Vanguard Vipers: Vanguard funds are big buyers of firm's ETF

[runningman]

Interesting article for Vanguard watchers:

http://makeashorterlink.com/?D533253DB

[Bylo Selhi]

There's nothing new here. Vanguard has used VTI as a place to park cash in its equity funds since the inception of that ETF. Other fundcos do likewise with ETFs, whether they're from Vanguard or BGI.

"Daniel Wiener, editor of The Independent Adviser for Vanguard Investors newsletter" is both a whiner and a wiener. He needs to be both to "justify" his newsletter, considering that it's antithetical to what Vanguard and its investors believe in and stand for.

"Vanguard ought to disclose that shareholders in Vanguard mutual funds are driving the scale that's led to cost reductions in the Vipers," Wiener said.

Why? How are existing unitholders, either in the funds that hold the ETFs or in the ETFs themselves, harmed by this practice? There you go again Dan, blowing lots of smoke and trying to pretend there's a fire.

[George$]

I think Daniel Wiener will say just about anything outrageous, true or not, that gets him some press and its free publicity.

[Bylo Selhi]

[url=http://www.marketwatch.com/news/print_story.asp?print=1&guid={8FB9FBF9-23EE-470B-A9BC-C66C6D92D664}]Charmed Vipers[/url] [MarketWatch, 19Sep05]

The Vanguard Group has created a unique structure for its exchange-traded funds, and any competitor considering a copycat product will have to get the mutual-fund giant's permission first.

Unlike other ETFs, the Vipers, or Vanguard Index Participation Equity Receipts, are separate share-classes of Vanguard's index funds. In contrast, rival firms' ETFs are "stand-alone" funds.

The pioneering construction is evidently important enough to Vanguard that the Valley Forge, Pa.-based company has quietly but significantly moved to prevent other firms from imitating its design.

"We have a patent on our Vipers ETF structure that we invented," said Gus Sauter, Vanguard's chief investment officer.

The patent protection means that rivals will have to negotiate with Vanguard in order to introduce similar funds - an arrangement that Sauter said would be seriously considered.

"We would be willing to talk to other fund companies that would want to use the innovation," Sauter said.

[dagan]

[Restored from backup 2006-07-18]

Can anyone shed light on why the volumes are so low for the Vipers? Some of them are pretty thinly traded compared to older ETFs. Why wouldn't institutional and other investors favour the lower MER vipers?

[Bylo Selhi]

Perhaps it's not so much that VIPERs are thinly traded but rather that SPYs et al are so heavily traded

I'm looking at VTI (Wilshire 5000) vs. BGI's IWV (Russell 3000). So far today volume is 18,100 vs. 15,600. And that's despite the NAV of the former being almost twice the latter. Granted, the volume on SPY is three orders of magnitude higher, but it's been around far longer and is more familiar to institutional players.

[adrian2]

Can anyone shed light on why the volumes are so low for the Vipers? Some of them are pretty thinly traded compared to older ETFs. Why wouldn't institutional and other investors favour the lower MER vipers?

Force of habit? Rival mutual fund companies shunning them?

For me, the ones I'm interested in have enough volume, even if it's lower compared to iShares.
Spreads are reasonable, too.

[dagan]

[Restored from backup 2006-07-18]

Makes sense. Thanks. I own the IVV (iShares) because I thought that the MER difference was negligable between that and VV (Large cap Vipers) and the vloumes of VV were very low when I last looked.

How about this one?

Why is VTI (Total market) MER 0.15%, when VV (Large) and VB (Small) are only 0.07% and 0.10%?

[Bylo Selhi]

Why is VTI (Total market) MER 0.15%, when VV (Large) and VB (Small) are only 0.07% and 0.10%?

It's not. It's 7bp. (Look in the horse's mouth.)

[jiHymas]

Interesting article for Vanguard watchers:

http://makeashorterlink.com/?D533253DB

There's a better version of that article here (no sign-in required).

I think Daniel Wiener will say just about anything outrageous, true or not, that gets him some press and its free publicity.

When Vanguard buys these things for their mutual funds, they are double dipping. They are in a conflict of interest.

Does this necessarily mean they're doing a bad thing? No, of course not. Is it something I want to know about? Yes.

If, f'rinstance, Royal Bank's Dividend Fund were to buy 20% of a new issue of Royal Bank prefs, my eyebrows would rise - particularly if I thought the issue was expensive. But, of course, nobody would ever dream of such a thing happening because Royal Bank is a big company and has TV ads and everything.

It's something of a conundrum for the industry as a whole: the risk with little firms is that the principals will be unprincipled, whereas the risk with big firms is that there are huge opportunities for self-dealing. And the trouble with the investment business is that there is so much room for handwaving when justifying a decision that something has to be egregious before you can even think of doing anything about it.

Vanguard funds' investment in Vipers has grown by $1 billion since the end of 2002, in part due to market movement, while the Vipers themselves have grown by $4.9 billion, Sauter said.

7 bp on $1-billion is $700,000. It's a nice addition to P&L.

There's nothing new here. Vanguard has used VTI as a place to park cash in its equity funds since the inception of that ETF. Other fundcos do likewise with ETFs, whether they're from Vanguard or BGI.

I've never quite understood this investment philosophy.

Well, OK, I don't mind if a rush of cash that the portfolio manager gets told about at 3:30pm goes into ETFs. And I don't even mind too much if they keep some around to fund potential late-in-the-day outflows. But, f'rinstance:

The Vanguard Explorer fund (VEXPX) counted Vanguard Small Cap Vipers (VB) as its largest individual holding at the end of 2004, with $155.9 million parked there. That position represents 72 percent of the $215.8 million ETF's total assets.

However, that's still OK as long as it really is a short-term parking spot for cash coming in, or a buffer against cash going out. I'd want to know more about the typical holding periods, though. If it's supposed to be a buffer, do the transactions make it behave like a buffer?

While a can sympathize with PM's who may face daily cash flow spikes in 8 figures (well, I can when I'm not feeling jealous, anyway), there's not enough information in the article even to begin to form an opinion on Vanguard's practice.

Cash flows are unpleasant, but their damage to the portfolio can be mitigated by selling off stuff you don't like and buying stuff that you do .... and maybe that is, in fact, what Vanguard is doing, with all due haste consistent with good execution. But there is the possibility that some PM's are like the male codfish who, having had his union blessed by the arrival of 10,000 baby codfish, resolves not to have any favourites but to love them all equally. And to stick as much as possible into index funds in order to minimize the number of decisions he has to make and therefore, the number that will turn out badly.

How are Vanguard's funds doing, anyway? That's the bottom line.

[Norbert Schlenker]

When Vanguard buys these things for their mutual funds, they are double dipping. They are in a conflict of interest.

Does this necessarily mean they're doing a bad thing? No, of course not. Is it something I want to know about? Yes.

Double dipping is possible but verifying or dismissing it requires some financial statement analysis.

Mitigating the risk are two factors unique to Vanguard's ETFs. The first is that the ETFs are legally just a separate share class of the underlying fund and there could very well be legal restrictions and/or internal policy that prevents charging MERs on what amounts to treasury shares. The second is Vanguard's mutual structure, with the funds themselves owning the advisor. Under normal conditions, any double dip paid to the advisor would be to the benefit of the funds themselves. Of course, this does not ensure that such moneys aren't wasted on internal frivolity, but that's not a risk unique to Vanguard.

[jiHymas]

When Vanguard buys these things for their mutual funds, they are double dipping. They are in a conflict of interest.

Does this necessarily mean they're doing a bad thing? No, of course not. Is it something I want to know about? Yes.

Double dipping is possible but verifying or dismissing it requires some financial statement analysis.

Well, I say that if I give my money to somebody to actively manage AND he invests it in something with a management fee AND the manager of the sub-investment is affilliated with the guy I've hired .... well, I say there's double dipping going on, and a conflict of interest that I have to be advised of and understand. Perhaps I'm wrong.

Mitigating the risk are two factors unique to Vanguard's ETFs. The first is that the ETFs are legally just a separate share class of the underlying fund and there could very well be legal restrictions and/or internal policy that prevents charging MERs on what amounts to treasury shares. The second is Vanguard's mutual structure, with the funds themselves owning the advisor. Under normal conditions, any double dip paid to the advisor would be to the benefit of the funds themselves. Of course, this does not ensure that such moneys aren't wasted on internal frivolity, but that's not a risk unique to Vanguard.

I just had a look at the "Statement of Additional Information (SAI)" svailable by clicking the indicated button on this page

pp. B-38, B-39, "Description of Compensation", particularly the final paragraph commencing "Under the long-term incentive" and most especially the last clause of the last sentence makes fascinating reading.

[Norbert Schlenker]

I just had a look at the "Statement of Additional Information (SAI)" svailable by clicking the indicated button on this page

pp. B-38, B-39, "Description of Compensation", particularly the final paragraph commencing "Under the long-term incentive" and most especially the last clause of the last sentence makes fascinating reading.

