Vanguard announced Tuesday its entry into factor ETFs, a move that's a sharp departure from its index-based exchange-traded funds — and, quite possibly, one designed to appeal to advisers.
Vanguard plans to roll out six new factor ETFs next year, specializing in minimum volatility, value, momentum, liquidity and quality. A sixth ETF will be a multifactor approach. The Valley Forge, Pa., company also will roll out a multifactor open-ended mutual fund.
Factor funds take one or more investment strategies, or factors, into their securities selection. Morningstar Inc. lists 21 factor mutual funds and 60 factor ETFs. Factor ETFs have attracted an estimated $3.1 billion the past 12 months, according to Morningstar.
The move is significant for several reasons.
The first is simply the Vanguard effect: The mutual fund behemoth vacuums up investor assets like an elephant sipping from a baby pool. Investors have poured an estimated $348.6 billion net inflow to Vanguard mutual funds and ETFs the 12 months ended October 31, according to Morningstar, giving the company a 23.6% market share. (Those figures exclude money market funds and fund of funds).
The five single-factor ETFs will have an estimated expense ratio of 0.13%, while the multifactor ETF and mutual fund will weigh in at 0.18%. iShares, the largest factor-fund provider, weighs in at 0.15% to 0.32% for its largest factor ETFs, and archrival Fidelity charges 0.29% for its factor offerings.
Vanguard's entry into the arena should send shivers down its competitors' spines. Its factor funds would be cheaper than iShares' offerings, which are the current leaders.
"The average Vanguard ETF has more than $10 billion in assets, and given their strong brand with advisers and retail investors, we expect these factor products to be successful in gathering assets early," said Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA.
The new Vanguard ETFs are also a sharp departure from Vanguard's long-time promotion of capitalization-weighted index funds, championed by its founder, Jack Bogle. A 2011 Vanguard research paper, for example, "supports market-cap-weighted indexes over these alternative equity benchmarks, both for their theoretical basis and their practicality." A 2015 paper concluded, "By definition, alternatives to market-cap-weighted indexes, such as smart-beta strategies, should be considered active strategies, because their rules-based methodologies tend to generate meaningful security-level deviations, or tracking error, versus a broad market-cap index."
The new ETFs will follow no index, but rather broad guidelines as to how they select stocks, Mr. Rosenbluth said. And unlike other Vanguard ETF offerings, the new ETFs will reveal their holdings daily.
"Investors won't have the full road map, but they will have guidelines," Mr. Rosenbluth said. "They will be able to conduct due diligence based on holdings and costs rather than waiting three years."
Vanguard acknowledges that, like all factor funds, their performance won't track a broad-based index, and that some factors can go out of style for extended periods of time. For that reason, the funds might appeal more to advisers than individual investors. The multifactor ETF and mutual fund, however, seems more targeted at individual investors, said Dan Wiener, editor of the Independent Adviser for Vanguard Investors.
Mr. Wiener was skeptical of how useful the ETFs will be. The company has rolled out factor funds in Europe and Canada, but their assets aren't impressive, at least by Vanguard standards. The Canadian Vanguard Minimum Volatility ETF, for example, was rolled out in June 2016 and has $18 million in assets.
"Smart beta is a marketing gimmick: It's a way for companies to put an indexing sheen on active management," Mr. Wiener said. "All factors go in and out of favor and timing your purchases and sales of one or another factor is a fool's errand."
And, he said, Vanguard's record at multifactor investing is middling at best.
"Vanguard's multifactor product sounds an awful lot like their existing quantitative strategies used on funds like Strategic Equity, Strategic SmallCap Equity and U.S. Value," he said. "Sure, there are differences, but the bottom line is that Vanguard's record on these quant funds is decidedly poor."