We currently work with 26 external investment advisory firms, and most of them handle active equity portfolios for our clients. “Vanguard continuously seeks out leading investment firms that demonstrate the expertise, diversity of thought, and accountability needed to drive successful outcomes for investors,” said Dan Reyes, head of Vanguard Portfolio Review Department.
To ensure that external advisors’ interests are aligned with those of our investor-owners2, most of our funds’ active equity advisory agreements are not based solely on flat fees calculated off the amount of assets under management. After all, performance matters.
The amount the funds pay under those agreements can often be adjusted up or down to reflect the investment performance of a fund relative to the total return of an appropriate market benchmark over the long term—a trailing 3- or 5-year period. With this symmetrical incentive/penalty arrangement, external investment advisors are penalized for underperforming a market benchmark and rewarded for outperforming it. Such performance-based adjustments typically result in very small changes in a fund’s expense ratio.
In the 2021–2022 fiscal year reporting cycle, 12 out of 30 Vanguard active equity/balanced funds with external investment advisors saw expense ratio changes that were performance-related. Expense ratios decreased for 7 of them because their advisors were paid less in management fees related to underperformance, while expense ratios increased for 5 of them because their advisors were paid more based on outperformance.
That said, the average asset-weighted Vanguard active equity fund expense ratio is 0.24%, which is lower than 99% of U.S.-domiciled active equity funds.3