A new Morningstar report has raised questions about investing powerhouse Vanguard, with research analysts questioning whether competitive pressures have eroded the company's customer service and forced it into an ill-advised move into proprietary funds and advisory services, and private equity.

In the final analysis, they ask, does the company still stand for the values held by founder Jack Bogle?

“The trouble is, Vanguard has attracted too many imitators,” John Rekenthaler, Morningstar vice president of research, said in a report released this week. “No longer does Vanguard walk alone. These days, BlackRock, State Street, Fidelity and Schwab, among others, offer comparably priced index-fund lineups. To be sure, Vanguard remains the industry’s leader, attracting about 40% of this year’s net index-fund sales, but it faces fierce competition—leading to pressure on its funds’ expense ratios. As with the rest of the industry, Vanguard has been forced to cut its index funds’ costs, repeatedly.”

In fact, if trends persist, BlackRock and its iShares ETF business in 2021 will take in more new money than Vanguard’s U.S. funds for the second year in a row.

The financial pressure is exhibiting itself in two ways, Rekenthaler claimed. First, customer service at the firm that prided itself on answering every phone call within three rings has suffered dramatically, with some investors claiming it takes 45 minutes or longer to get through, according to the report.

The second change that gives Rekenthaler greater pause regarding Vanguard’s motivation and rankles some advisors is the firm’s foray into the advice business.

Rekenthaler said the aggressive promotion of the company’s advice platform, Personal Advisor Services, which was launched in 2015 and charges 30 basis points, “bolsters the suspicion that the main reason is money.”

“The service has been an unquestioned success," he said. "At roughly $250 billion, it has thrived in the marketplace, becoming easily the largest digital-advice platform. ... And the platform’s revenue has surely been to Vanguard’s liking, checking in at close to $750 million per year."

But two recent Vanguard announcements “have startled observers,” he said. “This spring, Vanguard promised to bring private-equity funds to qualified PAS clients. Then, last month, the company introduced three actively run Advice Select funds, available exclusively for the program’s customers.”

Private-equity funds “directly contradict Vanguard’s existing brand, being costly, complex, illiquid, rather than cheap, simple and easily traded,” he said.

Even more surprising, however, are the Advice Select funds, which are actively managed and exclusive. If clients leave the PAS platform, they can continue to hold or redeem these shares and can move them to another platform. After leaving the service, however, no new purchases of these funds are permitted.

“Never did I think that Vanguard would remind me of Wall Street wirehouses, circa 1990. But marketing special, in-house funds that could only be held by their advice clients was, in fact, how those firms operated,” Rekenthaler wrote.

Vanguard spokesperson Laura Bulman clarified: “A client who invests in Vanguard Advice Select Funds and then decides to leave Personal Advisor Services can continue to hold or redeem their shares in the funds.” 

“Our focus on advice is directly aligned with the firm’s mission to give investors the best chance for investment success. We believe advice can help investors achieve better outcomes, whether it is delivered directly by Vanguard or through independent financial advisors using Vanguard’s products and services,” she said.

“While we have made progress, we recognize there is more to do, and are committed to continuing to evolve and improve,” Bulman added.

Since Vanguard has entered the advisory business, it has become one of the largest employers of newly minted CFPs. This move has not gone unnoticed among advisors, many of whom are Vanguard fans.

“I’ve used Vanguard index funds for 20 years,” said Scott Salaske, founder and CEO of FirstMetric, an RIA firm based in Troy, Mich. “They do a great job." But the PAS service is not for everyone.

Salaske said he recently signed a high-net-worth client from Vanguard’s Personal Advisor Services and moved him to Schwab's advisory platform because the client, a long-time Vanguard investor, didn’t like the recommendations or the fact that he kept being assigned different advisors.

“There was no reason for us to pay 30 basis points for his index funds inside PAS," Salaske added.

Advisor Daren Blonski, co-founder and managing principal of Sonoma Wealth Advisors, Sonoma, Calif., said Vanguard hasn’t wandered off course “as much as they are just being forced to evolve. They realized they have to give clients what they want. Why would I pay Vanguard 30 basis points for advice if all I get is index funds? What you’re going to find is investors want alternative investments and actively managed investments and that’s what Vanguard is giving them."

Some question whether Vanguard's foray into alternative investments is as new as critics claim. They note that Vanguard has offered a market-neutral, long-short equity fund since 1998.

In 2014, Morningstar named the Vanguard Market Neutral fund its alternatives fund of the year. While that vehicle's 1.18% expense ratio dwarfs most index funds, it is substantially less than most hedge funds deploying a comparable strategy.

But like many alternatives funds, the Vanguard market-neutral fund has lagged indexes in recent years, posting declines of -9.57% in 2019 and -11.57% in 2020. So far in 2021, it has climbed about 20%.

Rekenthaler acknowledges that changing times may have prompted Vanguard to explore new tactics. “The strategy that carried Vanguard through its first 40 years, appears to have reached its breaking point,” Rekenthaler said.

“In response, Vanguard executives have broadened the company’s revenue stream, thereby altering its mission. A Vanguard that offers private-equity investments and an advisory service that features exclusive funds isn’t Jack Bogle’s Vanguard. Whether that means that Vanguard has lost its way, or has sensibly adjusted to changing times, I cannot tell,” Rekenthaler said.

Morningstar analyst Alec Lucas agreed, saying, “Vanguard is adapting to the industry conditions it helped create. When your competitors start offering your indices for free, what direction do you go if you’re trying to maximize return? ... Vanguard has wisely tilted toward offering advisor services, adding an active option that has a good shot at attracting dollars.”

Lucas said he is skeptical the company can democratize private equity for public school teachers—as they’ve suggested—but said that remains to be seen. “The real question is what kind of service will Vanguard provide to those not in its advisory business. That’s the pain point,” Lucas said.