Active asset management companies are better off doing nothing and continuing with their current business models than slashing fees in a bid to compete with passive providers, according to Vanguard founder Jack Bogle.
Speaking at the Morningstar conference in Chicago Bogle set out at two short-term survival strategies for active management shops, which are coming under increasing pressure from low-cost index fund providers, such as his own Vanguard.
He split active companies into two broad categories, those which are closely held and controlled by their founders, inside executives and minority public shareholders, and then those which are owned by financial conglomerates and banks.
‘For the closely held firms, the optimal strategy will be: “don’t do something. Just stand there,”’ he said.
He said many of these firms offered sound, if not market-beating, strategies and that while they have the resources to diversify their product set and expand beyond their core skills, this would be unlikely to create value for investors in their funds.
He said experimenting with index funds was unlikely to help these firms, nor was cutting fees as even at 50 basis points (bps) rather than 100bps they could not compete with 4bps offered by passives.
‘Boring as that “do-nothing” strategy might seem, it is far more likely to preserve the profits of managers than slashing fees, or more aggressive marketing, or jumping (likely fruitlessly) on the bandwagon of low-cost traditional indexing,’ he said.
Bogle added that moves towards smart beta funds and niche ETFs might generate short-term flows but that he was skeptical of the concept.
‘This sort of strategy is… really an actively managed wolf in an index fund sheep’s clothing,’ he said. ‘Mark me down as dubious as to their long-term staying power. Offering narrow, even speculative ETFs could well be the optimal short-term marketing strategy for attracting cash inflows and generating trading commissions. But it is unlikely to be the optimal long-term investing strategy.’
The Vanguard founder said those fund groups owned and controlled by financial conglomerates would adopt a different approach, although there would be some similarities.
He said they were currently very profitable businesses with significant margins, and should continue to be run along those lines, although with inevitably decreasing volumes.
Bogle said, that like the previous group, they should not cut fees nor should their parent companies invest further capital in these businesses.
‘Using the terminology of The Boston Consulting Group, maintain your fund business as the “cash cow” that it is today,’ he said. ‘Delivering high margins and generous profits, albeit likely at a declining rate.’
He said this approach would work in the short term but that ultimately he expected conglomerates and banks to sell off their asset management arms.
‘With this cash-cow strategy, these conglomerates will have a perfectly good business rationale, but I’m guessing that many of their mutual fund subsidiaries will ultimately be sold at bargain prices or merged with other similarly-situated firms,’ he said.
Bogle said longer-term asset managers needed to transition to offer better returns for their fund investors rather than the owners of the companies.
‘The remarkable growth of mutual fund assets has served the owners of fund management companies bountifully, but it has bypassed the owners of mutual fund shares,’ he said.
Bogle was speaking at the Morningstar conference in Chicago. A full transcript of his talk can be found here.