Financial Markets and its affect on Vanguard

Introduction

What is the critical factor for success in the U.S. mutual fund industry? Is it top-ranked investment performance, innovative products, or pervasive distribution? In our view, it is none of these factors, despite their obvious importance. Instead, the best predictors of success in the U.S. fund business are the focus and organization of the fund sponsor. We believe that the most successful managers over the next decade will be organizations with two characteristics: dedication primarily to asset management and control by investment professionals. This paper aims to discuss affect of Financial Markets on Vanguard.

Discussion

The mutual fund diversified firms have faced challenges, the dedicated firms have surged ahead in the mutual fund rankings. The Vanguard has increased their market share over the last two decades from 19 percent to 33 percent entirely through internal growth rather than external acquisitions (Pozen, Hamacher and Phillips, 472-481).

What are the features of its model? First, it is dedicated to asset management, although Vanguard has diversified significantly outside this business. Vanguard has a record-keeping business for retirement plans, a discount broker for retail investors, and an insurance company to support its variable annuity products. Vanguard derives most of its net income from fund management, although it runs a record-keeping retirement business, a small discount broker, and an annuity insurance company (Pozen, Hamacher and Phillips, 472-481). Capital Group has remained focused on asset management.

Second, Vanguard has a nonhierarchical organizational structure, with few layers separating investment staff from the CEO. Capital Group physically demonstrates its flat management structure by making all its offices the same size and by requiring that all executives—including the chairman and president—actively manage money. At Vanguard, senior executives make important decisions about their mutual funds only after consulting with key investment personnel (Pozen, Hamacher and Phillips, 472-481).

Third, Vanguard can develop compensation programs that meet the needs of the investment business by providing adequate incentives for top-performing investment staff, regardless of their level in the organization. For example, they can design a bonus plan that makes it possible for an analyst who picks strong-performing stocks to make as much money as a portfolio manager.

Finally, Vanguard is privately held, which means they are not subject to the short-term pressures from public shareholders to increase quarterly earnings. They each have a different legal structure. Vanguard has a unique legal form: The management firm is owned by the shareholders of the Vanguard mutual funds (Pozen, Hamacher and Phillips, 472-481).

Unfortunately, although the private partnership model does insulate asset managers from the pressures of the financial market, it does have inherent weaknesses. Most significantly, without a publicly traded stock, there is no easy way to value the shares of the management firm, which are issued to the investment professionals as compensation and redeemed when they retire. Vanguard's competitors Fidelity and Capital Group use complex formulas to price their shares, whereas Vanguard's board of directors uses fund and operating performance as a basis for valuing the “partnership plan units” distributed as ...