Will Vanguard Really Change Anything?

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.

27 Responses to Will Vanguard Really Change Anything?

  1. Doug June 13, 2011 at 4:14 pm #

    What can you tell us about a “fund of funds” as far as costs go.

    I quickly clicked on the Mawer link that you provided above and see that their balanced fund which charges 0.96% simply holds a bunch of other Mawer funds that charge up to 2.0%.

    That seems weird to me. Especially when it’s mentioned as an example of low-cost investment options. Or am I just thoroughly spoiled by me TD e-funds?

  2. Canadian Couch Potato June 13, 2011 at 4:37 pm #

    @Doug: I haven’t done the math on the Mawer balanced funds, but there is never any stacking of MERs in funds of funds. So if one or more of the funds inside the balanced fund has a high MER, that will already be factored in. Te overall cost of the Mawer balanced fund is still under 1%.

  3. Think Dividends June 13, 2011 at 4:56 pm #

    I think most people will be disappointing with the initial Vanguard lineup of Funds not ETFs. Everyone will be expecting rock-bottom fees, but I think it won’t happen right away as the funds need to gather assets above a certain threshold to achieve economies of scale. I would expect their fees to be reasonable to start and should decline over time.

  4. Canadian Capitalist June 13, 2011 at 6:30 pm #

    I sadly agree with your conclusion though I hope I’m proven wrong. I hope Canadians start asking tough questions on costs and vote with their wallets for low(er) cost products. Nevertheless, competition is good and Vanguard is a good competitor to have on the side of the good guys.

  5. Canadian Couch Potato June 13, 2011 at 6:47 pm #

    @Think Dividends: You raise a good point. Vanguard does have a history of lowering its fees as its funds grow larger, which is something that I can’t recall anyone else doing. But in Canada there will be a fairly low ceiling for fund sizes: XIU holds $10.3 billion, which is gigantic by Canadian standards. I don’t think any other ETF or index fund holds even $2 billion. Compare that with the big Vanguard funds in the US, such as VTI ($170 billion), VOO ($112 billion), BND ($88 billion) and VWO ($65 billion). Will Vanguard be able to charge 10 or 20 basis points on funds with $500 million or $1 billion?

    @CC: I do think Vanguard’s presence (and marketing) in Canada may help raise the profile of indexing and low-fee investing in general. Maybe that will have an effect on investor indifference. Let’s hope so!

  6. Jim Yih June 13, 2011 at 7:06 pm #

    Well Said Couch Potato. I can’t help but agree. Maybe this is the first step to a direct market strategy.
    Jim

  7. Mike Holman June 13, 2011 at 10:56 pm #

    There’s no doubt in my mind that Vanguard won’t have any impact on actively manage mutual fund fees in Canada.

    I disagree that the problem is commission-based advisors however. I think the problem is mentioned in another statement you made:

    most Canadians prefer to work with commission-based salespeople rather than investing on their own or paying a transparent fee to an unbiased advisor.

    The only way to reduce investing costs is to avoid expensive investment advice. And Canadians just haven’t done that.

  8. Chris June 14, 2011 at 2:10 am #

    Do most Canadians really prefer to work with commission based salespeople? Or are they simply left with no other choice?

    Assuming most Canadians don’t have nearly enough money to attract a fee based adviser (some require $1 million in investable assets!), and lack the confidence or time to become DIY investors. What options are left? Bank mutual funds or the big commission funds sold by an “adviser”!

    What Canadians need is not just a company to provide low cost investment options (there are already lots around), but also accessible advice at a reasonable cost.

  9. BC_Doc June 14, 2011 at 6:38 am #

    It will be good to see BlackRock and Claymore have some competition on this side of the border. iShares Canada products are fairly pricey– looking at the Vanguard Australia website, it looks like Vanguard Canada may offer a 25- 30 basis point advantage over BlackRock. Hopefully there will be a few good indexed bond fund offerings coming too, similar to what’s available on the US side (e.g. a Canadian version of short, intermediate, and “total bond market” ETFs).

    Low cost, direct to buyer mutual funds (similar to what is available on the US side) would be a huge thorn in the side of Canadian investment firms.

    All of this may take some time, however, I’m optimistic. If Vanguard pushes it’s US business model hard in Canada, it could be a game changer.

  10. Michel June 14, 2011 at 7:05 am #

    By setting up shop in Canada, will Vanguard (a US company) be paying taxes in Canada? On their Cdn profits of course.

  11. Canadian Couch Potato June 14, 2011 at 8:33 am #

    @Chris: It’s not so much that Canadians prefer to work with commissioned salespeople, specifically. But there is great resistance to paying an advisor directly for his or her services. Most people much prefer to have the costs buried in the funds they buy. Even when this is pointed out to them, they still ignore these costs and push back against transparent costs. I have heard this over and over from fee-based advisors.

