The Independent Adviser for Vanguard Investors
•
August 2014
•
7
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step with assets under management.
By the way, you should take these
numbers as an estimate as opposed to
an exact figure. For a single share class
of a fund, I estimate the revenue gener-
ated by multiplying the year-end assets
and the expense ratio of that share class
as reported in the shareholder report
released closest to year-end. I applied
this method to each share class, and
over time, summing the revenue from
each share class gives an overall rev-
enue figure for Vanguard that takes into
account that different shareholders pay
different fees for the same product.
However, this method does not
account for the fact that assets varied
throughout the year, nor does it capture
Vanguard funds based overseas. It is
also slightly skewed by the fact that not
every fund files its annual report at the
end of December, and expense ratios
can fluctuate slightly throughout the
year. So it is far from a perfect measure,
but it should get us in the ballpark.
Is $3.5 billion to run Vanguard too
much, too little, or just right? It’s hard
to say. Not all of that money is going to
Vanguard—some of it goes to the sub-
advisers Vanguard has hired. Plus, keep
in mind, Vanguard is a much larger firm
today, offering more services to clients
than it did two decades ago. So, let’s
narrow down the analysis a bit.
What Does It Cost to Index?
Vanguard’s index funds are a great
place to make some historical compari-
sons. Additionally, by narrowing our
scope, it’s possible to get a bit more
accurate on the revenue (cost) side of
the equation. Within each fund’s annu-
al and semiannual reports, Vanguard
shows the total expenses paid by the
fund for management and administra-
tion as a line item in the Statement of
Operations. So, let’s look back.
At the end of 1993, there was
$11.9 billion invested in
500 Index
,
Institutional Index
(which is the
institutional version of 500 Index) and
Total Stock Market
combined, and the
average fee paid by shareholders was
0.14%. The total expenses reported for
1993 were $16.8 million.
At the end of 2013, investors had
$666.4 billion in the two U.S. stock
index funds (including the institutional
versions) and paid an average expense
ratio of 0.06%. So yes, the expense ratio
dropped significantly—0.14% to 0.06%.
But in 2013, Vanguard’s cost to run the
two index funds was $392.3 million!
What Vanguard was able to do for
under $20 million in 1993 now costs it
nearly $400 million? That’s an average
annual increase of 17%, well ahead of
the 2% average annual rate of inflation
we’ve experienced. Had costs increased
at the pace of inflation, it would only
cost Vanguard $26 million or so to run
the two index funds today—which trans-
lates into an expense ratio of 0.004%.
To Vanguard’s credit, the cost to run
these index funds has not increased at
the same pace as their assets, which
have grown at a 22% annual rate over
the past 20 years. Additionally, equating
the costs of a running a fund to overall
inflation is not a fair comparison, as the
number of shareholders has increased
dramatically in the two index funds. That
means, among other things, lots more
phone calls to answer, and statements
and annual reports to mail. Yet, the other
side of that coin is that there should have
been huge economies of scale gained.
Either way, it is still hard to fathom
how it costs $400 million to run just
two index funds. Yes, there are lots
of annual reports to produce and ship
(though lots of investors have now
forgone paper documents for online
downloads), but there is no cadre
of research analysts required to run
an index fund. Plus, the managers
and traders on these index funds are
undoubtedly working on other index
funds at Vanguard.
At the very least, it begs the questions:
What does Vanguard really mean when
it says it runs funds “at cost?” How is
that cost determined? Are some of those
fees being used to subsidize expenses
elsewhere within Vanguard? As a share-
holder in one of these index funds (or
both), you may benefit from these other
services, but you may not. Who’s to say
how much of these costs you, as a share-
holder, should be shouldering?
While considering those questions,
keep in mind that though Vanguard talks
as if it is a non-profit, it generates a ton
of profits and compensates the top execu-
tives with millions every year. (See the
Partnership Plan
story from last month’s
issue for more.) Pulling in upwards of
$400 million running two index funds
alone certainly helps in that effort.
Vanguard’s push to lower expense
ratios has certainly benefited investors,
both at Vanguard and at other fund com-
panies that have lowered their fees to
compete. While I hope to see expense
ratios continue to trend lower, Vanguard’s
size and the billions it takes in still beg
the question of whether costs could be
lowered even further.
n
Expense Ratios Have Come
Downwith Asset Growth...
12/93
12/95
12/97
12/99
12/01
12/03
12/05
12/07
12/09
12/11
12/13
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
0.00%
0.05%
0.10%
0.15%
0.20%
0.25%
0.30%
0.35%
Total Assets
Avg. Expense Ratio
Vanguard Assets Under Management (Billions)
Avg. Expense Ratio
...But Absolute Revenues
Have Continued to Grow
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
$3.5
$4.0
Total Assets
Fee Revenue
Vanguard Assets Under Management (Billions)
RevenueCalculatedFromExpenseRatios (Billions)
12/93
12/95
12/97
12/99
12/01
12/03
12/05
12/07
12/09
12/11
12/13
It is still hard to
fathom how it costs
$400 million to run just
two index funds.
What does running a fund
“at cost” mean?
