Value of ownership
July 19, 2022
Low expense ratios have played a part in helping our actively managed equity funds outperform.1 The expense ratios of these funds can head lower for a variety of reasons, including a change in assets under management, operational efficiencies, and advisor performance. They also can head higher, often because of an increase in advisory fees based on a fund’s outperformance. This movement in expense ratios for our active equity funds is a mechanism for Vanguard to align the interests of our portfolio managers to our clients’ experience in each fund.
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
Vanguard is one of the few firms in the industry to employ performance incentive/penalty arrangements using a trailing 3- or 5-year period with its external investment advisors.
This approach, however, uniquely aligns fund management with investor experience—those advisors are paid more when they achieve better results for our investors.
1 For the ten-year period ended June 30, 2022, these percentages of Vanguard actively managed funds outperformed their peer group averages: 100% of money market funds (6 of 6), 100% of bond funds (44 of 44), 100% of balanced funds (6 of 6), and 86% of stock funds (32 of 37); results will vary for other time periods. Only actively managed funds with a minimum ten-year history were included in the comparisons. (Source: Lipper, a Thomson Reuters Company) Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks. For the most recent performance, visit our website at www.vanguard.com/performance.
2 Vanguard is investor-owned, meaning the fund shareholders own the funds, which in turn own Vanguard.
3 Notes: The asset-weighted average of Vanguard active equity funds is based on all share classes of Vanguard U.S.-domiciled active equity funds. Comparisons to non-Vanguard U.S.-domiciled active equity funds include all share classes of the non-Vanguard funds.
Sources: Vanguard and Morningstar, Inc., as of December 31, 2021.
Notes: All investing is subject to risk, including the possible loss of the money you invest.