    @BC_Doc: It will be interesting to see if the cost of iShares, Claymore and BMO ETFs come down. That may happen in some cases. Note that BMO already has low-cost ETFs covering the bond sectors you mention, and all the index funds tracking the DEX Universe index can be considered “total bond market” funds. I’m not sure there is all that much room for new ETF products in Canada. All the meaningful sectors (and a few meaningless ones) have already been covered.

  12. Greg June 14, 2011 at 3:19 pm #

    The cell/smart phone industry in Canada is indicative of how Canadians behave. Canadians want very low upfront costs and don’t care that they are committing for the long term. People choose $0-$99 phones and lock themselves in contracts rather than $450 phone and have freedom. The investment industry is no different in Canada.

    I hope Vanguard makes a difference. While there are lots of different ETF options, I truly believe that there is a lack of low cost indexed mutual funds in Canada. The current ones either lock you into a TD platform, have poor selection, or have high management fees. CIBC has a great set of index mutual funds – if their MERs were significantly lower they would be in my portfolio. I hope Vanguard entering the market puts pressure on CIBC and other banks to lower their MER. However, I do fear the consequences will be minimal. When ING introduced their index funds, I thought that after a period of time, their MERs would drop. Not only was I wrong, but they ended up raising their MERs.

    I can see Vanguard suveying the index fund market and joining the party in the 0.6 to 1.0 range of fees instead of the rock bottom fees that they seem to charge in the US.

  13. Canadian Couch Potato June 14, 2011 at 3:34 pm #

    @Greg: Thanks for the comment. I completely agree that index mutual funds are far too high in Canada, but I have no expectation that they will come down in price any time soon. The banks have shown no interest in attracting index investors, with the possible exception of BMO via its line of ETFs. Even then, its mutual fund versions of these cost more than 1%.

    To be fair to ING, they didn’t raise their management fees on the Streetwise Funds; they just had to start charging HST. But even 1% is too high for an index fund unless you are investing very small amounts.

  14. Jon Evan June 14, 2011 at 6:54 pm #

    As a DIY investor I am perplexed as to why an investor would choose to purchase an equity ETF instead of an individual stock! In my mind it is far more complicated to understand an ETF or an indexed fund and their fee structures then there is in understanding a BMO stock which presently pays a pleasant dividend! No, Vanguard and ETF company will not impact me. Why not be a DIY investor and do it all yourself with easier to understand investment instruments like bonds, stocks, GICs and discount brokerages?

  15. Greg June 14, 2011 at 11:29 pm #

    @CC – My issue with ING raising the MER is that they were quoted early on during the introduction of the HST that they were going to absorb it in order to keep the total MER at or below 1%. At some point they reversed this decision. While I am not their typical investor I actually own one of the streetwise funds and was upset when I saw they decided to pass on the full amount of the HST (my TFSA resides there and it was too convenient to not throw some money into it).

    @Jon – Picking a stock easier than an ETF or index mutual fund? Really? What can be easier than knowing that all your investments will follow the index (minus a fee)?

  16. Jon Evan June 15, 2011 at 12:00 am #

    @Greg “What can be easier than knowing that all your investments will follow the index”
    It is not easy to understand what an “index” is. Are there many such “index” metrics. Does a human or a computer program pick the stocks for the index. Can you understand how that’s done and trust it/him/her. What about tracking error. Who can understand that. What does “follow the index” mean? What about when the index changes then the fund has to sell stocks that have to be removed from the index. This is not easy. Moreover, it’s all to passive for me because I care about what stocks I might own ie. what companies I want to invest in. The example of owning BMO stock is that it is easy. I like the bank. I deal there. I understand the company. I like the dividend and the capital gain should I sell it. It’s just easy to understand that investment. I think what you mean is that index funds are simple to invest in. That is true but there being so many such index funds that it is not easy to choose amongst them not to mention their cousins the etfs. It all gives me a headache!

  17. Chris #2 June 15, 2011 at 1:00 pm #

    @Jon Evan: It may be “easier” to buy individual stocks in a kind of tangible sense, but it’s *much* more difficult to achieve competitive returns by stock picking. For instance, your example, BMO, returned 5.9% TOTAL (dividends included) over the last five years, according to the inside front cover of the most recent BMO annual report. In comparison, the iShares MSCI Canada Index Fund (EWC), returned 47.4% total (dividends included) over the same five year period.

    Not to mention, if interest rates go up, it’s quite possible BMO will not do as well in the future as it has done in the past.

