A Chat With Vanguard Canada: Part 1

December 19, 2011

When Vanguard announced its arrival in Canada this summer, investors welcomed the company with open arms: perhaps no country would benefit more from Vanguard’s devotion to low-cost investing. The company’s first Canadian ETFs started trading on the TSX on December 6.

On the day of the launch, I had the pleasure of sitting down with Atul Tiwari, managing director at Vanguard Investments Canada; Dennis Duffy, Vanguard’s director of business development for non-US markets; and Joel Dickson, a principal in Vanguard’s Investment Strategy Group.

Here are some highlights from the interview dealing with Vanguard’s overall strategy in Canada. Later this week I’ll run another excerpt that focuses specifically on the new ETFs and Vanguard Canada’s plans for the future.

Why did you decide to enter the Canadian market with ETFs rather than mutual funds? And why did you target advisors rather than retail investors?

AT: Having looked at the Canadian market for at least 14 or 15 years, Vanguard considered a number of different entry strategies. The reason we executed now is that the Canadian marketplace is changing. We are seeing a lot more advisors moving from a commission-based approach to a fee-based approach, and that fits in squarely with the Vanguard model. We don’t pay for distribution anywhere in the world, so to enter the Canadian market with mutual funds would be kind of tough, because it is a very commission-oriented business.

About 20% of advisors’ overall business in Canada uses a fee-based model, whereas in the US it is about 65%. Canada is probably where the US was about eight years ago. The other thing is, there are a lot of regulatory changes going on globally. By the end of next year, commissions will essentially be banned in the UK. Same thing in Australia. In the US, they are discussing the fiduciary standard for brokers, and even the OSC [Ontario Securities Commission] has said recently that they are going to consider a fiduciary standard. So with a little help from the regulatory changes, we think we will be well-positioned.

What were some of the uniquely Canadian challenges that you faced? For example, low-cost, direct-sold mutual funds are extremely popular in the US, but investors in Canada haven’t really embraced them.

AT: You’re absolutely right: a number of companies have tried, but direct-sold funds just haven’t caught on in Canada. And a lot of that is because mutual funds are sold and not bought. We haven’t got any plans to launch mutual funds at this stage, but that is not to say that in the future we won’t. We entered the market with the product that we thought would be the best entry point for Canada, and that is ETFs.

One of our other challenges—and certainly one of the key components of our Canadian strategy—is investor education. We will be doing a lot of thought leadership, a lot of seminars—we will do whatever we can to get the message across to investors and advisors about the effects that costs have on your returns over the long run.                                  

Index investors are well aware of the benefits of low costs. But how do you make that case to advisors?

DD: This has been a challenge for us in every market. Even before ETFs, we had a pretty significant advisor business in the US, but the fee-based business was a relatively small percentage of the overall market back in the early 2000s. We went into the UK prior to the legislation banning commissions: we felt there was enough fee-based business there, and we were willing to make the commitment. We are very patient company: look at how long it took us to get into Canada! But there is a lot of education that is going to be needed.

JD: It’s important to recognize that the advisor’s compensation doesn’t need to change at all [if they start using Vanguard ETFs]. Even if they are getting 1% or 1.5% or whatever for their services, we would hope that there is an opportunity to lower fund costs: if you can show 24 basis points with your ETF holdings as opposed to another 1.5% on underlying mutual funds, that’s a huge benefit.

Yet many advisors—and their clients, for that matter—continue to insist that active management is part of their value-added, despite overwhelming evidence to the contrary.

JD: That is a key issue: the value-added model has been disrupted. We talk about a concept we call advisor’s alpha, which is to say, how do you as an advisor position your value to clients in a world where it is not about picking the best funds, or the best managers? It’s about focusing on things you can control, like costs, and risk, and taxes and behaviour.

The problem is, these things are sometimes hard to measure. Some of the best “performance” an advisor could have provided came when the client called them up in the depths of the market in 2009 saying, “Get me out now!” and the advisor said, “Remember our overall asset allocation for the long run?” That doesn’t show up on your statement as the performance of your portfolio versus some benchmark. But if the investor would have sold out on their own, there is huge value added.

No new models yet

Many readers have emailed to ask me whether I will be updating my model portfolios with the new Vanguard ETFs. I’m not planning to do that just yet—for a couple of reasons.

First, the funds have been trading for only a couple of weeks, and while I have little doubt that Vanguard will do a good job keeping tracking errors and bid-ask spreads low, I would like to wait and see.

Second, Vanguard Canada’s US and international equity ETFs use currency hedging, which I have avoided in my model portfolios. It is possible that Vanguard will eventually launch unhedged versions of these ETFs, at which point I would be more likely to incorporate them.

