarranted. Morningstar showed there is no market impact from leveraged ETFs. Leveraged strategies can be implemented in a number of ways. It’s the strategy that important, not the ETF structure. Our own experience indicates ETFs haven’t distorted the marketplace. However, education is very important. A lot of investors didn’t understand what they were getting into with some of these leveraged strategies. There is more education now so they may realize that these are short-term trading vehicles. But there is a need to educate investors so they know what they’re getting into.
Q: Why are Vanguard ETFs structured as separate share classes of existing index funds?
Sauter: The ETF share class helps preserve the integrity of the index funds. Like any mutual fund, we don’t want investors coming and going, which boosts transaction costs. ETFs were a way to provide a place for traders. We always try to screen short-term investors out of the mutual fund share classes. ETFs are another arrow in the quiver. ETFs are also a great way for us to work with the intermediary community. ETFs are an attractive vehicle for financial advisors. It opened up a new market to us. The index funds already had critical mass in the portfolio. This makes the ETF easier to manage and the index funds have a long-term performance record.
Q: What accomplishments are you most proud of at Vanguard?
Sauter: I loved everything I was involved in here. Building an equity team here was the first thing I tackled. It was a tremendous amount of fun and things grew dramatically. The past decade has been building out the fixed-income side. I like new challenges, so that afforded an opportunity. I also liked working with the SEC on initiatives and market structure changes. I’ve been with the senior staff the past 15 years and I’ve enjoyed guiding the direction of Vanguard.