    You have to have a very serious amount of time to devote to investing, combined with a significant amount of skill, to trade a large portfolio consisting of individual stocks and earn competitive returns. Most active managers cannot do it. You have an advantage because you’re not charged MER, but your transaction costs are higher too. It’s a large uphill battle, as the BMO example above shows.

  18. Andrew Hallam June 17, 2011 at 6:38 am #

    You guys are going to think I’m totally nuts, and this might be hard to believe but…. most Canadians don’t know what an index fund is. We sometimes get close to our topics of interest, and those close to us tend to share much of the knowledge that we share so we can lose sight over what the majority of people know and understand. But if we wander into a local shopping center, and conduct a poll, you might be very surprised that most people can’t tell you…
    A. that low cost funds produce higher investment returns
    B. that index funds are passively managed (what’s that?)
    C. that actively Managed funds are passively managed (what’s that?)

    Vanguard will impact us (those with investment interests)…but it won’t impact the general population until the general population learns some of this stuff in schools.

  19. Canadian Couch Potato June 17, 2011 at 7:21 am #

    @Andrew: I don’t think you’re nuts at all — and there’s plenty of evidence for what you say. BMO just released a survey that showed more than half of people who hold investments (never mind non-investors) are too unfamiliar with ETFs to consider using them. In Canada, given the media attention paid to ETFs, I would think that index mutual funds are even less well understood.

    As you point out, I think all of us in the PF blogging community occasionally take this stuff for granted. A great many people equate investing with stock picking and probably always will. The whole idea of passive investing, once explained to them, seems slightly insane.

  20. jonevan June 17, 2011 at 9:20 pm #

    I suppose I’m one of the insane ones. I like to sleep at night! The idea of being “passive” is the issue for me. This idea of letting the market decide and me passively sliding along prevents me from sleeping. I suppose it depends why you are investing! Do you want to get rich? Do you want to achieve “competitive returns” as Chris #2 wants? Or, are you like me who want to invest for retirement income because I have no pension. Then one needs an endgame investment goal: how much do I need starting now for a comfortable reasonable retirement income. Then calculate your annual rate of return required to achieve that goal. For me, it is making at least 4%. Therefore, I need to actively monitor my investments to make sure minimum yearly rate of return is met. I can’t have a year where my rate of return is < 4%. I know that over a 10 year period certain investment strategies outperform others BUT we all know that previous returns do not necessarily equate to future returns. Are we into a new investment paradigm. Perhaps! No one knows. So, the important thing is to sleep well at night!

  21. Canadian Couch Potato June 17, 2011 at 10:00 pm #

    @jonevan: Thanks for the comment. I’m curious as to what investing strategy you use. From your previous comments, it sounds like you pick individual stocks. If so, I have to ask why you think you have any control over how your individual stocks perform. You seem to believe that index investing is mindlessly sticking your head in the sand, while active investing somehow gives you the power to control your returns. I hope you can see this is nothing more than an illusion.

    You also say that “I can’t have a year where my rate of return is < 4%." Again, how are planning to achieve this goal? The safest investments (GICs and government bonds) are yielding less than this, and any risky investment can easily lose a lot more than that in any given year. Most of us here are investing for the same reason you are: to fund our retirement, or kids' education, or other similar goals. Once you understand how index investing really works you will see that we sleep just fine at night. 🙂

  22. Jon Evan June 18, 2011 at 4:37 am #

    By active investing I simply mean deciding on a goal for the investment and figuring out a minimun annual rate of return for the portfolio to get there with the strategy of preservation of capital and the power of compounding and buying only assets that I understand. For my own purposes it was to retire at 65 with an annual income thereafter of 60,000 for 25 years. In the 80s when interest rates were high I sold my entire RRSP mutual fund port. and bought one large provincial strip maturing in 2015 which has yielded 10%/yr. Each yr. after this because interest rates allowed I max. out my RRSP with GICs and gov’t bonds which yielded bet. 4-6%/yr. I have bought individual stocks in my non-registered acct. when market corrections occurred but sold them as soon as I reached a 10% return on investment. And so, I believe that I have been able to control my returns and am achieving my goal. Presently, it’s a different paradigm with a difficult investing milieu. Would an index fund buy and hold strategy achieve as certain a goal for me in this new future going forward? That uncertainty won’t allow me to sleep. But, I can still obtain 4% today going long on provincials and with the present correction in the market maybe buy more value stocks to sell them again as the market recovers. Why is this strategy an illusion?

