(PUB) Investing 2015

8

What Happens When Vanguard Owns Everything? Morningstar Research | John Rekenthaler

Another way of putting the matter: Last year, Vanguard netted more assets than did all the leading fund companies combined during the New Era of 1995 – 2000 . The seventh consecutive year of industry-leading sales has pushed Vanguard to record market share. Whereas previous leaders commanded between 10% and 15% of total industry assets, Vanguard ended 2014 at 19% . It almost certainly will be above 20% by the time 2015 concludes. The Implications This raises two questions. What does the company’s record-breaking success mean for Vanguard investors? Also, what does it mean for the financial markets overall? The first answer seems straightforward: not much. Previous fund sales leaders almost immediately struck icebergs. Fidelity’s domestic-stock funds ceased being extraordinary; Putnam and Janus sunk when growth stocks fell; and American Funds, booming because of the belief that it would beat bear markets, promptly failed 2008 ’s test. But Vanguard is a different animal. Unlike those other firms, Vanguard has not implicitly promised to outperform the benchmarks. To maintain its brand and satisfy customers, Vanguard need only match its benchmarks and avoid unpleasant surprises. That should not be a difficult task, as Vanguard was built for volume. Not only are most of its monies passively run, but those indexes are also exclusively cap-weighted, rather than tilted to capture a “stra- tegic beta.” Consequently, Vanguard’s passive funds need not make trades to realign as the markets move. In addition, most Vanguard assets are in large, liquid securities, and even its active funds follow a mainstream, low-turnover approach. Some have argued that index investing was a major factor in the stock market declines of 2000 – 02 and 2008 , with investor inflows initially pushing up stock prices, then outflows exacerbating the declines. However, while it is perhaps possible to trace a hindsight connection between the popularity of index

Annual Net Sales ($ Billion) U.S. Mutual Funds and ETFs p Fidelity Investments p Vanguard p Other

Estimated Net Flow ($ Billion)

p American Funds

250

200

150

100

50

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Market Share U.S. Mutual Funds and ETFs

Percentage of mutual fund assets held by company with largest assets

p Fidelity Investments

p Vanguard

p American Funds

20

16

12

8

4

93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Source: Morningstar

Vanguard is the most dominant fund company in history. It already manages the largest stock mutual fund in the world; it soon will run the largest bond mutual fund; and despite being a latecomer to the business of exchange-traded funds, it places a close second to iShares for new U.S. ETF sales over the past 12 months. No fund company has ever enjoyed anything like Vanguard’s 2014 net inflows of $219 billion into U.S. mutual funds and ETF s. Until American Funds managed the feat in 2003 , no firm had ever even cracked the $50 billion mark.