Michael Lovett Head of Distribution Vanguard
The low cost revolution 3
ETF growth in Australia Value in A$m 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Aus Market Cap: $15,925,100,000 bn # of Aus ETFs listed: 104 120 100 80 60 40 20 # of ETPs 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 4 Source: ASX, as at January 2015 report: ASX Funds (Listed Managed Investments and ETPs).
New ETF s Vanguard MSCI Index International Shares ETF (VGS) Vanguard MSCI Index International Shares (Hedged) ETF (VGAD) Investment Objective To track the return of the MSCI World ex- Australia (with net dividends reinvested), in Australian dollars Index, before taking into account fees, expenses and tax. To track the return of the MSCI World ex-australia (with net dividends reinvested) hedged into Australian dollars Index before taking into account fees, expenses and tax. ASX Code VGS VGAD Fees p.a. 0.18% p.a. 0.21% p.a. Distributions Quarterly Semi-annually DRP Yes Yes Share Registry Computershare Computershare 5
Global outlook: Are we stuck in second gear? Alexis Gray Economist Vanguard Investment Strategy Group 6
Headlines Global recovery to continue, but expect slower economic growth than past decades Low interest rates and inflation to persist Global fixed income muted returns, but no bubble Positive equity outlook is more guarded (in some places) 7
Economic growth slowing Real GDP growth (%year over year) 10 9 8 7 6 5 4 3 2 1 0 China India Australia United States United Kingdom Brazil Canada Eurozone Russia Japan Pre-Recession (1990-2007) Projected future (2014-2019) 8 Notes: Pre-recession and projected trend are based on average annualised real potential GDP growth from IMF WEO. For Australia, data available only to 2015. For euro area, data begin in 1991. For Russia, data begin in 1993. Sources: Vanguard calculations, based on data from IMF and U.S. Census Bureau.
Inflation pressures easing Inflation (%year over year) 10 9 8 7 6 5 4 3 2 1 0 Russia India Brazil China United States Australia United Kingdom Euro area Canada Japan Pre-Recession (1990-2007) Projected future (2014-2019) 9 Notes: Pre-recession and projected trend are based on average annualised real potential GDP growth from IMF WEO. For Australia, data available only to 2015. For euro area, data begin in 1991. For Russia, data begin in 1993. Sources: Vanguard calculations, based on data from IMF and U.S. Census Bureau.
Why are the major economies slowing down? Medium Demand term Financial crisis overhang Unfavourable demographics Global slowdown Long Supply term Productivity growth slowdown 10
Assessing drivers of the economic slowdown Demand Highly significant factor Somewhat significant factor Factor not present Business and consumer deleveraging Government austerity Monetary policy ineffectiveness Income inequality Japan Euro area United States Australia China United Kingdom Canada 11
Assessing drivers of the economic slowdown Supply Highly significant factor Somewhat significant factor Factor not present Population growth slowdown Productivity growth slowdown High unemployment Business investment slowdown Japan Euro area United States Australia China United Kingdom Canada 12
Implications of economic slowdown Relative to history, we can expect: Slower economic growth Lower inflation Lower interest rates 13
Implications for investment markets and portfolios Investment markets Lower interest rates / bond yields Elevated equity valuations Portfolios Lower expected bond market returns Lower expected equity market returns Higher probability of market volatility 14
Bond market projections 10 year annualised return Global Bonds ex-australia hedged in AUD Australian Bonds Australian Cash 3.8% 3.5% 3.7% Australian Inflation 2.0% Historical average 15 Note: Forecast corresponds to distribution of 10,000 simulations from VCMM for the 10 year annualised returns as of December 2014 in AUD for asset classes shown above. See Vanguard s economic and investment outlook (Davis, Wang, Gray and Ahluwalia, 2015) for further details on the asset classes shown above. Source: Vanguard
Equity market projections 10 year annualised return Global Equity ex-australia unhedged in AUD 8.4% Australian Equity 7.2% Australian REITs 6.4% Historical average 16 Note: Forecast corresponds to distribution of 10,000 simulations from VCMM for the 10 year annualised returns as of December 2014 in AUD for asset classes shown above. See Vanguard s economic and investment outlook (Davis, Wang, Gray and Ahluwalia, 2015) for further details on the asset classes shown above. Source: Vanguard.
