putting a value on your value: quantifying vanguard ... · • the traditional value proposition...
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For Financial Advisors and Institutional Investors Only. Not for Public Distribution.
Putting a value on your value: Quantifying Vanguard Advisor's Alpha™ Michael DiJoseph, CFA Investment analyst The Vanguard Group, Inc.'s Investment Strategy Group June 2015
2 For Financial Advisors and Institutional Investors Only. Not for Public Distribution.
• The traditional value proposition for financial advisors has been primarily focused on outperformance.
• However, this value proposition has extremely high hurdles. • Requires tremendous alpha after fees and taxes
• Expected outperformance has not been achieved for vast majority. • Result: lower asset retention rates
• Vanguard Advisor's Alpha framework emphasizes the more reliable benefits of a professional relationship.
Redefining the advisor's value proposition
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• A holistic investment advisory value proposition
• A reframing of the benchmark for the value of advice
What is Vanguard's Advisor's Alpha?
Investment management
Wealth management
Behavioural coaching
Service model: Time, willingness
and ability
Success not solely on outperforming a cost-free policy portfolio
Source: The Vanguard Group, Inc.'s Investment Strategy Group.
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How much, and by what methods,
does an advisor add value?
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The value of an advisor: "About 3%"
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Value added using Vanguard's Advisor Alpha framework
Vanguard Advisor's Alpha strategy
Value-add relative to "average" client experience
(in basis points of return)
I. Suitable asset allocation using broadly diversified funds/ETFs >0*
II. Cost-effective implementation (expense ratios) 131
III. Rebalancing 47
IV. Asset location 0 to 42
V. Spending strategy (withdrawal order) 0 to 41
VI. Total-return versus income investing >0*
VII. Behavioural coaching 150
Range of potential value added (bps) "About 3%"
Source: Ryan Rich, Colleen M. Jaconetti, Francis M. Kinniry Jr., Donald G. Bennyhoff, and Yan Zilbering, May 2015. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha in Canada. Valley Forge, Pa.: The Vanguard Group, Inc. *Return value-add for numbers one and six was deemed significant but too unique for each investor to quantify. Also, for "Potential value added," we did not sum the values because there can be interactions between the strategies. Bps = basis points. Note: "About 3%" means 3 percentage points of additional net return over an unspecified period of time.
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I. Asset allocation
Equities increase both expected return and volatility
8.0% 8.2% 8.3% 8.5% 8.6% 8.7% 8.8% 8.8% 8.8% 8.8% 8.8%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
100%Bonds
10%/90% 20%/80% 30%/70% 40%/60% 50%/50% 60%/40% 70%/30% 80%/20% 90%/10% 100%Stocks
Ann
ual r
etur
n
10%/ 90%
20%/ 80%
30%/ 70%
40%/ 60%
50%/ 50%
60%/ 40%
70%/ 30%
80%/ 20%
90%/ 10%
Source: The Vanguard Group, Inc.'s Investment Strategy Group. Data as of December 31, 2014. Notes: Bars represent the best and worst 1-year returns. Equities are represented by the S&P/TSX Composite Index. Fixed income investments are represented by the Citigroup World Government Bond Index from 1985 through 2001 and the Barclays Canadian Issues 300MM Index thereafter. Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Average
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NACUBO-Commonfund (2014) study on the performance of endowment portfolios
I. Asset allocation: Simplicity has been very competitive
0
2
4
6
8
10
12
3 years 5 years 10 years Since July 1, 1985
Ret
urn
perc
enta
ge (%
)
Large endowments 10% of endowments Medium endowments 39% of endowmentsSmall endowments 51% of endowments 60% stock / 40% bond portfolio
Sources: Vanguard and NACUBO-Commonfund Study of Endowments. Note: Data are as of June 30 for each year. Data through June 30, 2013. 60% stock/40% bond portfolio: Domestic equity (42%) is Dow Jones Wilshire 5000 Index through April 22, 2005, and the MSCI US Broad Market Index thereafter. Non-U.S. equity (18%) is MSCI World ex USA through December 1987 and MSCI All Country World Index ex USA thereafter. Bonds (40%) are Barclays U.S. Aggregate Bond Index. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
Large endowments (10% of endowments) Small endowments (51% of endowments)
Medium endowments (39% of endowments)
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II. Cost-effective implementation (expense ratios)
Equities/fixed income 80/20 50/50 20/80
Asset-weighted expense ratio1 1.64% 1.46% 1.28%
"Lowest of the low"2 0.41% 0.36% 0.31%
Cost-effective implementation (ER) 1.23% 1.09% 0.96%
1 Asset-weighted expense ratio includes F Class shares which are only sold through fee-based advisors, and on average, contain lower management expense ratios. 2 "Lowest of the low" is the lowest-cost quartile of mutual funds and ETFs available for sale across Canada. Source: Vanguard calculations, based on data from Morningstar, Inc. as of December 31, 2014.