I am resisting the urge to tinker with the model portfolios every time new ETFs are launched. However, this time next year I will re-evaluate the marketplace, and it’s likely that I’ll make some changes to the portfolios to reduce their cost.

Quicken winner

Thanks to everyone who entered the draw for the copy of Quicken Home & Business 2012 money management software. The lucky winner is Chris, who contributes some of the wisest comments on this blog. Congratulations!

{ 10 comments… read them below or add one }

Raman December 19, 2011 at 8:47 am

Thanks for the interview, Dan. I, too, have been waiting for unhedged versions of Vanguard’s US and EAFE ETFs — they didn’t happen to mention in the interview if they would be realeasing them anytime soon, did they? I wouldn’t want to buy some of Vanguard’s ETFs in USD in the new year, only to have them released to be sold in CAD only a few days later.

Thanks again!

Canadian Couch Potato December 19, 2011 at 8:52 am

@Raman: No commitment as yet, but they have said they are open to considering it. More details in Part 2 later this week. For what it’s worth, Claymore launched its hedged version of CLU first, then added an unhedged class three years later!

Dale December 22, 2011 at 3:22 pm

Competition is what makes the world go wrong. Perhaps they will sell them properly in Canada. Currently, less than 6% of Canadians are in etf’s compared to mutual funds. As an advertising and marketing person, it is my opinion that the companies have great products and horrible advertising and branding strategies.

I’ve worked in the financial markets for many years (even on low fee clients such as ING Direct Canada and US) and as it is also my passion I am studying to get my securities license so I too can sell etf portfolios and advice. This is the most obvious untapped market. There’s 94% on the table. And the way to market etf’s is so obvious. But they’re all missing it.

Dale December 22, 2011 at 3:25 pm

Sorry make that go round. Naomi Klein must have taken over my keyboard for a moment.

Canadian Couch Potato December 22, 2011 at 3:34 pm

@Dale: I was going to correct your little malapropism, but your own follow-up comment was much funnier. :)

Let’s remember that not everyone wants low-cost ETF portfolios and fee-only advice. It’s just about marketing: Vanguard is a huge player in the US and everyone knows the brand, but active funds and commissioned-based advisors are still extremely popular. There is a huge proportion of investors who think that index strategies are for naive fools and are quite happy to pay higher fees because they think they’re getting value for active management.

Dale December 22, 2011 at 4:05 pm

Thanks Dan. I agree, but within that 94%, there’s a huge opportunity. Index fund and etf creators are missing a massive and obvious emotional switch that they are failing to capitalize on. I will share with you as I get closer to making this a reality.

Dale December 22, 2011 at 4:14 pm

And in the US penentration in etf’s and indexes is 33% greater. Looks like they are about 9%. And I think that is due to the fact that Vanguard and others are a little closer to the mark on how to market these wonderful financial instruments.

They’re a little more ‘American’ about it…

Rod December 23, 2011 at 10:01 pm

Would you enlighten me on the evils of currency hedged etfs for Canadians.
Thanks

Canadian Couch Potato December 24, 2011 at 10:31 am

@Rod: Definitely no “evil” here! There is a legitimate case to be made for hedging at least part of the foreign currency in a portfolio. However, I tend discourage it for several reasons:

- The management fees of Canadian-listed ETFs that use hedging are usually much higher than unhedged US-listed ETFs.
- The cost of futures contracts is significant and causes a long-term drag on returns. It is also quite tax-inefficient if you’re investing in a non-registered account.
- Hedging is not very precise. For example, iShares XSP has lagged the S&P 500 by at least 1.5% every year, regardless of whether the currency moved up or down.
- Some currency diversification is useful in a portfolio: this year, for example, exposure to the US dollar was a huge benefit. Of course, in other years, it will work against you, but overall, it tends to lower portfolio volatility.

Some articles you may find helpful:
http://bit.ly/tNneYb
http://canadiancouchpotato.com/2010/10/29/to-hedge-or-not-to-hedge/
http://www.canadiancapitalist.com/the-costs-of-currency-hedging/
http://www.canadiancapitalist.com/why-currency-hedged-funds-have-large-tracking-errors/
http://www.canadiancapitalist.com/currency-hedged-funds-underperformed-in-2010/

Invest It Wisely January 1, 2012 at 10:41 pm

“Naomi Klein must have taken over my keyboard for a moment.” Haha, that made me laugh as well.

I am really happy to learn more about this and see that at least they are entering the market with something. We need more competition here in Canada, and who better to bring it than Vanguard.

Leave a Comment

{ 2 trackbacks }

Previous post:

Next post: