Updated: Tuesday, November 7, 2017, 1:14 PM
Mortimer “Tim” Buckley takes over in December, 2017 as Vanguard Group’s fourth chief executive since John C. Bogle started the Malvern investment group 42 years ago. In one of his first public appearances since he was named to the top job, Buckley stopped by Ritholtz Asset Management’s Evidence-Based Investing Conference in New York on Thursday and introduced himself in half-hour remarks for around 200 attendees.
Founder Barry Ritholtz, who recommends Vanguard indexed ETFs to many of his clients, quizzed Buckley about running Vanguard, where investors this year have poured a billion dollars a day into accounts, boosting assets to nearly $5 trillion. Ritholtz’s firm manages around $600 million. Highlights of Buckley’s talk, edited for brevity and clarity:
JOURNEYMAN TO BOSS: Vanguard is the type of place where we develop leaders by rotating them around the company, to learn context and knowledge. No one takes the same path… I was fortunate to (head) information technology, retail, and investments. If you marry the three together, you can make better decisions on what we should be investing.
I’ve been very lucky to work for all three of our previous CEOs. From Jack Bogle, I learned the founding investment principles. Jack Brennan, there’s no one better at driving people to achieve what they need to do. Bill McNabb, he’s a master of teams… It may sound cliche. But this team is top notch.
It’s an awesome responsibility. $4.7 trillion is a lot of retirements, a lot of college educations. Many of the people in the room here, you have put your clients in and you have invested personally in Vanguard. It’s a lot of trust.
WHAT KEEPS HIM UP NIGHTS: I was driving my kids to soccer practice when they heard the announcement. My nine-year-old didn’t know what a CEO was. My 13-year-old said, ‘Dad, congratulations, that’s pretty awesome! But how do you sleep? You have $4.7 trillion. You got millions of shareholders. What if Vanguard were hacked?’ And then he gets out of the car and leaves Dad alone. (Laughter.)
It’s front of mind all the time. So (cybersecurity is) a huge investment for us. You can never think you are not vulnerable… So (our data is) segmented. Any data someone can get to is encrypted.
VIRTUALITY: When I arrived at Vanguard, we were $63 billion, we had four retail offices. We ended up closing those down (in favor of) phone and mail. That evolved to be the website. And now it’s mobile.
You could say, we’re integrated digital… Always think about that value stream… We ask, what are the routine exercises people here do? — things like asset allocation, rebalancing, reporting. And we draw those down. These are all things you can write rules about, things that you should expect they will be automated…
What doesn’t get automated are empirical things. Longterm care. Estate planning… How to be a good coach… The fairly routine exercises, they will be automated.
If you’re an adviser, that’s good news. There will be tools to automate.
NO VAPORWARE: A lot of what you do when you are chief information officer is, you learn to sift what is the vaporware, what is the buzz, and what can actually be real.
That’s also very important in the investment world… If you believe all the hype (about self-driving cars), you’d believe nobody’s going to grab a wheel again, the highways five years from now will be all automated. But it never moves as fast as you think.
HOW LOW WILL FEES GO? If you invest in Vanguard you own Vanguard. We’re a mutual structure. It means the overhead is zero.
We try to make the best returns we can in our business. To grow faster, to be more successful, like any other company. (When there is) extra income, other companies, say, retain earnings, or invest in the business. For us, we invest in the business (if it) meets our hurdle rate. Or we give it back to you in terms of lower expenses. We keep going on. Pretty soon it gets to zero.
HUMBLED: My first job was working for Jack Bogle. He was writing his first book. I spent a lot of time (checking data.) Those grueling hours. He cared a lot about all the managers who outperformed the market… You didn’t have Morningstar… I was struck, this was in the ’90s, by how many managers didn’t outperform. You might have 60 percent, in a good year. Most years were 20. Or 10. Longterm there were very few. And there’s so many brilliant people in this business — I’m always struck, with all the excellence, how so few outperform. That’s humbling.
(The 2008 financial crisis) was humbling. I was running our retail business, talking to clients, telling them they should still have stocks. To reassure them. You believe in it. But at some point, when they are down 35 pecent and so much pain, it becomes tougher to say, ‘Stick it out.’
TOO MUCH OF A GOOD THING? I was at the market yesterday. I bought bananas — I didn’t haggle. Most things in life are like that: you are a price taker. The index says we will buy that security at the market price, in real time. That’s what the index fund buys it at.
Does that distort price discovery?… Indexing doesn’t distort prices at all. When you index, you’re a price taker. Not a price maker.
Indexing is, how much? 35 percent of the mutual fund market; 15 percent of assets; 5 percent of trading. We could double it and academics say (there would not be price distortion.)
ACTIVISM: We have more than $1 trillion in active funds. Most of the fixed-income is internally managed. Fundamental equity, except about $30 billion, is managed externally.
(Vanguard’s active management funds came) out of Wellington Management Co. We still hire what we believe to be the best managers out there. We look for outside managers… who have diversity of thought, and can (execute) at the right price. Unlike other firms, we don’t want one chief investment officer making the call… And we look for uncorrelated asset return. Go over 10 years, and look at Vanguard active managers, versus our benchmarks. We’ve outperformed by about 80 basis points.
And think of costs. Put in industry expense, and all their return tends to disappear. Active management can do really well. But it’s a brutally competitive game. The manager has to share (his profits.) You can’t have 100 basis points (of fees) and still outperform.
CHANGE: I’ve been cautious… Vanguard has come of age with mutual funds (and now) exchange-traded funds. (The culture is now) taking hold outside mutual funds. Look at the advice world. Can the advice world be more efficient? Can we help advisers scale their business better? Can we help them offer more for their clients? And can we offer something for people who come to Vanguard directly? I think we’ll see a lot more offerings.
NO IMPOSING MORALS: (Environmental, social, governance) investing — for how many of you here today is this front of mind? (A few hands go up) Just a smattering of hands. Maybe 10 percent. It’s growing, but it’s growing slowly. I ask that question of audiences in the U.S. a lot of times. I get a very different answer in the Netherlands and New Zealand. They have been at it a lot longer.
Our first experience with ESG was about 2000. It was a fad back then. It came and it went. People wanted a social index. It underperformed. Then they didn’t want it.
What’s the current thing in ESG? Traditionally, social investing has been exclusionary. No big oil. No munitions companies.
You are taking the social morals of some and imposing it on the people. You can never get them to agree. Some people don’t mind oil but they don’t like tobacco… As you start to exclude each… you create the sin factor…(and increase the likelihood) you will underperform in the long run. It’s kind of the story of Philip Morris, which has done pretty well, above the market.
Should we be making a positive selection? ‘In these companies managers believe are changing things in the future.’ Are you liking companies that will benefit from electrification, from the buildout of the grid? With positive selection, you don’t have to get close to the gray area.
The other approach is to ask for more disclosure. We’re very active in governance circles looking for what might be environmental disclosure We’ll push big oil companies. (to disclose hazards and risks). To help understand what companies’ opportunities will be. It’s a different idea.
INDEX INVESTORS DON’T RUN FROM TROUBLE: We can’t sell when we are in an index. That’s actually a big benefit. Suddenly these companies realize we’re permanent shareholders. We’re going to be around even longer than management. We don’t care about (some random) activist fight. We want to make the best decisions for the long run. And by the way we own five or six or seven percent. And we vote.
Once they realize we vote the shares, it’s surprising how many people find their way to Malvern to talk to us.
We let people know ahead of time where we stand. We send letters to companies on what we think good governance looked like. If there’s an issue we’ll have a meeting. If they say they will make a change, we give them a chance… If they don’t, (Vanguard can withhold votes or vote against management) at the next annual meeting. That’s where we take the value for shareholders — long term. We try to make quiet change.
‘THE VANGUARD EFFECT’ ON FEES: It’s amazing to see Vanguard’s effect. We’re very purpose-driven. We want to see shareholders doing better. We want to see the cost and complexity go down. We have to sharpen our game and be even better.
What’s disappointing is (that rival fund managers only cut fees) where we will be offering funds. They won’t cut their fees all around. They only do it where they can compete with Vanguard. They won’t do it with funds in Europe… I’d love to see that low-cost investing permeate all around.
APPRENTICE TO THE FOUNDER: (Working for John C. “Jack” Bogle) You learned to work hard. You learned to do your math correctly. There was a lot of analysis. He’s quantitative. Very evidence-based. He is very purpose driven, and it permeates throughout Vanguard. Today that mission-driven culture is as strong as the day I showed up. That carried from Jack Bogle to Jack Brennan to Bill McNabb. Put that client first. Do the right thing.
TOP JOB IN A BULL MARKET: What’s the alternative? To step into a mess? Vanguard is in an incredible position. But if this is a 50-ring ladder, we’re only on rung No. 3. We have had great impact with indexed and exchange-traded funds, with low-cost index funds. We are not done. We are looking to lower the cost and complexity for investors. There’s a lot we can do for advisors, product or tools. There’s a lot we can do overseas. There’s a lot we can do indirectly.
We have a director who says, ‘Why aren’t you bigger?’ You’d think they’d say ‘Congratulations!’ But it is well meant. They see this value proposition at Vanguard.
If you think about companies, how many will give you the top-performing products of any company, at the lowest cost? Usually someone wants to get paid (extra) for the top performance… You want to keep that value proposition going. You want to extend it.
ARE ETFs STABLE IN WEAK MARKETS? Participating in the creation and the redemption process is such a small part of ETFs. With broad-based ETFs there is so much liquidity. I get concerned about ETFs, when people have these thin-slice ETFs — ‘Hey, this biotech price’ or ‘this small-cap stock’. They can be subject to short-term market distortions. Those would be where you can see some active opportunities in the short term. Watch those narrow sectors… We have a rule, if it’s limited-capacity, maybe it shouldn’t have ETFs.
WHY DOESN’T VANGUARD SELL MORE THAN INVESTMENTS? Have you read Jim Collins? In his book, Good to Great, his hedgehog concept — ‘Where can you be great?’ We don’t really have the hubris to think we can be great in the insurance market. We don’t know that market. Banking? A lot of people fled banking. I will never say never but it would be hubris to think we could move into those markets.
WILL VANGUARD CHANGE ITS FUND-OWNED STRUCTURE? Not on my watch. Sorry. It’s who Vanguard is.
We are structurally owned by our client. In demutualizing (as with mutual insurers who convert to stock ownership), your owners benefit. But they already own the company!
You have to be willing not to be a billionaire. What is your strategic differentiation? As soon as Vanguard isn’t mutual, you have to have outside shareholders. You have to pay someone else. You have to have a (profit) margin. Instead of zero. It would undermine the strategic purpose of Vanguard. If we demutualize, you can kill the company. It’s not going to happen.