Which reads "Vanguard's operating efficiencies in providing services to the Vanguard funds" if I'm looking at what you're looking at. It's a Delphic statement. It could mean that there are incentives for the manager to drive fund expenses either up or down. I don't know how one would determine which is happening without detailed access to a particular fund's financials.

Well, I say that if I give my money to somebody to actively manage AND he invests it in something with a management fee AND the manager of the sub-investment is affilliated with the guy I've hired .... well, I say there's double dipping going on, and a conflict of interest that I have to be advised of and understand. Perhaps I'm wrong.

The Vanguard Explorer fund (VEXPX) counted Vanguard Small Cap Vipers (VB) as its largest individual holding at the end of 2004, with $155.9 million parked there. That position represents 72 percent of the $215.8 million ETF's total assets.

I can't find those particular asset figures on the Vanguard site but let's presume that they're correct.

The first issue is the VIPER itself and whether double dipping happens there. It's actually possible because the VIPER is a separate share class of an underlying fund and that fund holds about 5% of its asset base in an internal Vanguard money market pool. For all we know, that pool has a fee charged to it internally, while the VIPER shareholders are getting dinged for about 0.10% on the same assets themselves. So it's possible. I doubt that it's big but it's possible.

Now to the active fund. VEXPX is an $8-10 billion active fund with a stated expense ratio of 0.57%, i.e. about $50 million a year in fees. People buy the fund knowing that the fee is 0.57%. What's the effect on the VEXPX shareholder of having ~2.5% of this fund invested in a VIPER that may - emphasized because we do not know that it's even happening - charge another 0.10% on that fraction of the assets? The ER goes from 0.57% to 0.5725%, which rounded off to the two standard decimals is 0.57%; i.e. there is no discernible effect on an investor.

Is Vanguard double dipping with VIPERs? We don't know.

If they are, is there a noticeable effect on any investor? Not with the expense ratios on VIPERs where they are now.

If they are, should they be disclosing? Absolutely.

Given the things other companies pull, e.g. "zero" MERs on wraps of high MER underlying funds, should anyone be worried about Vanguard? Not hardly.

[Bylo Selhi]

It could mean that there are incentives for the manager to drive fund expenses either up or down. I don't know how one would determine which is happening without detailed access to a particular fund's financials.

It could go either way in principle, however, Vanguard has a 30+ year track record of relentlessly persuing cost reductions for their shareholders (i.e. us.) My bet is that the incentives are to push costs down and hard.

should anyone be worried about Vanguard? Not hardly.

IMO, even less

[jiHymas]

I just had a look at the "Statement of Additional Information (SAI)" svailable by clicking the indicated button on this page

pp. B-38, B-39, "Description of Compensation", particularly the final paragraph commencing "Under the long-term incentive" and most especially the last clause of the last sentence makes fascinating reading.

Which reads "Vanguard's operating efficiencies in providing services to the Vanguard funds" if I'm looking at what you're looking at. It's a Delphic statement. It could mean that there are incentives for the manager to drive fund expenses either up or down. I don't know how one would determine which is happening without detailed access to a particular fund's financials.

The full paragraph reads, of course:

Under the long-term incentive compensation program, all full-time employees receive a payment from Vanguard’s long-term incentive compensation plan based on their years of service, job level, and, if applicable, management responsibilities. Each year, Vanguard’s independent directors determine the amount of the long-term incentive compensation award for that year based on the investment performance of the Vanguard funds relative to competitors and Vanguard’s operating efficiencies in providing services to the Vanguard funds.

If you choose to believe that there is no incentive for a Vanguard PM to put client money in another Vanguard fund - or to do so on a reciprocal basis with another PM - you are free to do so.

I, however, will believe that something along the lines of:

Earlier this month, Vanguard cut fees for its Vipers ETFs to reflect asset growth and economies of scale. For example, the expense ratio on Vanguard's oldest ETF, Vanguard Total Stock Market Vipers (VTI), was reduced by more than half to 0.07 percent.

was casually mentioned, just in passing, at bonus time.

Well, I say that if I give my money to somebody to actively manage AND he invests it in something with a management fee AND the manager of the sub-investment is affilliated with the guy I've hired .... well, I say there's double dipping going on, and a conflict of interest that I have to be advised of and understand. Perhaps I'm wrong.

