Price customers into the market

Barrie Dunstan

Vanguard is looking for a business boost from the government’s superannuation reforms. Photo: Bloomberg

While some are critical of the government’s superannuation reforms and the emphasis on the lower-cost MySuper product, Vanguard group’s Jim Norris welcomes the trend and believes it will benefit most Australian investors.

Certainly Vanguard, as a major provider of index products, is looking for a business boost (especially from exchange-traded funds or ETFs) but Norris believes passionately in the Vanguard gospel: that low-cost investments deliver the best returns.

As managing director of Vanguard’s international business, based in London, Norris has responsibility for all operations outside the US, including the Australian arm that now manages $58 billion as part of the global group total of $1.8 trillion.

Will putting people into the lowest-cost MySuper products reduce their returns? Norris says Vanguard’s experience everywhere is that low-cost products (whether or not they are index funds) usually produce the best investment returns.

Citing a Morningstar study, he says if you want to predict the top-performing funds in the next 10 years, “you can be sure that the low-cost funds, whether they are indexed or not, are going to dominate the top quartile. You can be certain the bottom quartile will be dominated by high-cost funds.”

He says the costs across the entire investment chain can be 350 basis points and, when investment returns are set to be lower, it’s very difficult to build wealth if you start off that far behind.

Norris says any reforms should make sure that the costs to investors still aren’t hidden away in the layers in the system. The big move away from commissions in the US – “in 10 years there won’t be any” – has happened almost without any regulation or banning; it has followed more transparency in the system, making people aware of what they were paying.

Norris dismisses the idea that people here don’t care about their fees. “Everybody cares about fees,” he says. “They just don’t know about their fees.”

After the US, “We think this is the second best market in the world,” Norris says. With the compulsory superannuation system, fund managers have $100 billion every year coming into the system.

“With a few hundred million people,” he muses, “it would be the best market in the world”.

He is a fan of the Australian regulatory regime: “We want to be in places where we feel the regulators are on top of things.”

He describes Australian regulators, in the midst of major reforms, as “quite enlightened”. The local structure, with the market mix of wholesale and retail, has suited Vanguard and, as a major index manager, Vanguard likes the move away from commissions towards fee for service. Norris expects this to boost the level of indexing, along with MySuper’s emphasis on lower cost investments.

He sees the new squeeze on fees and commissions affecting the margins of platforms and asset managers but, as a low-cost manager, Vanguard is quite happy with price competition.

In the advice market, Norris says adviser value is in selecting active managers, i.e. picking alpha (or added value). Now, he argues, advisers need to see value in their advice on tax, getting clients into proper asset allocation and stopping them being emotional and doing silly things.

He expects Vanguard will serve retail investors through advisers.

The current low level of indexing should rise and “we should get more than our fair share of that”, Norris says. The wild card for indexing in Australia may be how the exchange- traded funds market evolves, he says.

“That’s clearly on our global agenda. We have been the [cash flow] leader in ETFs for three years now,” although still behind State Street and BlackRock in total ETF funds.

The Australian ETF market is still relatively undeveloped, he says, though Vanguard is encouraged by the recent move by the ASX to allow fixed interest ETFs, recently the most popular ETFs in the US.

It may take a few more months to see the first local products but Vanguard believes they offer a large potential market if investors start to seek fixed interest alternatives to bank term deposits with lower interest rates. This is likely to include many retail investors running self-managed super funds, who have already embraced the equity market ETFs.

Billions of dollars in short-term bank term deposits is a significant pool of money, some of which should be invested in longer-term securities to give people a reasonable chance of reaching their retirement savings goals, he says.

Norris believes ETFs are such a compelling package for investors that “it’s hard to imagine that it won’t be a significant market here”.

With the rapid growth in the size of the total super market and expected rapid consolidation as funds become larger, he says there are “incredible scale opportunities”.

One part of Vanguard’s approach is being aware of what it can and can’t do. There are large areas where it has no representation.

Here, Vanguard has taken the view that some strategies are too risky – for example, currency overlays – and it would rather do what it is good at. This has led it to rationalise some of its strategies and concentrate on its strengths.

“They say the essence of strategy is to decide what not to do,” Norris says.

This year Norris will tick over 25 years with Vanguard. He says, only half-jokingly, that after a time Vanguard executives are “damaged goods” in terms of being unable to adapt to life with another fund manager.

He spent almost seven years as executive assistant to Jack Bogle, the legendary Vanguard founder and former chief executive. Bogle, 82, has just celebrated 60 years in the funds management business and, following a successful heart transplant in early 1996, he has maintained an active interest in the business.

Norris has been the longest-serving “slave” (or executive assistant) to Bogle, a role also occupied by former Australian Vanguard head Jeremy Duffield. Jokes Norris, “I must have had the highest pain tolerance. When you worked for Jack, you measured it in dog years.”

The Australian Financial Review