Balanced portfolio projections 10 year annualised return 6.9% 7.9% 4.6% History 1958-2014 History 2000-2014 17 Note: Forecast displays the 5th/25th/75th/95th percentile range of 10,000 simulations from VCMM for projected nominal returns for balanced portfolios in AUD as of December 2014. The equity portfolio is 50% Australian equity and 50% global Ex-Australia equity. The bond portfolio is 40% Australian bonds and 60% global Ex- Australia bonds. Hedged returns from June 1969 until 1990 based on availability of 3-month yields for the US and Australia, and forward rate based on interest rate differentials. After 1990, returns are hedged using Barclays methodology. SeeVanguard s economic and investment outlook (Davis, Wang, Gray, and Ahluwalia, 2015) for further details. Source: Vanguard calculations using data from Thomson Reuters Datastream, Bloomberg, Barclays Live, OECD via Federal Reserve, and Moody s Analytics Databuffet.
Summary Global recovery to continue, but expect slower economic growth than past decades Low interest rates and inflation to persist Global fixed income muted returns, but no bubble Positive equity outlook is more guarded (in some places) Now is the time to invite investors to adjust portfolio expectations 18
Quantifying Adviser s Alpha Fran Kinniry Principal Vanguard Investment Strategy Group The Vanguard Group 19
Traditional value proposition for advice The traditional value proposition for financial advisers has been primarily focused on outperformance As such, this value proposition has extremely high hurdles Requires tremendous alpha to overcome fees and taxes Expected outperformance has not been achieved for vast majority Result: lower asset retention rates Vanguard Adviser s Alpha framework emphasises the more reliable benefits of a professional relationship 20 Source: Vanguard Investment Strategy Group.
Vanguard s Adviser s Alpha What is the Adviser s Alpha concept? The focus: Holistic advisory model Adviser s Alpha: reframes the benchmark for the value of advice Investment management Behavioural coaching Wealth management A service model: Time, willingness and ability Success not solely on outperforming a cost free policy portfolio 21 Source: Vanguard Investment Strategy Group.
How much and by what methods can an adviser add value? 22
The value of an adviser: About 3% 23
Quantification of Vanguard Adviser s Alpha Vanguard Adviser s Alpha strategy 1. Suitable asset allocation 2. Cost (expense ratios) 3. Rebalancing 4. Behavioural coaching 5. Tax efficiency 6. Total-return vs income investing Potential value added Value-add relative to average client experience (in basis points of return) >0 bps 75 42 150 >0 >0 About 3% 24 Source: Francis M. Kinniry Jr. CFA, Colleen M. Jaconetti, CPA, CFP, Paul W. Chin, F Fin, Frank Polanco, PhD, CFA,and Yan Zilbering 2015. Putting a value on your value: Quantifying Vanguard Adviser's Alpha. Southbank Vic.: The Vanguard Group. * 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. Return value-add for Modules I, V and VI was deemed significant but too unique for each investor to quantify. See page 8 for detailed descriptions of each module. Also, for Potential Value added, we did not sum the values because there can be interactions between the strategies. (bps = basis points).
Asset allocation - Simplicity has been very competitive Comparing performance of superannuation funds and a diversified portfolio - Australian analysis 25 Source: Vanguard and Superannuation Fund-level Profiles and Financial Performance published by Australian Prudential Regulation Authority (Jan 2014): http://www.apra.gov.au/super/publications/pages/superannuation-fund-level-publications.aspx. Distributions of annualised returns for Australian superannuation funds grouped by fund size. Fraction of funds categorised as small, mid, and big were respectively 50%, 40%, and 10% of funds. Diversified fund returns represent a hypothetical growth fund, constructed using indices, with growth and income exposures of respectively 70% and 30%. Returns on superannuation funds include operating expenses but exclude fees and commissions. Time period ends June 2013. Past performance is not an indicator of future performance.