The Vanguard Explorer fund (VEXPX) counted Vanguard Small Cap Vipers (VB) as its largest individual holding at the end of 2004, with $155.9 million parked there. That position represents 72 percent of the $215.8 million ETF's total assets.

I can't find those particular asset figures on the Vanguard site but let's presume that they're correct.

The quotation is from the article that started this thread. At 2004-10-31, Explorer fund held $112-million in small-cap Vipers, and another $687-million-odd in other Vanguard funds (almost all money market). That's on page 25 of the Annual Report available via http://flagship5.vanguard.com/VGApp/hnw ... IntExt=INT

Small cap Viper net assets at Dec 31, 2004, were $185-million. That's on page 24 of the annual report available through http://flagship5.vanguard.com/VGApp/hnw ... IntExt=INT

Now to the active fund. VEXPX is an $8-10 billion active fund with a stated expense ratio of 0.57%, i.e. about $50 million a year in fees. People buy the fund knowing that the fee is 0.57%. What's the effect on the VEXPX shareholder of having ~2.5% of this fund invested in a VIPER that may - emphasized because we do not know that it's even happening - charge another 0.10% on that fraction of the assets? The ER goes from 0.57% to 0.5725%, which rounded off to the two standard decimals is 0.57%; i.e. there is no discernible effect on an investor.

Where were you, Norbert, when the market-timers needed you so badly?

Is Vanguard double dipping with VIPERs? We don't know.

In the absence of any information to the effect that the exchange-traded VIPERS, having taken money off the top for expenses, pays some of that back to favoured ETF shareholders as a dividend not paid to other shareholders of the same class, I'd say it's a slam-dunk.

should anyone be worried about Vanguard? Not hardly.

IMO, even less

If you'll look back, you'll see that I posted to this thread simply to point out that, yes, there is double dipping and yes, there is a conflict of interest in the decision to keep investments all in the family. There seemed, in my opinion of the posts, to be an opinion that Vanguard was so incredibly pure that not only were they able to resist temptation, but that temptation didn't even exist!

Such a lot of fuss over a fairly trivial observation! You guys take your hero-worship really seriously.

[Norbert Schlenker]

I, however, will believe that something along the lines of:

Earlier this month, Vanguard cut fees for its Vipers ETFs to reflect asset growth and economies of scale. For example, the expense ratio on Vanguard's oldest ETF, Vanguard Total Stock Market Vipers (VTI), was reduced by more than half to 0.07 percent.

was casually mentioned, just in passing, at bonus time.

I'm sure it was mentioned more than casually, but what's your point? I interpret that statement plus the paragraph you previously quoted re how Vanguard determines compensation as an indication that Vanguard will pay their staff more when their investors pay less. While that's a somewhat contrary notion, as staff payroll has to come out of the MERs that investors are paying, the simple fact is that VTI's MER went from 0.18% to 0.07% and that's good for investors. That the MER might be as little as, say, 0.05% if no bonuses were being paid ignores the issue that the MER might also be 0.18% if staff were not incented to cut costs in the first place.

VEXPX is an $8-10 billion active fund with a stated expense ratio of 0.57%, i.e. about $50 million a year in fees. People buy the fund knowing that the fee is 0.57%. What's the effect on the VEXPX shareholder of having ~2.5% of this fund invested in a VIPER that may - emphasized because we do not know that it's even happening - charge another 0.10% on that fraction of the assets? The ER goes from 0.57% to 0.5725%, which rounded off to the two standard decimals is 0.57%; i.e. there is no discernible effect on an investor.

Where were you, Norbert, when the market-timers needed you so badly?

I hope that some of the people reading this forum who are receiving their settlement cheques will provide an indication of what they're being compensated, not in dollars, but as a percentage of the assets they had invested. I realize that, for some, it's a complicated process because of periodic purchases or withdrawals, but surely someone here had an existing investment at the time the shenanigans started and kept it throughout the period. If that percentage is as small relative to the fund's base MER as it is in the case of Vanguard Explorer, say 1/200 - for the average settling fund in Canada, say less than 1.5 bp - then I accept your critique. But I see people in other threads writing about getting hundreds of dollars in the mail. Even if they had $100k in a particular fund, even if they held it for 5 years while the managers let favoured clients extract lolly (IIRC the investigation covered less than 5 years, but I could be wrong), 1.5 bp only comes to $75.

Now, in the Canadian market timing situations, I may have underestimated the size of positions or the length of time it went on, but I note in contrast that a person with $100k in VEXPX might be - not is because we have no evidence that it is happening, only that it might be - double dipped for $2.50 a year. That's at least an order of magnitude smaller than the sorts of compensation cheques arriving via Canada Post these days.

