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Who's watching your money? A look at Vanguard's portfolio review process

July 06, 2017

Vanguard Portfolio Review Department at a glance

Number of Portfolio Review professionals: More than 130 (including 30 CFA® charterholders)

Funds and ETFs overseen: 355

Annual client engagements: More than 1,400

Number of external advisors: 28

Assets managed by external advisors: $533 billion

Global fund launches in 2016: 40

Note: Data are as of December 31, 2016.

Overview

Investors all over the world entrust Vanguard with more than $4 trillion in assets. But who watches over that vast sum, ensuring that every dollar is invested effectively?

Vanguard's fund oversight and governance is a multilevel—and multinational—process. It's led by each fund's board of directors, who have fiduciary oversight, and the Global Investment Committee, whose senior management members include Vanguard Chairman and CEO Bill McNabb and Chief Investment Officer Tim Buckley.

Vanguard Portfolio Review Department supports the board and the investment committee in the day-to-day fund governance. Portfolio Review sits at the intersection between the investment teams managing client money and the Vanguard business units that serve clients. It's responsible for the oversight of Vanguard funds, ETFs, and their advisors; adjusting or expanding the overall fund lineup; and analyzing the funds' health, usage, and competitive landscape.

Board of directors and senior management

Board of directors

Vanguard's board of directors ensures that its mutual funds are organized, operated, and managed in the interest of shareholders. The directors serve as trustees of each fund. They help select investment advisors; monitor operations, performance, and costs; review contracts; and elect officers.

Nine of the board's ten directors are independent—they have no affiliation with Vanguard and the funds apart from any personal investments. The diverse board includes former CEOs and senior managers from prominent companies such as IBM, Xerox, Cummins, Johnson & Johnson, and Rohm and Haas. It also includes a university president and financial experts such as Scott Malpass, the chief investment officer at the University of Notre Dame, and André Perold, a professor emeritus of finance and banking at Harvard Business School.

The board has the ultimate say on decisions that affect Vanguard's mutual fund lineup. For example, earlier this year the board decided to add ClearBridge Investments as an advisor to Vanguard Explorer™ Fund. In 2012, it made the call to change the benchmarks for 6 Vanguard international stock index funds from MSCI to FTSE. At the same time, 16 U.S. stock and balanced index funds switched to new benchmarks developed by the University of Chicago's Center for Research in Security Prices.

Global Investment Committee

The board works closely with the Global Investment Committee, which is chaired by McNabb and consists of long-tenured members of senior management. Portfolio Review presents any advisor changes, new fund ideas, or strategy tweaks to the committee, which works with the board on initiatives that make the most sense for shareholders.

This CEO-led search and oversight process ensures that Vanguard takes a long-term perspective. The committee's stability reduces the potential to overreact to short-term events and promotes manager-evaluation continuity. A selection process that relies on a single decision-maker can trigger manager turnover, especially if that person leaves the firm. The commitment of Vanguard's CEO and its experienced senior executives is a key reason why the process has been so consistent over the years.

Portfolio Review Department organizational structure

Portfolio Review consists of three main groups:

Fund Oversight & Manager Search

This team monitors both Vanguard's internal index and active investment teams, as well as 28 external advisory firms that manage more than half a trillion dollars in assets. Throughout the year, team members meet regularly with fund advisors and also develop relationships with dozens of potential candidate firms. They work closely with the board and the investment committee and advise both on all manager selections.

The group develops opinions about the funds, grounded in thorough research. It does this through rigorous, two-pronged fundamental analysis that focuses on long-term drivers and outcomes.

Drivers include a firm's culture, its people, and its investment process and philosophy. Vanguard wants to partner with advisors who are passionate about investing and who are building enduring firms with strong corporate cultures. Their process and philosophy must be transparent, clearly articulated, and repeatable.

Outcomes are the end result of the drivers—the portfolio and performance that come from implementing the investment strategy. Vanguard analysts monitor portfolios to ensure that their holdings accurately reflect over time the advisors' investment strategy and the fund's mandate. This includes monitoring sector weightings, the portfolio's financial metrics such as price/book or price/earnings, holdings concentration, and turnover. Long- and short-term performance are scrutinized using appropriate market benchmarks and peer groups.

"We believe our process ensures that shareholders in both active and passive mutual funds are getting access to world-class advisors and investments," said Dan Newhall, head of Oversight & Manager Search.

This process has been particularly effective at spotting superior external managers, who oversee a sizable portion of the assets in Vanguard's active strategies. "Outsourcing to independent managers is a better solution than trying to employ all those professionals in-house," Newhall said. "It gives us access to a rich pool of global talent and objectivity when it comes to negotiating fees and assessing managers."

Portfolio Review also conducts manager searches in an effort to create a bullpen of top-notch advisors who could manage assets in the future. Teams focus on potential growth, value, and international advisors across asset classes.

Product Strategy

This group aims to stay abreast of developments in the mutual fund and ETF industry by planning and researching potential new funds and working to improve existing ones.

Its long-term product plan informs the annual pipeline of anticipated fund launches and changes. The team's proven process includes combining academic and industry research with Vanguard's investment principles and client needs.

Team members emphasize adding funds that make sense for clients' portfolios over the long term as opposed to those that follow hot investing trends. They build a client and investment case for each new product and present those findings to the investment committee and the board. If a new fund is approved, Product Strategy works with various teams throughout the company to launch it. Over the past three years, the group has launched more than 70 new products in the United States and overseas.

Product Management

This group grew out of a need to address the changing landscape of the past several years. Vanguard's client base was expanding and becoming more global, and its product mix was also growing more complex and international. At the same time, the investment marketplace became more crowded, product choices increased, and differences in competitors' pricing and performance narrowed.

Serving clients with various needs and preferences requires a deep level of investment support. This team serves as the hub of specialized product expertise by analyzing fund health, fund usage, the competitive landscape, and market dynamics. Product Management also educates clients to help improve their chances of investment success. The group aims to help investors better understand Vanguard's products and the investment processes behind them.

By taking on these tasks, the team enables Vanguard's internal and external advisors to focus on their primary responsibility of managing client assets.

Product Management is, in a sense, an extension of Vanguard's investment teams, representing them, their funds, and investment performance to clients. Team members are organized along the same asset, product type, and strategy categories, which helps deepen their areas of focus and expertise.

Global reach

In addition to Vanguard's Valley Forge headquarters, Portfolio Review has offices in Canada, the United Kingdom, Hong Kong, and Australia. These sites ensure that Vanguard has the local expertise to handle the specific needs of markets across the world.

Most Product Strategy and Product Management work is conducted at the local level, in consultation with U.S. colleagues and Vanguard's International Product Planning and International Product Strategy and Development teams. The one exception is Oversight & Manager Search: The U.S. office evaluates existing funds and advisors and any potential new firms.

The end result

Portfolio Review's three groups have different but complementary functions. They work seamlessly together to serve clients and give them the best chance for investment success.

"We take oversight of clients' money seriously," Newhall said. "Our process has proven successful over the long term. When you marry strong results, top-notch management, and low costs, the combination is hard to beat."

Notes:

  • All investing is subject to risk, including the possible loss of the money you invest.
  • Vanguard ETF Shares are not redeemable with the issuing fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

CFA® is a registered trademark owned by CFA Institute.

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