Want a Vanguard mutual fund? You'll need an advisor

Costs of four actively managed funds will be reduced if they lag benchmarks.

Rudy Luukko 23 February, 2018 | 6:00PM

Unlike in the U.S., where Vanguard is a champion of low-fee direct investing, individual Canadian investors won't be able to buy Vanguard mutual funds directly from the company once they go on sale. If you want to invest in a Vanguard mutual fund, once they receive final regulatory approval, you'll need to be a client of a fee-based advisor.

Vanguard Investments Canada Inc.'s advisor-only distribution strategy for mutual funds will set it apart from its giant U.S. parent, Vanguard Group Inc., a dominant player in direct sales of mutual funds in the U.S.

Here in Canada, where Vanguard's family of 36 exchange-traded funds now ranks third in market share with more than $14 billion in assets, there are no toll-free numbers to call, nor chat lines nor any other venue for investors to communicate directly with Vanguard. As Vanguard notes on its website, its current registration in Canada allows the company to discuss its products only with registered dealers and financial advisors.

Nor will the opening lineup of four Vanguard mutual funds include any of the low-fee index funds which are the U.S. parent's largest and most popular mutual-fund offerings. Vanguard Canada's starting four are all actively managed and rely primarily on external sub-advisors.

For Canadian investors who are looking to Vanguard as a source of low-cost investing, its exchange-traded funds will remain the products of choice. The cost of ownership will be higher for the mutual funds, since active management costs more.

But not all that much more. As noted in Vanguard Canada's Feb 22 press release, the maximum management fee is 0.5% for the Series F units, not including fund expenses. That's a cheap price to pay for actively managed funds in the fee-based advisory channel.

In addition, because of the performance-fee provisions that Vanguard has negotiated with its external sub-advisors, the management fees could be even lower than the maximum 0.5%.

But you wouldn't want to be paying anything less than 0.5%, because that would mean that the funds would be underperforming the performance benchmarks that Vanguard has set for them. Vanguard says that if the funds underperform, the sub-advisors will be paid less, and that these savings will be passed on to investors.

Vanguard will pay its sub-advisors a base rate, plus or minus a performance adjustment. If the funds outperform their benchmarks, Vanguard will pay the performance bonuses to the sub-advisors at no extra cost to fundholders. Vanguard says this performance-fee structure is designed to align the interests of investors with those of the portfolio managers responsible for managing the funds.

Vanguard's Feb. 21 preliminary prospectus is for two series of units. The only retail series is Series F, which require investors to have a fee-based account with a dealer. The other is Series I, for institutional accounts.

Communicating only with advisors will help Vanguard Canada save money, but an even more important cost advantage that it shares with other foreign-owned companies is its ability to piggyback on investment strategies and sub-advisory relationships that are already in place outside Canada.

For instance, Vanguard U.S. Value Windsor is sub-advised by Wellington Management Canada LLC and its Boston-based parent, and New York-based Pzena Investment Management LLC. Its investment mandate is similar to that of a U.S.-domiciled fund that is also sub-advised by Wellington and Pzena. The fund for U.S. investors has a 3-star Morningstar Rating for its risk-adjusted past performance, and a Bronze rating from Morningstar research analysts.

Another soon-to-be-launched Canadian mutual fund is Vanguard International Growth, whose external sub-advisors are Baillie Gifford Overseas Ltd. of Edinburgh, Scotland, and Schroder Investment Management North America Inc. which is based in New York. Baillie Gifford and Schroder are also sub-advisors for a U.S. fund with a similar mandate. This fund has a 4-star Morningstar Rating and a Silver analyst rating.

The other two funds to be launched in Canada, subject to final regulatory approval, are Vanguard Global Dividend, sub-advised by Wellington and Vanguard Group's quantitative equity group, and Vanguard Global Balanced, also sub-advised by Wellington.

About Author

Rudy Luukko

Rudy Luukko  Rudy Luukko is a freelance writer who contributes to Morningstar.ca on topics involving fund industry trends and regulatory issues. He retired in May 2018 from his position as editor, investment and personal finance, at Morningstar Canada, where he had worked since 2004. He has also worked as an editor and writer for various general, specialty and institutional media, and he has co-authored courses for the Canadian Securities Institute. Follow Rudy on Twitter: @RudyLuukko.