  23. Maxwell C. June 18, 2011 at 5:12 am #

    @Jon Evan
    Are you just doing this to joke around and play the devil’s advocate…or are these your actual thoughts? I don’t think someone who had actually bothered to read much of this blog would be making such posts 🙂

    As for your plan to be “buying only assets that I understand”, well, that is why we have this and other blogs, to *broaden* your understanding (and therefore selection of products that you understand). Keep reading, gain a proper understanding of how index funds and ETFs work, and chances are high that you will eventually want to include them as at least a part of your portfolio. Only going with specific bonds may work for you…but then again it may not. Only going with specific stocks is perhaps certain (sooner or later) to result in a less than 4% yearly gain (though I recommend that you get used to this idea). There is no certainty with any stock. Look at what is happening to RIMs stock right now! You could still get screwed by inflation and other factors with bonds.

    As for stock picking: I consider myself to be a pretty intelligent, well-informed guy when it comes to financial instruments, but I realize my limitations. If most professionals who devote 40+ hours a week to this and have attended special schools to gain knowledge that I probably lack cannot beat a simple index fund for me after their expenses are deducted, then I realize that my chances of being able to do so are probably much slimmer, even if I did have that kind of time to worry about my investments (I don’t…I like to sleep at night ;-).

    Keep reading though! Read this whole blog, it is excellently well written! Good luck 🙂

  24. Canadian Couch Potato June 18, 2011 at 8:58 am #

    @Jon Evan: Thanks for clarifying your argument. I think we’re really just arguing about semantics here. Active investing, by definition, refers to the attempt to beat the market by selecting individual securities and/or using market timing. What you’re doing is just fixed-income investing. By buying GICs, strip bonds and other fixed income instruments, you can, of course, control the returns you get. Those returns will usually be low, but they are predictable, and if they meet your needs they’re perfectly fine.

    Those of us who need more than 4% have no choice but to take some equity risk. Otherwise our sleeplessness comes from knowing that our returns will barely outpace inflation.

    In an earlier comment you asked why anyone would buy an index fund rather than picking individual stocks. The answer to that is much more complicated, but the short answer is that all the evidence shows that picking stocks that will outperform the market is a loser’s game with a low probability of success. So the best way to take equity risk is through a diversified index fund or ETF.

  25. Jon Evan June 18, 2011 at 2:36 pm #

    @ Couch Potato Thank you for responding and I appreciate the dialog. “So the best way to take equity risk is through a diversified index fund or ETF.” I suppose I’m not there, BUT if I suddenly lose my job and find myself in a lower paying one than I’ll be with you regarding needing more than 4%/yr.! What will I do then? I don’t know. Sounds like you completely discount active investment using your definition whether that is regarding equities or fixed income? Are you that convinced that buy and hold passive index investing is the best going forward? Do you not think that active fund managers will evolve and adapt going forward as well? What did you think of Stan Luxenberg article at:
    http://registeredrep.com/columns/stan-luxenberg/finance_irrational_exuberance_index_0411/
    He seems to make a case for things to change?

  26. Canadian Couch Potato June 20, 2011 at 7:43 pm #

    @Jon Evan: No one can predict what the best investment strategy will be going forward. However, the evidence is overwhelming that active management has a low probability of beating the market over the long term. My Resources page is filled with books that present the evidence.

    The Luxenberg article was interesting—thanks for the link. Most of what he writes is true as far as it goes, but none of it is new. They’re the same old tired arguments people have been making forever. The one absurd statement in the article is “On average, active funds do about as well as index funds.” This can never be true. William Sharpe established this many years ago:
    http://www.stanford.edu/~wfsharpe/art/active/active.htm

    I loved that the strongest evidence they could come up with in favor of active management was that five (yes, five) index funds finished in the third quartile over the last 10 years. Funny how they didn’t mention the hundreds of others that were first quartile.

    No one can deny that active management gives an investor the opportunity to outperform an index strategy. The question is, how likely is that outcome? The evidence suggests it is extremely rare.

  27. New Potato July 1, 2011 at 6:19 am #

    Hi Dan, I want to thank you for your excellent blog. The Moneysense articles on the Couch Potato strategy caught my eye and I am ready to take the plunge. I am NOT a sophisticated investor…the whole reason that the Couch Potato appeals to me is that it’s simple and I can forget it most of the time. Your easy explanations gave me the confidence to really start taking a look at my investments, so thanks again.

    Anyway, a quick question…I’m interested in the Complete Couch Potato portfolio but can’t decide if I’m freaked out more by the currency exchange fees associated with the VTI and VXUS picks or by the thought of trying to pull off a gambit with TDWH (it sounds like they’re clamping down on this anyway). This is within my RRSP. Any words of advice? I’ve got about $55,000 and have run the math and it seems that ETFs are a better deal for me that index funds, but just barely at this point.

    Also, this is likely a dumb question to folks more experienced with the gambit thing, but…if I can buy an interlisted stock online through the Web Broker interface at TDWH then sell immediately and indicate that I wish to settle in USD…why is it necessary to also phone TDWH to journal? I think I missed something.

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