Vanguard's arrival in UK bodes well for investors

Regular readers will know well that we believe low costs are crucial to investment success and that UK investors often pay too much for funds. That's why I was pleased to see that Vanguard Investments is planning to enter the UK market: The asset management giant built its business by being the low cost provider of passive and active funds in the US retail market, and the fees it levies on funds in there are much lower than the norm in the UK. Indeed, the average TER across the retail shares of all of Vanguard's US-sold trackers is just 0.23%--lower than any single retail tracker we know of in the UK.

The firm is keeping mum about it specific plans, as it as still seeking authorisation for its funds from the FSA, but we would expect a suite of low-cost index trackers to start with. That's how the firm made its name, and it's the simplest type of offering for them to bring into the UK. Exchange traded funds would also make sense, but that would seem likelier further down the road given the existing competition in that arena.

We'd also be happy to see Vanguard offer active funds here at some point--the firm is known for offering access to top quality management at rock bottom prices. It typically farms out management to well-regarded outside firms and negotiates a low management fee with the hired firm. The result is an average TER across its actively managed equity line-up of just 0.35%. That's staggeringly low by any standard, but particularly so in the UK where most actively managed equity funds charge upwards of 1.50%

Competition is much needed
For several years now, we have run a study showing that UK investors pay nearly double what US investors pay for large-cap domestic equity offerings. Further, roughly 65% of large-cap domestic equity funds in the UK cluster at management fees of 1.5%, suggesting that competition is sorely lacking. In contrast, the median management charge for US-sold large-cap funds is jut 0.67%.

Trackers alleviate the pain somewhat, but not nearly as much as they could. The average domestic equity tracker we follow in the UK has a TER of 0.89% for retail shares. In contrast, the average domestic-equity tracker in the States carries a TER of just .57% for retail shares. In the UK, the cheapest FTSE All Share tracker available to retail investors is Fidelity Moneybuilder Index, with a TER of 0.30%. Stateside, the two cheapest S&P 500 trackers are Fidelity Spartan 500 Index at 0.10%, and Vanguard 500 Index at 0.15%. There is a key difference insofar as funds in America benefit from economies of scale that aren't available to funds here given the smaller size of the UK market (Vanguard 500, for example, had $69bn at last count, down from $120bn at the end of 2006). Nevertheless, paying too much for a fund that just mimics an index largely defeats the point of the exercise--with index funds, investors should go with the lowest cost option they can find. In this regard, Vanguard's presence should give investors a much needed alternative and give competitors in the market incentive to lower their prices.

A bit of history
I can't point to a single UK or European fund house that has a specific goal of being a low-cost provider--the only possible exception are ETF providers such as iShares. Vanguard does so emphatically. The firm was founded by the Jack Bogle in 1975 and offered the first retail index fund in existence in 1976. At the time, people scoffed at the idea, but Vanguard 500 index went on to become at one point the largest fund in the US and has inspired legions of imitators. Vanguard remains unusual among fund firms in its ownership structure--it is owned by its funds. This is not insignificant: One of the biggest problems asset managers face is the need to serve two masters, the owners of the asset manager itself, and the investors in the funds offered by the asset manager. To give one clear example, raising fund fees will generate more profits for shareholders of the asset manager, but hurt returns of investors in the funds where fees are increased. The structure used by Vanguard effectively limits this conflict, because the owners of the company are, in fact, the owners of the funds.

In addition to low costs, Vanguard has a history of communicating clearly with fund shareholders, avoiding launching trendy "hot-dot" funds, and working hard to educate fund holders on the core tenets of investing: diversification, low costs, and the importance of investing for the long term. The firm has also typically closed funds when needed to avoid bloat or simply to avoid the possibility of investors burning themselves by sending too much money to a hot area of the market.

Of course, the Vanguard of today is not the same firm Bogle founded in 1975. For starters, it has grown enormously, and now ranks as one of the largest fund groups in the world. However, through it all, we continue to believe the firm is one of the most shareholder friendly organisations round. Our US analysts have followed Vanguard closely for many years, and have written extensively about the firm's culture. You can read their current view of the company here.

Optimism, with a word of caution
We expect Vanguard to offer lower-cost trackers than most UK investors can access currently, and to be transparent about their operations. However, much of our enthusiasm at this early stage is based on our long history of analysing Vanguard funds in other markets. We don't yet know for a fact which funds they will offer in the UK, or what their charges will be. Indeed, the firm already has a Dublin range, and while its fees are low, they aren't as low as those on the US range. If, contrary to our expectations, the firm doesn't enter the market as a low-cost provider or appears to approach their business differently than in other markets, we'd have to revise our view.