Our talent scouts: Recruiting world-class fund managers
February 20, 2014
Vanguard is well known as a champion of indexing. But we're also the fourth-largest U.S. sponsor of actively managed equity funds, where we have deep roots. Low-cost investing is our true passion, and we believe that both index and low-cost actively managed funds can play a role in investor portfolios.
For investors who want a chance to beat the market, Vanguard offers access to world-class active managers at costs that are well below industry averages.* Here is a look at how we recruit and monitor that talent.
(A quick note: In this article, "manager" refers to a fund's investment advisory firm, rather than to the individuals who manage the portfolio.)
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Identifying who might beat the odds
There's plenty of evidence that most actively managed equity funds underperform their benchmarks over the long run. (You can see that evidence in The case for index-fund investing.) Vanguard works to improve investors' chance of success by identifying exceptional managers using a step-by-step process developed and refined over many years.
Our manager searches are overseen by CEO Bill McNabb and a panel of senior officers. They meet monthly to discuss markets, portfolios, investment mandates, and managers, and they also meet annually with each Vanguard fund manager, including the company's own managers of active and index funds.
The hands-on talent scouts are a dedicated team of 20 experienced professionals. "They are on the prowl all the time," said Dan Newhall, who leads the team. To ensure that managers can be tapped when needed, the team meets with about 150 prospects each year to assess their compatibility for the investment mandates we are looking to fill.
The companies that advise Vanguard actively managed funds (as of January 2014):
- Acadian Asset Management LLC
- ARGA Investment Management, LP
- Armstrong Shaw Associates Inc.
- Baillie Gifford Overseas Ltd.
- Barrow, Hanley, Mewhinney & Strauss, LLC
- Cardinal Capital Management, L.L.C.
- Century Capital Management, LLC
- Chartwell Investment Partners, L.P.
- D. E. Shaw Investment Management, L.L.C.
- Delaware Investments Fund Advisers
- Donald Smith & Co., Inc.
- Edinburgh Partners Limited
- Frontier Capital Management Co., LLC
- Granahan Investment Management, Inc.
- Hotchkis and Wiley Capital Management, LLC
- Jennison Associates LLC
- Kalmar Investment Advisers
- Lazard Asset Management LLC
- Los Angeles Capital
- M&G Investment Management Limited
- Marathon Asset Management LLP
- Oaktree Capital Management, L.P.
- PRIMECAP Management Company
- Pzena Investment Management, LLC
- Sanders Capital, LLC
- Schroder Investment Management North America Inc.
- Stephens Investment Management Group, LLC
- Sterling Capital Management LLC
- Wellington Management Company, LLP
- William Blair & Company, L.L.C.
A focus on six key criteria
Potential candidates are identified through such sources as manager databases, industry conferences and publications, and suggestions from current Vanguard managers. The scouting team narrows the field using six key qualitative and quantitative criteria: four "drivers"—the firm, its people, its investment philosophy, and its process—and two "outcomes," which are the advisor's existing portfolio and performance.
Among other factors, Vanguard examines a firm's ethics and stability of ownership. We evaluate its people by the depth of investment talent, tenure and expertise, succession and contingency planning, and demonstrated ability to handle large mandates. In assessing investment philosophy and process, Vanguard looks for enduring beliefs and a steady approach. And we gauge portfolio and performance by a track record of competitive results compared with benchmarks and peers and by demonstrated success in different market environments.
Vanguard devotes significant resources to talent scouting because managing our clients' assets is a serious responsibility and we seek long-term relationships. In fact, the 30 firms that manage assets for our funds have an average tenure with us of about 15 years.
Low fees and long-term incentives
After a prospect passes our tests, Vanguard negotiates on an arm's-length basis a low management fee (as a percentage of the assets managed) in return for a much larger assignment than a manager is typically able to win from other clients. Most of Vanguard's external advisors are paid a base fee plus a symmetrical results-based fee that rewards outperformance and penalizes underperformance to help align the interests of the manager and investors.
Vanguard actively and independently monitors all its advisors using the same six criteria as it does in recruiting. Sometimes this leads to a fund's temporary closure, if additional cash flows could compromise the manager's ability to perform effectively for existing shareholders. Under some circumstances, we may replace a manager, but that is as rare as possible. Mr. Newhall explained: "We know all managers experience droughts, so we take a patient, long- term view. We've never hired or fired a manager solely based on performance. Confidence in the firm and its people is what counts the most."
We're the first to acknowledge that selecting even the most talented active managers can't guarantee outperformance. But our funds' track record is one indication of the merits of our rigorous, disciplined search process when combined with Vanguard's hallmark low costs: For the ten years ended September 30, 2013, 35 of Vanguard's 38 active equity funds (92%) outperformed their peer group's average annual return, based on data from Lipper.*
*As of December 31, 2012, Vanguard's average annual expenses for actively managed funds were 0.28%, compared with the industry average of 1.14%, according to Lipper, a Thomson Reuters Company. For the ten-year period through September 30, 2013, 35 of 38 Vanguard actively managed stock funds outperformed their Lipper peer group averages, also according to Lipper. Results will vary for other time periods. Only funds with a history of at least ten years were included in the comparison. Note that the competitive performance data shown represent past performance, which is not a guarantee of future results, and that all investments are subject to risks. For the most recent performance, visit our website at vanguard.com/performance.
Note: All investing is subject to risk, including the possible loss of the money you invest.