While Washington has long been debating how to reform big Wall Street banks, Vanguard Group is quietly doing just that as the company and its army of index funds remove about $20 billion a year in revenue from the financial industry.
So far in 2015, Vanguard is leading a record $365 billion in net flows into low-cost and passively managed index funds and exchange-traded funds (ETFs), according to Bloomberg data. Meanwhile, the active mutual funds that constitute some of Wall Street's best customers have lost $147 billion, according to the Investment Company Institute. That adds up to about a half-a- trillion-dollar swing so far in 2015, which will be the most ever in a year.
Vanguard’s take of this is a phenomenal $185 billion, or about 55 percent of the total inflow, which puts it on pace to bring in more money in one year than any asset manager in history, according to Barron’s. The rise of Vanguard and other passive managers comes at a time when Wall Streeet is under intense pressure to boost its collective profits.
Vanguard’s assets now stand at $3.1 trillion, which effectively means that this year alone it will have removed more than $16 billion from the financial industry just through fees. That figure is based on the average asset-weighted fee of a Vanguard fund of 0.13 percent, compared with the 0.66 percent average asset-weighted fee of an active mutual fund.
Of course, $16 billion is merely a dent for a financial service industry that generates approximately $200 billion a year in global trading and asset management revenue, per figures from Bloomberg Intelligence. But the dent gets bigger once it includes the "hidden fees" that active managers rack up from continuously tweaking their portfolios.
Active mutual fund managers are some of Wall Street’s best customers because they spend money through trading commissions and research as they attempt to outwit the market and turn over the securities in their portfolios.
On average, an active manager has turnover that is 10 times more than a Vanguard index fund, where average annual turnover is about 3 percent to 4 percent.* One extra percent of turnover translates to about an extra basis point in cost, equating to another $3 billion or so a year in lost trading revenue.
This $20 billion dent is only expected to grow larger. It took Vanguard 32 years to reach $1 trillion in assets, eight years to get to $2 trillion, but then just three years to get to $3 trillion. At this rate, Vanguard will be removing $40 billion in revenue each year from the financial industry by 2020, equivalent to a 20 percent hit to revenue based on today’s numbers.
But it gets worse, or better, depending on which side of the active vs. passive divide you stand.
Beyond Vanguard’s direct effect, there is also a revenue decrease caused by the so-called Vanguard Effect, which sees other funds lowering their fees to compete with the rock-bottom prices on offer from the company.