Neither Bylo nor I have claimed that Vanguard is lily white. You are quite correct that conflicts may exist, may not be adequately disclosed, and may be exploited even as I write. My attempt to defend Vanguard is not to pretend otherwise. It's just to point out that Vanguard's corporate structure makes it less likely to be a problem (not impossible because, if management or employees are thieves, all bets are off no matter how things are organized and how many rules are in place) and that, if it is happening, it's a tiny problem at Vanguard relative to egregious and often unremarked examples elsewhere.

[jiHymas]

I'm sure it was mentioned more than casually, but what's your point?

The quotation from the compensation disclosure draws a straight line between decisions to invest client funds in Vipers and cash in the portfolio managers own personal pocket ... which makes watching and understanding these investments a whole lot more interesting than might otherwise be the case.

I hope that some of the people reading this forum who are receiving their settlement cheques will provide an indication of what they're being compensated, not in dollars, but as a percentage of the assets they had invested.

At what precise percentage of assets does fiddling become stealing? A very good case can be made and has been made that Viper investments really are in the best interests of the investing unitholders - notwithstanding the fact that they're being charged 57-odd beeps to be put into an index fund costing 18 beeps more - but the relative triviality of the extra costs isn't one I consider all that relevent.

I note in contrast that a person with $100k in VEXPX might be - not is because we have no evidence that it is happening, only that it might be - double dipped

I don't understand your reluctance here. I had a look at the Index fund's financials, and there's no indication of any kick-back to VIPER shareholders. Viper shareholders paid the fund $130,000 in Management, Administrative, Marketing & Distribution fees, as well as a share of the other charges (mainly custodian fees).

It seems to me that clients are being charged once for the assets in the fund itself, and charged again when some of those funds are placed in a related fund. I can't find anything in the financials that comes remotely close to casting doubt on that conclusion. Can you?

Neither Bylo nor I have claimed that Vanguard is lily white.

No. But a question was raised ...

How are existing unitholders, either in the funds that hold the ETFs or in the ETFs themselves, harmed by this practice?

... so I thought I'd help out.

[Bylo Selhi]

Vanguard Slashes Costs to Keep Fidelity, Barclays From Its Turf

Oct. 3 (Bloomberg) -- On a hot July morning, Vanguard Group Chief Executive Officer John Brennan says he's found another way to save money: recycling old stationery. ``How much is it going to save us?'' he asks. ``Fifty bucks? It's the client's 50 bucks, so why wouldn't I do that?'' And forget lunch in the executive dining room at Vanguard's Malvern, Pennsylvania, campus. There isn't one...

As Brennan prepares for his 10th anniversary as CEO, he says he's taking pains to secure Vanguard's unique culture -- one dedicated to saving money for fund shareholders while furnishing them with top-flight returns...

Vanguard haggles on behalf of its fund shareholders. ``Vanguard is known as being tough, negotiating fees to an absolute minimum,'' Malkiel says. ``Or to some advisers' view, below an absolute minimum.'' Neff says the firm used his retirement as a reason to adjust fees downward for his successor. ``I thought it was dirty pool,'' he says. Demming says the cut was one of several at the time...

Brennan will no doubt keep looking for other ways to help Vanguard's fund shareholder-owners; the company's DNA is programmed to reduce costs and garner better returns. Thirty-one years ago, Bogle created a new company that today is viewed as revolutionary. He says today that Vanguard is inspired by a 1981 SEC ruling that validated its mutual structure. ``Funds should be managed and operated in the best interests of their shareholders, rather than in the interests of advisers, underwriters or others,'' the SEC said.

[Bylo Selhi]

VIPERs are no more.

In the interest of greater clarity, and perhaps more investment offerings, the Vanguard Group said yesterday that it would rename its five-year-old line of exchange-traded funds. Exchange-traded funds, a fast-growing segment of mutual-fund investing, are mutual funds that trade like stocks. They account for 25 percent of new deposits at Vanguard, a spokesman said.

Starting today, the Malvern fund family's Vipers, short for Vanguard Index Participation Equity Receipts, will now simply be called Vanguard ETFs. "The name Viper was limiting in a sense because it signifies index and equity," said John S. Woerth, a Vanguard spokesman. "At some point, our ETF lineup may extend beyond index and equity."...

So that leaves the door open to actively-managed ETF share classes from Vanguard