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The goal of rebalancing is risk reduction rather than return maximization.
III. Rebalancing: Appropriately used as a risk mitigation technique
1960-2014 50% stocks and 50% bonds Rebalanced Non-rebalanced
Average annualized return 9.3% 9.2%
Average standard deviation 9.2% 11.5%
1960-2014 70% stocks and 30% bonds Rebalanced
Average annualized return 9.7%
Average standard deviation 11.9% Sources: The Vanguard Group, Inc., based on data from FactSet, FTSE and MSCI. Notes: Equities are represented by the S&P/TSX Composite Index through 1969 and MSCI Canada Index thereafter. Bonds are represented by FTSE TMX Canada Long Term Bond Index through 1979 and FTSE TMX Canada Universe Bond Index thereafter. Returns are in Canadian dollars, with income reinvested to December 31, 2014.
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Purchasing actively managed equities or taxable bonds in taxable accounts may subject clients to:
• Ordinary income and interest tax rate on taxable bond income up to 29%
• Capital gains tax rate up to 14.50%
• Tax rate on taxable dividend income up to 19.29%
IV. Asset location: Add 0–42 bps in the first year…compounded
Notes: Tax rates are federal marginal tax rates for Canada for 2014–2015. Tax rate on dividend income applies to eligible Canadian dividends. Bps = basis points.
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• Many clients hold multiple account types, creating complexity during drawdown phase.
• Informed withdrawal-order strategies can minimize total taxes paid over retirement.
V. Spending strategy: Withdrawal order
Taxable portfolio
Taxable flows
Required Minimum Withdrawals (if applicable)
Tax-free
Tax-deferred
Higher expected marginal tax bracket in the future
Tax-deferred
Tax-free
Lower expected marginal tax bracket in the future
Source: The Vanguard Group, Inc.
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VI. Total-return versus income investing
Income-only strategy
Impact on a portfolio (compared with capital-weighted portfolio
at the sub-asset class level)
Overweight credit bonds Credit risk
Downside protection
Overweight dividend-centric equity
Concentration risk
Tax efficiency Diversification
Source: The Vanguard Group, Inc.
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• Numerous studies1 conclude behavioural coaching adds 1% to 2%.
• Investors commonly receive much lower returns from the funds in which they invest.
• This drag is significantly more pronounced for more concentrated or narrow funds.
• This drag is much lower for broad index funds.
VII. Behavioural coaching
1 Studies include the Investment Funds Institute of Canada's The value of advice: report (2011) and Past performance is indicative of future beliefs. (Philip Maymin and Gregg S. Fisher, 2011). Source: The Vanguard Group, Inc.
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40
50
60
70
80
90
100
110
120
130
140
Bal
ance
d po
rtfol
io v
alue
(in
dexe
d to
100
as
of m
arke
t pea
k)
100% Stock50% stock/50% bond100% Bond
VII. Behavioural coaching: Staying the course is difficult
A balanced, diversified investor has fared relatively well
Peak-to-trough return
–48.48%
–23.36%
9.02% + 17.99%
+ 31.37% + 34.32%
Peak through December 31, 2014
Source: S&P/TSX Composite Index and Citigroup World Government Bond Index Canada (rebalanced monthly). Data provided by Barclays and Thomson Reuters Datastream, as of December 31, 2014.