Cost-effective implementation - Expense ratios Australian asset-weighted expense ratios versus low-cost investing Equities/Bonds mix 100%/0% 50%/50% 0%/100% Asset-weighted expense ratio (Indirect Cost Ratio ICR ) 1.03% 0.74% 0.44% Lowest of the low 0.28 0.24 0.19 Cost-effective implementation (ICR bps) 0.75 0.50 0.25 26 Source: Vanguard calculations based on data from Morningstar, Inc., as of December 2013. Note: Lowest of the low category (or the first quartile within Quartile 1) is the funds whose indirect cost ratios (ICR) ranked in approximately the lowest 7% of funds in our universe by fund count. Past performance is not an indicator of future performance
Rebalancing - Asset allocations show trend following Hypothetical example of investor behaviours and their advisers over time 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Jun-97 Jun-99 Jun-01 Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Allocation Among Asset Classes (%) Jun-13 38% 53% 45% 55% 54% 47% Max Min Median Sep-14 Equity 56.1% 37.6% 51.6% 54.5% Fixed Interest 31.0% 18.9% 22.4% 22.1% Property & Infrastructure 14.1% 8.1% 10.6% 10.3% Cash 22.3% 12.2% 14.3% 13.1% Equity (Aus + Int'l) Fixed Interest Cash Property & Infrastructure 27 Source: Vanguard calculations, using data from Morningstar.
Rebalancing and staying the course have the potential to cover years of an advisory fee 28 Remember when Portfolio Portfolio value, value, Index = 100 at Nov at 2007 Nov 2007 160 140 120 100 80 60-18.4% Market bottom bottom = 6 Mar = 6 2009 Mar 2009 50% EQ/50% AFI 100% Aus Bonds 100% Cash 40 Nov-07 Nov-09 Nov-11 Nov-13 Source: Vanguard Investment Strategy Group using data sourced from FactSet to Dec 2014. Notes: 1 Nov 2007 represents the EQ peak of the period, and has been indexed to 100. Assumes that all dividends and income are reinvested in the respective index. Equities are made up of 50% Aus Equity and 50% Intl Equity, which are rebalanced back to the 50/50% split at month end. Aus Equity = S&P/ASX 300 Index Total Return, Intl Equity = MSCI World ex-aus in A$ Total Return, Aus FI = Bloomberg AusBond Composite Index, Aus Cash = Bloomberg AusBond Bank Bill Index. Past performance is not an indicator of future performance. From trough to to now 81% 44% 24%
Behavioural coaching - Overview Numerous studies conclude behavioural coaching can add 1 to 2 percentage points 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 The discipline & guidance through behavioural coaching could be the largest potential value-add of the tools available 29 Source: Francis M. Kinniry Jr., Colleen M. Jaconetti, Paul W. Chin, Frank Polanco and Yan Zilbering, 2015. Putting a value on your value: Quantifying Vanguard Advisor's Alpha in Australia.: The Vanguard Group.
Behavioural coaching - Performance chasing is not limited to asset classes but to managers as well Cash flows are associated with performance rankings High ratings have not led to future outperformance Cumulative cash flows (US$ billions) 250 200 150 100 50 0-50 -100-150 1 year 3 year 5 year 5-star 4-star 3-star 2-star 1-star Annualised 36-month excess returns (basis points) 10-10 -30-50 -70-90 -110-130 -150-136 -122-98 -69 5-star 4-star 3-star 2-star 1-star -6 30 Sources: Vanguard calculations using data provided by Morningstar. Data as of Dec 2012. Past performance is not an indicator of future performance..
The result - Investor returns lag the returns of the markets and the funds in which they invest Return difference between TWR and IRR % Difference between 10-year investor and fund returns in Australia 0% -1% -2% -3% -4% -5% -6% -7% -8% -9% Equity Australia Large: 138-5.2% Equity Australia Mid/Small: 35-7.9% Category and number of funds in sample Equity World Large: 73 Equity World Mid/Small: 8 Multisector: 198-1.4% -1.4% -1.7% 31 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. Data as of Dec 2013. Past performance is not an indicator of future performance..
