By Todd Rosenbluth, CFRA
When an elephant prepares to take steps in the jungle, the other animals should take notice. Such an analogy is appropriate with Vanguard and the ETF market as the average Vanguard product has $10 billion in assets under management and the firm gathered $50 billion in assets through the first four months of 2017, second only to industry heavyweight iShares’ $78 billion, according to Factset data.
Unlike some ETF providers, Vanguard has been more prudent in expanding its product lineup, with just three new offerings since the beginning of 2014 and 70 in total; CFRA has data on 162 ETFs launched since 2014 from the three other top-four providers. Yet, in late May, Vanguard updated its regulatory filings to potentially launch transparent, actively managed ETFs, giving CFRA confidence that the firm is providing additional insight to regulators ahead of hopeful approval. Given the firm’s success in managing active strategies and its ability to retain and grow assets despite competitive pressure from passive products, CFRA thinks Vanguard will have continued success with such future iterations. However, our crystal ball on possible timing is much cloudier.
To protect shareholders from some of the transparency risks, CFRA thinks Vanguard could launch a quantitative active equity approach, similar in style to the mutual fund Vanguard Strategic Equity Income Fund (VSEQX). For this existing fund, Vanguard’s quant group relies on a computer-driven stock selection process to build a portfolio with a similar risk profile to an MSCI small/mid-cap blended index, while seeking to generate better returns.
According to the fund’s annual report, management believes that attractive stocks exhibit healthy balance sheets and steady cash flow generation; sound investment policies that favor internal over external funding; consistent earnings growth; strong market sentiment; and reasonable valuation.
Regular CFRA ETF Trends & Ideas readers will recognize some of these attributes as consistent with the general philosophy many asset managers, including Franklin Templeton, Goldman Sachs, and John Hancock have communicated with their multi-factor ETFs. However, CFRA thinks Vanguard will keep management’s discretion on whether to buy or sell a stock, rather than creating an index to track that could be potentially front run.
Another option would be to offer an ETF version of Vanguard Global Minimum Volatility Fund (VMVFX), an active strategy that launched at the end of 2013. In building the portfolio, Vanguard’s quant group evaluates a variety of factors that they think drive a stock’s volatility. According to the fund’s annual report, these fundamental drivers include risk factors such as growth, value, dividend yields, size, volatility, and liquidity. In addition, the portfolio construction process includes estimates of each stock’s correlation.
While CFRA thinks investors should not rely solely on a three-year track record, VMVFX’s one-year total return as of May 26 was stronger than passively managed iShares Edge MSCI Minimum Volatility Global (ACWV). VMVFX has a 0.25% net expense ratio that is higher than ACWV’s 0.20%. While both funds have approximately half of assets in the U.S., ACWV has more exposure to Japan, while VMVFX has a 6% weighting to Canada, a country that is not part of ACWV. Both funds, ranked independently by CFRA due to their different fund structures, are viewed favorably for the low-risk holdings inside.
CFRA quantitative ranks more than 1,000 equity ETFs and 12,000 equity mutual fund shares classes based on a combination of holdings-level and fund-specific attributes. We have favorable ranking attributes on products from range of providers. For example, iShares, PowerShares and SSGA are among the asset managers that offer strong U.S. focused low volatility ETFs despite distinct methodologies. VTEB, TFI,ITM,MUB
When Vanguard has launched ETF products in the recent past, they have had success in gathering assets. For example, Vanguard Tax-Exempt Bond Fund ETF (VTEB) came to market in August 2015 and already has $1.2 billion in assets. CFRA ranks the index-based investment-grade municipal bond product, which has a favorably low 0.09% expense ratio that is cheaper than alternatives. iShares National Muni Bond (MUB), SPDR Nuveen Bloomberg Barclays Municipal Bond (TFI) and VanEckVectors AMT-Free Municipal Index (ITM) all have more than $1 billion in assets, but only recently have faced competition from Vanguard.
CFRA thinks that investors should look beyond a likely low expense ratio for a new product, to understand what’s inside and whether that makes a prudent investment. However, potential launches by a patient industry leader such as Vanguard are likely to draw interest. How the industry responds could affect relative standings in the ETF jungle.
Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.