The Vanguard Effect

I grew up in a family where our entire income was based on my father’s business. He often came home for dinner only to go back to the office afterwards and work late into the night. As a result, his business did well, but like most business owners, he didn’t have the safety net of a pension and knew a bad year or two could be just around the corner. This obviously meant he and my mother needed to be careful with their money.

I watched, and often joined, my parents when they regularly went to several different grocery stores to get the best prices for all the items our family needed, among other money-saving strategies. A good sale meant them coming home with enough toilet paper to ride out a war.

Experiences like this often lead’s people down one of two paths: you begin to want to live less frugally, or you absorb and emulate those same lessons. For me, it was the latter. Although I like quality items, there are few things I like more than saving money. I guess it’s in my blood.

Unfortunately, one of the last places you’ll regularly find a good deal is the investment industry. Like many industries, it has been slow to lower fees and prices given the lack of demand to do it. Luckily, on the investment product side, there’s finally a reason to necessitate this, and I’m very happy about it.

For context though, let’s take a step back first.

For investors wanting diversified portfolios, by breadth of securities and geography, mutual funds have been the dominant option for most of the past 20 years. Much like the dominance of long distance telephone rates in the ’80s and ’90s, the dominance of mutual funds led to high fees with little pressure to lower them from any source of meaningful competition. And then came the exchange traded fund, or the ETF.

The first ETF in 1989, which was created in Canada, but their broad scale arrival really started less than 10 years ago. The iShares ETF product line from the U.S. was the first to arrive with any semblance of scale. These funds were a godsend for financial advisors like me who were frustrated with the high fees mutual funds charged. This is not to say all mutual funds did poorly, many provided nice profits for our clients, but they would have been better with lower fees.

These new products allowed us to make the same type of investments in geographic areas like Canada, the U.S., and emerging markets, at a much lower fee level for our clients, and often with more diversification. Although this was a big improvement, Canada lagged years behind the U.S. and other countries in terms of the number of ETFs available, letting iShares dominate the landscape, without the need to lower its fees given their relative cheapness compared to mutual funds.

Although other smaller companies jumped into the ETF market, the Bank of Montreal was the next big company to make a splash. They not only offered similar products as iShares, but also expanded into other areas which gave an increased variety of investments to choose from. Due to iShares’ name recognition and first mover advantage, it still owned a dominant market share of 85% to 90% of the Canadian ETF industry. BMO needed to offer some different product lines and more competitive prices. And then an investment company entered the Canadian market that changed everything—Vanguard.

Vanguard is one of the world’s biggest ETF providers and is known for the breadth of its product lines, but also for one thing in particular—incredibly low fees!

Vanguard has made its name by having the lowest fees in the investment industry across the board. There may be one or two ETFs that have similar products at a lower price, but the difference is so miniscule it’s almost irrelevant. It’s widely understood that no company can compete with Vanguard on fees.

In fairness, Vanguard has been able to provide such low fees due to a very unique structure. The company doesn’t have outside owners. It’s actually owned by its funds, which are in turn owned by their shareholders. In other words, if you own any Vanguard products you’re a part owner of the company.

Due to Vanguard’s presence and growing market share, we have seen iShares, BMO, and other ETF providers lower their fees on a number of products. Fortunately for investors, this fee-cutting trend has cascaded through the ETF industry, and is now affecting the mutual fund industry, as it loses market share to the ETFs.

Perhaps they’re seeing the writing on the wall, or perhaps they want to hedge their bets, but mutual fund companies are now entering the ETF space—albeit, mostly on the actively managed side as opposed to the passive index approach. How far this latest trend will continue is hard to predict, but it’s definitely a welcome situation for investors.

If there is a down side to all of this, it’s that there are now so many investment products to choose from it can take quite a bit of work to decide which products are the appropriate ones to invest in.

All in all, however, this has been great news for Canadian investors. They can now enjoy a much more competitive landscape that should continue to improve the amount of fees they have to pay, as well as, the number and breadth of offerings provided.

I think this is something we can all celebrate!