Vanguard weighs alternatives as way to woo advisers

Jan 27, 2013 @ 12:01 am

By Jason Kephart

The Vanguard Group Inc., a longtime champion of low-cost, passive mutual funds, is weighing a more aggressive push into alternative investments.

The company's consideration of investments outside traditional stocks and bonds is being driven mainly by demand from financial advisers. Since the 2008-09 stock market downturn, advisers have been relying more heavily on alternative investments as a way to reduce risk and volatility in their clients' portfolios.

In recent years, Vanguard has courted advisers aggressively. At the end of last year, its adviser group had about $673 billion in assets, up from $265 billion in 2007.

More than 80% of 472 advisers surveyed by InvestmentNews in November said that they had some of their clients' assets invested in alternatives.

Of those, 43% said that they planned to increase that exposure this year and 33.1% said that they planned to keep it at the same level, the survey found.

Mutual funds that invest in alternative strategies have had more than $10 billion in inflows every year since 2009.

Before that, annual inflows had never topped $2 billion, according to Morningstar Inc.

Despite the popularity of nontraditional assets, Vanguard isn't looking to jump too deeply into the alternatives pool. Instead, it is considering products aimed more at reducing risk and volatility than boosting performance.

“We're looking at different betas,” chief executive William McNabb said. “We're not looking at hedge funds or ways to add alpha.”

A move to alternatives — however slight — would be unusual for Vanguard because the 37-year-old firm has staked its reputation on low-cost, passive investing. Due to the more active nature of investing in alternatives, mutual funds that use them tend to be more expensive.

Alternatives mutual funds often have expense ratios of between 1% and 2%. By comparison, most of Vanguard's funds charge less than 0.5%.

“To me, Vanguard stands for index and low cost,” said Nadia Papagiannis, an alternatives analyst at Morningstar Inc.

“Alternatives are primarily active and high-cost,” she said. “It's tough to marry those two ideas together.”

Vanguard has proved that it is capable of running fairly sophisticated strategies on the cheap. For example, the Vanguard Market Neutral Fund (VMNFX), which it launched in 1999, has an expense ratio of 0.25%, significantly less than the 1.75% charged by the average market-neutral fund.

The fund has stumbled, however, in terms of performance. The Vanguard Market Neutral Fund, which was subadvised by Axa Rosenberg Group LLC for more than a decade before being taken over by Vanguard in 2010, has five-year and 10-year annualized returns of -2.69% and 1.09%, respectively, putting it in the bottom-10th percentile of the market-neutral category.

Oliver Pursche, president of Gary Goldberg Financial Services, who already uses some alternatives, is keen on seeing what kind of value Vanguard can cook up in its product development lab.

“If they can come up with a product that matches their low costs and tradition, that's something I would be interested in,” he said.

Even advisers who have shied away from alternatives said that they would be eager to give Vanguard a chance.

“I'd certainly look at what they brought out,” said adviser George Papadopoulos, who runs an eponymous advisory firm.

Although he invests primarily in broad-based exchange-traded funds, which he said has served him and his clients well, he is open to ways to get better diversification, even if it is through a small part of a portfolio.

jkephart@investmentnews.com Twitter:@jasonkephart

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