The Big Interview – Tom Bartolacci at Vanguard

by , 6th April 2018

With the launch of factor funds in the US and a new deal to provide the funds architecture for German online interest rates broker Raisin, Vanguard has been in the news of late. From inception in the 1970s by founder Jack Bogle, the company has historically led the way in promoting passive investment. Here ETF Stream talks to Tom Bartolacci, head of European ETF capital markets, about Vanguard’s plans to further extend its ETF footprint while staying true to Bogle’s insistence on the superiority of passive investment over active.

This is an interesting time for ETFs – how much should the European industry be looking to the US as a path to follow?

I think there are a few forces at play right now. When we look at the US and see its scale, the first thing we look to is the transparency about costs. That has really played out and investors have gravitated towards that and really begun to understand that. In the European landscape, we have MiFID and the transparency around transaction costs. The RDR and similar tailwinds on the continent. The more focus on costs, investors start to understand how high-cost products can really eat into long-term returns. Regulators are really helping investors have a better understanding of how costs affect their long-term investment performance. And then, secondly, I would say the other fact at play is the better understanding how an ETF can be used as a core key building block in a portfolio. Investors can’t control the market but they can control the asset allocation and how much it costs. That’s what we are really beginning to see and in Europe there are more and more providers of platforms that are building the technology to allow ETFs to be that foundational investment rather than high-cost active.

Do you think the drive towards zero costs, first, will happen in the US, and second, how far do you think the UK and Europe is behind?

It depends on how you look at zero-cost funds. With the ability of some provider to add back in stock lending revenue, and if you are already earning more than your expense ratio in terms of performance you already have a zero-cost fund. In any investment management firm, it is all about size and scale. So, we are like a lot of firms, growing in terms of assets overall and in concentrating those assets into single-pooled funds which allows you to pass o economies of scale. The march towards zero is going to get louder. We will continue to see pressure across the industry, which is a good thing for clients. They investors will get to hold on to more of their returns.

Are ETFs a much more understood mass-market product in the US and what lessons can we learn in Europe?

I would say the exchange-traded nature of the product is more widely understood in the US and easily accepted by the investment public. In Europe we don’t see the same flexibility in platforms. It’s more accessible in the US.

What was the route to success for Vanguard?

In our history the idea was to launch direct to retail with mutual funds. We didn’t launch ETFs until early 2000s. What allowed ETFs to take-off was our partnership with advisers. Our success stated with our retail presence but the traction in ETFs came with the advisers. We carried over the argument on low-cost investment. We had a track record and a brand built around that, which lent itself well to indexing with an ETF wrapper. It meant the advisers could concentrate on providing other services to their clients. That’s where they can add the most value.

What are your key markets beyond the UK?

Switzerland, the Netherlands and Germany. There are different investor preferences, but the applicability of the ETF can help bridge some of that. The products we are putting out there are broad-based, low-cost diversified product that fit no matter what the distribution method is or what the end client’s main objectives are. They will be able to be used in some capacity whether strategic or tactical. That ubiquitous nature of the ETF is what makes it such a powerful tool.

What is your position on mark beta or factor investing?

When we think about indexing, it’s buying the market and the way to buy the market is through a market cap weighted index. Anything that deviates from that is really active. As soon as you move away from that market-weighted index, you are into active territory and there are many different ways to employ that active strategy. It could be rules-based like a smart beta or a factor fund or it could be fundamental active. But within an ETF wrapper, it really is up to the product provider to determine what they think they can put in an ETF wrapper that can add value in the long-term. The different types of strategies we have in Europe are factor-based, quantitative and rules-based; we don’t publish the rules, it is a proprietary model. They are: momentum, value, minimum volatility, liquidity. When it comes to an investor, if you recognise that, one, you are taking a risk that deviates form that market, and you believe there will be performance but there might not be performance forever, you just have to recognise how you put that in your portfolio. And we are coming up with more tools and papers to help advisers and individuals to understand how to marry index and factor (investing) together.

Is it unhelpful that there isn’t a strict definition of the rules for each factor?

Our methodology is definitely based on academic research. Within the academic community there is a pretty clear determination of what represents value and what represents quality, for instance, and where those premiums are derived from. I think there is a clear delineation and I think it is up to issuers not to muddy the waters through our product differentiation. We need to tell clients this is what we are putting out here, these are the returns you can expect and the environments this strategy will perform in. As long as we have clear investment mandates and those are explained in clear, plain language to investors, I don’t think there is too much of a need to further differentiate or categorise a lot more products or force things into certain buckets.

And these are reasonably new products – how have they been received?

We have just over two years of a track record right now. Like any active fund, it takes a while for the performance data to cumulatively prove itself.

This is in live as opposed to back-tested?

Exactly. It depends on the cycles of the market when it comes to inflows. Value was strong about a year ago and now we are seeing more in momentum, perhaps catching a rebound from the recent stock market dip. But there is still more education to be done for investors, not just to understand what the factor is but also how do I take this and implement it alongside traditional active or passive strategies because it is within that spectrum.

What is your view on the rise of robo-advisers?

Advice is necessary. Some investors are always going to want advice. Professional advice is something investors are going to seek out and as long as that advice comes at a low cost, that is something Vanguard will be in favour of. We want investors to have long-term investment results that are in their best interests.

What is your view of the debate about how ETFs might perform in a stressed market?

We’re seeing engagement from regulators across the globe. We have seen a tremendous amount of growth in ETFs so it’s not surprising that people are going to ask questions. We want those questions asked and we want, as issuers, to have the right answers. One thing regulators have got to understand is that the ETF doesn’t move markets. When the S&P goes down 5 percent, the ETF goes down 5 percent. Whether it is a stressed market or a normal market, the arbitrage mechanism that is in place for ETFs where any one of Vanguard’s 32 Aps can come to the market an arbitrage or keep that price within its band of fair value, we’ve seen the structure is tried and tested.

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