Adviser s alpha win-win 32
Index as the core can have many advantages % of active funds underperforming the average market return over 5 years 100% % of managers underperforming % of managers their underperforming benchmark their benchmark 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Aus Equities Broad Aus Equities - Small Cap Intl Equities Aus Bonds Aus Listed Property Securities 33 Source: S&P Dow Jones Indices, SPIVA Australia Scorecard. There has been no deduction of expenses from index returns. Australian Equity General returns based on S&P/ASX 200 Index, Australian Equity Small-Cap based on S&P/ASX Small Ordinaries Index, International Equity General based on S&P Developed Ex-Australia LargeMidCap Index, Australian Bond based on S&P/ASX Australian Fixed Interest Index and Australian Equity A-REIT based on S&P/ASX 200 A-REIT Index. Data as of June 2014. The results would be different if different asset classes were considered. Past performance is not an indication of future results.
Index as the core minimises the risk of losing clients by shrinking the distribution Underperformance often matters more than outperformance Deviates from market-cap 1. Client asks questions 2. Client pulls some assets 3. Client pulls most assets 4. Client pulls all assets Portfolio s periodic returns 34 Source: Vanguard Investment Strategy Group.
Index as the core minimises the risk of losing clients by shrinking the distribution Underperformance often matters more than outperformance Resembles market-cap 1. Client asks Client questions asks questions 2. Client pulls Client some pulls assets some assets 3. Client pulls Client most pulls assets most assets 4. Client pulls Client all pulls assets all assets Portfolio s periodic returns 35 Source: Vanguard Investment Strategy Group.
Annuitising your practice Adviser s Alpha J curve Client profit 15% 13% 11% 9% 7% 5% 3% 1% -1% -3% -5% 36 Source: Vanguard Investment Strategy Group. Trying to get here 0 1 2 3 4 5 6 7 8 9 10 Years
Closing thoughts Working with an adviser can add about 3% in net returns by following the Vanguard Adviser s Alpha framework While the value of this wealth creation is certainly real, it does not show up on any client statement The Vanguard Adviser s Alpha framework is not only good for your clients but also good for your practice 37
The power of low cost index investments Example: $250,000 portfolio $1,162.50 saving for the client or 23% fee reduction 38 Note: Assumes funds are invested for an entire year and there is no market movement. Figures used are for illustrative purposes. Source: Vanguard
Vanguard Diversified funds Asset Allocations (%) Vanguard Balanced Index Fund Vanguard Growth Index Fund Australian Shares 22 31 International Shares 22 31 Property 6 8 Fixed Interest 50 30 Cash 0 0 MER* 0.34% p.a. 0.36% p.a. 39 The asset allocations in this diagram are examples only and do not represent a recommendation. *ETFs may incur brokerage fees
Vanguard s growth ETF portfolio strategy Asset allocation 70% Growth 30% Income Managed Fund ETF Allocation MER* (p.a.) Australian fixed income VAF 12% 0.20% International fixed income VAN0103AU 1 12% 0.26% International credit securities VAN0106AU 1 6% 0.34% Total Income 30% Growth Domestic equity VAS 31% 0.15% International equity VTS VEU 17% 18% 0.05% 0.15% Property VAP 4% 0.25% Total Growth 70% Portfolio weighted management expense ratio p.a. 0.17% 40 Notes: 1 VIFIIFH = Vanguard International Fixed Interest Index Fund (Hedged). VISCIFH = Vanguard International Credit Securities Index Fund (Hedged). VCPIF = Vanguard Cash Plus Fund. These Vanguard Wholesale Funds have been used in to achieve exposure to international fixed interest and short-term money market securities to complement ETF asset allocations. Source: Vanguard. * ETFs may incur a brokerage fee.
Control the controllable 41
Thank you Connect with Vanguard > vanguard.com.au > 1300 655 205 42
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