I’ve been holding back on making comments about Vanguard’s arrival in Canada, because I wanted some time to collect my thoughts. Now I’m ready to go public with my cautious enthusiasm.
Make no mistake, I’m thrilled to see Vanguard in Canada. The company’s ultra-cheap, well managed index funds and ETFs have played a huge role in pushing fund fees lower in the US, and it’s easy to see why many expect the same thing to happen in Canada, where costs have always been much too high. A MarketWatch article suggested that “a new line of Canada-domiciled Vanguard funds would have a huge impact on Canada’s mutual-fund industry.”
I hope I’m wrong, but I would be shocked if that turned out to be true.
The problem isn’t a lack of products
Canadian retail investors face some significant obstacles, but a lack of excellent investment products is not an important one. Using the TD e-Series index funds or ETFs (including those from Vanguard), Canadians can already build excellent, low-cost portfolios. My Complete Couch Potato is available to anyone with a discount brokerage account for 29 basis points, plus $5 to $10 per trade. (Admittedly, they need to look for ways around the exorbitant currency exchange fees charged by brokerages.)
I realize that most investors don’t have the time, skill or inclination to invest on their own, but there are already good, low-cost options for those who need professional help, too. People who work with a fee-based advisor can get access to ETFs or F-Series mutual funds with annual costs of 0.5% or less.
Vanguard will almost certainly launch a lineup of low-cost Toronto-listed ETFs, and that would be welcome. But it isn’t going to be a game changer.
The problem is commission-based advisors
The biggest hurdle for investors in Canada is that low-cost mutual funds and ETFs are being ignored by the commission-based advisors who dominate the industry.
While the details aren’t clear, Vanguard has announced that it will make its first foray into Canada by offering products through fee-based advisors only. In other words, for all the investors in Canada who use commission-based advisors—and that is the vast majority—it will be business as usual.
There may be some savings for clients of fee-based advisors, but these are likely to be modest. I’m guessing here, but let’s assume that a typical portfolio of Vanguard F-Series funds would cost about 30 basis points. That’s not significantly different from the current cost of ETFs, or Dimensional Fund Advisors, or other low-cost options. Once you add the advisor’s fee, you’re quickly into the range of 1.3% to 1.7% or so—similar to what clients of fee-only advisors are already paying.
Give it to me directly
As a do-it-yourself investor, I’m much more anxious to hear about Vanguard’s plans for direct-distribution index funds. This would allow individuals to open an account with Vanguard and invest in their mutual funds directly, without having to go through an advisor or a discount brokerage. I’d give serious thought to doing this if the option comes to Canada, but I’m not holding my breath for it to cause an industry revolution.
This model is huge south of the border. According to Tom Bradley, “Direct distribution makes up 20 per cent of the fund market in the U.S., with Vanguard, Fidelity, T. Rowe Price and a few others having substantial assets under management.” But the situation is radically different here. Canadians can buy well managed, low-cost mutual funds directly from firms like Phillips Hager & North, Steadyhand, Mawer and ING Direct, yet all of these are small players compared with the big banks and giants like Investors Group.
Case in point: the Investors Canadian Equity fund, with its 2.7% MER (plus deferred sales charge) and its bottom-decile performance, has $2.34 billion in assets. The Investors Canadian Bond Fund charges 1.95% and has a rotten track record, but has attracted $3 billion in assets. These funds didn’t become huge because there are no better alternatives—there are dozens. They grew so large because most Canadians prefer to work with commission-based salespeople rather than investing on their own or paying a transparent fee to an unbiased advisor.
Whose market share will Vanguard take?
I have no doubt that Vanguard will be successful in Canada, but at whose expense? Will millions of dollars start pouring out of the banks’ wrap programs or the overpriced funds sold by Investors Group? There is no reason to expect this.
Instead, we’ll probably see Vanguard drawing money away from the other index products already used by fee-based advisors, including iShares, BMO and Claymore ETFs, mutual funds from Invesco Trimark’s PowerShares and Pro-Financial, and to a lesser extent Dimensional Fund Advisors. Will these providers feel compelled to drop their fees as a result of the competition? Maybe, but I doubt it.
I welcome Vanguard to Canada. They will certainly bring an excellent lineup of funds and a long history of standing up for Main Street investors. But if history is any indication, the landscape is not likely to be reshaped. The sad truth is that Canadians already have many good investment options they’re choosing to ignore. That’s something even Vanguard can’t change.