Vanguard Canada launches active mutual funds

Christian Charest: For Morningstar, I'm Christian Charest. Vanguard is one of the largest asset managers in the world with more than US$5 trillion in assets under management. In the United States, they are known for offering both mutual funds and ETFs at rock-bottom prices. But since entering the Canadian market in 2011, their offerings here have exclusively been on the ETF side. This changed on June 25 with the launch of four mutual funds, and I'm here with Tim Huver, head of product at Vanguard Investments Canada.

Tim, thanks for joining us.

Tim Huver: Thanks for having us.

Charest: So, before we talk about the funds themselves, I think the most important aspect of the story here is the fact that the fees on these new funds are significantly lower than what many Canadians may be used to. Can you explain what the strategy is here?

Huver: Sure. So, at Vanguard, it's never been a question about ETFs or mutual funds or active versus passive, because we do both. We do mutual funds and ETFs. We have a large active franchise in addition to a passive franchise. It's really been about low costs at the end of the day. So, if you look at what we've launched here in Canada with the introduction of four actively managed funds, at a first-year cost that will range between 34 and 40 basis points. That is significantly lower -- less than half of what you see in the industry on average today. So, it really comes from our mutual ownership structure of our parent company, the Vanguard Group, and really, ensuring that investors have the best chance of investment success.

Charest: Vanguard made its reputation worldwide as a provider of low-cost index funds. But these are actively-managed funds. Is this part of a switch in strategy at Vanguard?

Huver: Well, it's interesting to know, we are known for indexing expertise. But if you look at Vanguard's assets, the $5 trillion in assets under management that we have, about a quarter of those assets are actively managed funds. So, really, it's never been, as I mentioned, active versus passive. We offer both. We are one of the largest active managers in the world. We led with ETFs here in Canada when we launched in 2011. And over that time, we've grown to the third largest provider of ETFs in the market.

So, we've been really pleased with how investors have adopted and embraced our low-cost approach. When you look at the ETF industry, $160 billion in assets under management, primarily passive today. When you compare that to the active mutual fund industry that is $1.5 trillion in assets under management and that's some of the highest fees in the developed world. We saw an opportunity to bring our low-cost philosophy and products to a larger group of investors, Canadian investors, and really, give them the best chance of investment success on the active side as well.

Charest: So, can we expect more mutual fund launches in the near future then?

Huver: Very much closer to the starting line than the finish. As I mentioned, we do have quite a bit of active expertise. If you look at the first four funds that we've launched here, these are mandates that are well-recognized, some of our flagship products, some of our best partners in terms of subadvisors that we are using. So, we have replicated those proven strategies that we have around the world and have brought them to Canada in the form of Canadian-domiciled funds. So, we see this as very much the start and the beginning and would expect to continue to launch within this space.

Charest: Speaking of the new funds, can you tell us a little bit about the specific strategies that you brought to Canada?

Huver: Sure. So, four products that we've started with. We have the U.S. value fund. It's the Windsor U.S. Value. We have a Windsor fund in the U.S. that dates back to 1958. So, a long track record and history there; International Growth; a Global Balanced fund and a Global Dividend fund. So, not only with low fees but also, I think, a unique fee structure that we are introducing into the Canadian market as well. I mentioned those first-year fees will range between 34 and 40 basis points but then will upward or downward based on the performance of the underlying subadvisor.

So, as investors see returns of hundreds and hundreds of basis points on the positive side, that will move towards 50 basis points, capped at 50 basis points. So, still very, very low cost. And if for whatever reason we see underperformance from a subadvisor, the fees will also move in the other direction below that initial fee that we are charging within the first 12 months. So, that really is the base fee, and we will move there. So, we think that really aligns the best interest of investors with our subadvisors.

Charest: And I suppose leveraging existing relationships with existing subadvisors is one way to keep costs down. Another one that is interesting is the fact that these funds for now are only offered in Series F or institutional shares, which don't have any embedded compensation. Is this part of the Vanguard strategy then?

Huver: Well, so, if you look at Vanguard globally, we do not pay for distribution, we do not provide any trailers on our funds. So, really, the target initially will be that fee-based advisor. And we are seeing an organic growth with all this talk about transparency around fees and low costs, we are seeing organic growth in that fee-based advisor segment -- more what were maybe commission-based advisors gravitating towards a fee-based model and realizing the benefits of that. So, primarily, targeted at fee-based advisors. We will also have institutional share classes as well.

Charest: And you are also distributed right now on two discount brokerage platforms, Questrade and Qtrade, which are right now the only ones that take F Class shares. Given the changing regulatory environment where we just saw proposals to ban embedded commission for a discount brokerage, is there any plan to expand the distribution on the discount brokerage channel?

Huver: Vanguard hasn't historically paid for a distribution, whether that's trailers or platform fees. We do hope that the new regulation does free us up to be on more platforms and reach more investors in the future. But we feel that that payment part can create conflict of interest. So, that is something that we have steered away from in the past.

Charest: Tim, thank you very much for sharing all this with us today.

Huver: Thank you, Christian.

Charest: For Morningstar, I'm Christian Charest. Thank you for watching.