Cost is likely to become a greater concern for investors as the longer-term outlook for markets moderates, according to Vanguard Asset Management’s Andy Surrey.
While Vanguard is perhaps best-known for its range of passive vehicles, the firm also runs a significant amount in active funds.
Ensuring that its managers are able to generate alpha has become more important more recently, particularly as the era of particularly as the post-financial crisis era of quantitative easing (QE) and loose monetary policy has come to an end.
Surrey, Vanguard’s senior manager for active funds, said the asset manager had around £1trn globally in active strategies, which it manages both internally and outsources to other firms, mainly on the equity side.
How each fund is managed based on whether it has the expertise to run the fund internally or whether it would be best overseen by external managers.
“The external side definitely makes us one of the largest buyers of active management in the world,” he said. “We don’t believe we have a monopoly on the best way to run active equities and it can really benefit the product to have more than one complementary style of active managers.
“Our global equity fund for example is 50 per cent Baillie Gifford global alpha team of Charles Plowden, Malcolm MacColl and Spencer Adair and the other side is a value manager: David Palmer and his team at Wellington Management.”
Performance of fund vs sector & peer since launch
Source: FE Analytics
Since launch in May 2016 the £34.1m Vanguard Global Equity fund has made a return of 49.83 per cent against a 49.50 per cent gain for the FTSE All World benchmark and a 41.93 per cent return for its average IA Global peer.
However, the strong returns of the liquidity-driven markets are likely to come under increasing pressure as central banks begin to withdraw support more than 10 years after the crisis.
As such, investors may have to become accustomed to lower returns in the years ahead with strategies charging lower fees likely to benefit.
“We’ve had a lot of conversations with advisers about the lower returns,” Surrey said.
“It’s a bit of a fool’s errand to try and look over one year and make estimates over a short time period, but when you look out over 10 years or so for a sterling investor within a global equity portfolio our median estimate is looking like 4.1 per cent in terms of returns.”
Such a return would be well below the 9.5 per cent 10-year historical return recorded by asset allocation and smart beta specialist Research Affiliates for a portfolio of global equities, as shown below, and would mean fees will likely play a much greater role in how much an investor will make over the long term.
Source: Research Affiliates
Surrey explained: “There are some pretty brutal maths there. There are advisers’ fees, platform fees and inflation. We think 0.7-0.75 per cent is too high now for the return that global equity clients are going to get for the next 10 years or so.”
Another concept that investors may have to grasp is the core/periphery model, choosing index funds in equity markets like the US where outperformance is more difficult and choosing active strategies in areas like emerging markets where inefficiencies throw up greater potential for generating alpha.
The Vanguard active funds specialist said that when considering the types of funds that might sit within a core portfolio, investors should pay close attention to tracking error, which he said can be thought of as ‘active risk’.
“A periphery fund might be one with a tracking error of 10 per cent but the plus or minus outperformance might be 30 per cent and you wouldn’t want that to be part of a core [portfolio],” he said.
“That’s not to say that strategies with a high tracking error are a bad idea. We use strategies with high tracking error in our funds but we blend them together with distinct yet complementary strategies.”
One example is its Vanguard Global Emerging Markets fund, which is co-managed by Baillie Gifford, New York-based boutique Pzena Investment Management and US firm Oaktree Capital Management.
“It would be difficult to hold any one of those as a core emerging markets product together,” said Vanguard’s Surrey. “But you blend them together as a three and they very much become a core product for those people that want exposure to emerging markets.”
Performance of fund vs sector & benchmark since launch
Source: FE Analytics
The £43.5m Vanguard Global Emerging Markets fund has made a total return of 67.27 per cent since launch in May 2016. Its FTSE Emerging benchmark, meanwhile, is up by 55.08 per cent and its average IA Global Emerging Markets peer has returned 48.14 per cent.
More recently, however, there has been a greater uptick in demand for core funds that don’t favour a particular style, according to Surrey.
“Growth and value have been up and back down again so we’re very much noticing that extra bumpiness that comes from being either/or,” he said. “Rather than a blend of the two we’re getting a lot of demand for solutions that are core funds.
“Whether that is index funds – which, by definition, have no natural style – or our active solutions which are naturally balanced because of their construction.”
The Vanguard Global Equity fund has an ongoing charges figure (OCF) of 0.6 per cent while the Vanguard Global Emerging Markets carries an 0.8 per cent charge.