Vanguard tiptoes into the liquid alternatives market

New multialternative fund seen as endorsement of alts, while pressuring fees

The liquid alternative investments market has received an unlikely endorsement from low-cost indexing stalwart The Vanguard Group Inc.
Some money managers and financial advisers say the fund giant’s registration on Friday for the Vanguard Alternative Strategies Fund is proof that real diversification can’t be achieved without an allocation to alternatives.
“I think it’s about time a firm like Vanguard woke up and realized a properly managed portfolio has to have alternatives,” said Ed Butowsky, managing partner as Chapwood Capital Investment Management.
“This means they are setting things up where all of their investors will have an opportunity to have a well-balanced and diversified portfolio,” he added. “No matter how big or small you are, your money should be managed the same way.”
Despite initial reactions to Vanguard’s move into an investment arena that would seem counter to many of its long-stated principles related to fees and active management, the company isn’t actually jumping headlong into liquid alt mutual funds.
For now, access to the new fund by financial advisers and individual investors will only be possible through the Vanguard Managed Payout Fund, which is a fund of funds designed to provide investors with a 4% annual payout, typically in retirement.
The multialternative fund, which is expected to launch in May, will make up 10% of the Managed Payout Fund, which already includes the Vanguard Market Neutral Fund (VMNFX), and the Vanguard Global Minimum Volatility Fund (VMVFX), along with some index funds.
Institutional investors, through the Vanguard Institutional Advisory Services, will be able to invest directly in the new liquid alternative fund.
John Ameriks, a Vanguard principal and head of the quantitative equity group, said that even though the multialternative fund is a new direction for Vanguard, alternative strategies have always been part of the objective of the Managed Payout Fund, which his team manages.
“I’d love for people to be able to read the original prospectus that was filed in 2008 for our Managed Payout Fund, because our goal is to try and combine strategies and correlations,” he said. “You have to think about this as an active proposition, and an attempt to add value, and doing it in a way that dampens volatility. This whole effort is designed to introduce another tool into [the fund of funds] that will enable us to do that.”
Regardless of whether the prospectus has always made it possible, the idea that Vanguard is launching a liquid alternative fund to help diversify its $1.6 billion Managed Payout Fund is generally interpreted as an endorsement for liquid alternatives.
“Vanguard built a firm based on low fees and indexing, and now they believe you need to have these alternatives in your portfolio; that’s telling and it’s precedent setting,” said Bradley Alford, chief investment officer at Alpha Capital Management.
As fund analyst Jason Kephart of Morningstar Inc. explained, Vanguard has quietly backed its way into the liquid alts space through the 2007 acquisition of its market neutral fund from Charles Schwab & Co. That fund was subadvised by outside managers until the portfolio was taken over by Mr. Ameriks’ team in early 2011.
“If I have any concerns about the new fund, it would be that the quant equity group has a lot of experience in equities, but I don’t know how much experience they have beyond equities,” Mr. Kephart said. “So far, it seems like they have only focused on equities.”
The new fund’s 1.1% expense ratio is high for Vanguard but still cheap in the liquid alts space, where most multialternative funds are charging more than 2%, according to Mr. Kephart.
“When this fund launches, it will effectively be the cheapest or one of the cheapest in the multialternative fund category,” he said. “And I would be surprised if Vanguard said ‘no’ to financial advisers who wanted to access the fund directly.”
According to Vanguard spokesman David Hoffman, adding the multialternative fund to the Managed Payout Fund will increase the expense ratio for the fund of funds to 42 basis points from the current 40 basis points.
“Costs are coming down for alternative investments, and this [move by Vanguard] is the second leg,” said Thomas Meyer, chief executive of Meyer Capital Group.
“The ETFs are the disrupters, and Vanguard is the next phase,” he added. “Fee compression is everywhere, and now you’re even seeing high-net-worth investors banging the drum to get hedge funds to start cutting fees.”