100% equities
50% equities/50% fixed income
100% fixed income
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The result of these behaviours is that investor returns lag the returns of the markets and the funds in which they invest.
VII. Behavioural coaching: Where performance chasing can lead
-3%
-2%
-1%
0%
1%
Ann
ualiz
ed d
iffer
ence
in re
turn
s
Sources: Vanguard calculations, based on data from Morningstar, Inc. Notes: The time-weighted returns (TWRs) in this figure represent the average fund return in each category. Investor returns assume that the growth of a fund's total net assets for a given period is driven by market returns and investor cash flow. An internal rate-of-return (IRR) function is used, which calculates the constant growth rate that links the beginning total net assets and periodic cash flows to the ending total net assets. Discrepancies in the return "difference" are due to rounding.
Difference between 10-year investor and fund returns in Canada
Canadian equity
Canadian small/
mid-cap equity
Real estate equity
International equity
Emerging markets equity
Fixed income
High-yield fixed
income
Equity balanced
Fixed income
balanced
U.S. equity
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VII. Behavioural coaching: Index as the core has many advantages
Percentage of active funds underperforming benchmark
0%
20%
40%
60%
80%
100%
Based on survivors plus funds closed or merged during period
Sources: Vanguard using data from Morningstar, MSCI, and Barclays. Data cover the periods ended December 31, 2014. Notes: The number of index funds in Canada was insufficient for a direct comparison of active funds to index funds. An approximation was made by comparing each active fund to an appropriate benchmark. The benchmarks were adjusted downward by 25 basis points to approximate the return of a low-cost index fund tracking the same benchmark.
Large-cap Canadian
equity
Small-cap Canadian
equity
International equity
U.S. equity Intermediate-term bond
Short-term bond
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Advisor's alpha win-win
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Extremely high hurdle
Result: Low achievement = lower asset retention rate
Vanguard Advisor's Alpha model emphasizes more reliable benefits • Asset allocation and diversification
• Financial and wealth planning
• Long-term discipline and behavioural coaching
• The comprehensive service model — T.W.A.
Traditional value proposition: Outperformance
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Minimize the risk of losing clients by "shrinking the distribution"
This hypothetical illustration does not represent the return on any particular investment. Source: The Vanguard Group, Inc.
21 For Financial Advisors and Institutional Investors Only. Not for Public Distribution.
Minimize the risk of losing clients by "shrinking the distribution"
This hypothetical illustration does not represent the return on any particular investment. Source: The Vanguard Group, Inc.
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• Working with an advisor can add "about 3%" in net returns following Vanguard's Advisor Alpha framework.
• While the value of this wealth creation is certainly real, it does not show up on any client statement.
• The Vanguard Advisor's Alpha framework is not only good for your clients but also good for your practice.
Conclusion
Source: The Vanguard Group, Inc.
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Important information
Commissions, management fees, and expenses all may be associated with investments in a Vanguard ETF™. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. Vanguard ETFs™ are managed by Vanguard Investments Canada Inc., an indirect wholly-owned subsidiary of The Vanguard Group, Inc.
Date of Publication: June 2015
The opinions expressed in this presentation are those of the individual representative and do not necessarily reflect the opinions of Vanguard Investments Canada Inc. No implied or express recommendation, offer, or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy is made in this material. This presentation is not research, investment and/or tax advice and it is not tailored to the needs or circumstances of any individual investor.
Information, figures and charts are summarized for illustrative purposes only and are subject to change without notice. While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use. Information regarding third party investment fund managers is solely for educational purposes.
All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While Vanguard ETFs are designed to be as diversified as the original indexes they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment.
In this presentation, references to "Vanguard" are provided for convenience only and may refer to, where applicable only to The Vanguard Group, Inc. and/or may include its affiliates, including Vanguard Investments Canada Inc.
Notes on risk: All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While Vanguard ETFs are designed to be as diversified as the original indexes they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.
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Important information (continued)
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