putting a value on your value: quantifying vanguard ... · • the traditional value proposition...

For Financial Advisors and Institutional Investors Only. Not for Public Distribution.

Putting a value on your value: Quantifying Vanguard Advisor's Alpha™ Michael DiJoseph, CFA Investment analyst The Vanguard Group, Inc.'s Investment Strategy Group June 2015

2 For Financial Advisors and Institutional Investors Only. Not for Public Distribution.

• The traditional value proposition for financial advisors has been primarily focused on outperformance.

• However, this value proposition has extremely high hurdles. • Requires tremendous alpha after fees and taxes

• Expected outperformance has not been achieved for vast majority. • Result: lower asset retention rates

• Vanguard Advisor's Alpha framework emphasizes the more reliable benefits of a professional relationship.

Redefining the advisor's value proposition


• A holistic investment advisory value proposition

• A reframing of the benchmark for the value of advice

What is Vanguard's Advisor's Alpha?

Investment management

Wealth management

Behavioural coaching

Service model: Time, willingness

and ability

Success not solely on outperforming a cost-free policy portfolio

Source: The Vanguard Group, Inc.'s Investment Strategy Group.


How much, and by what methods,

does an advisor add value?


The value of an advisor: "About 3%"


Value added using Vanguard's Advisor Alpha framework

Vanguard Advisor's Alpha strategy

Value-add relative to "average" client experience

(in basis points of return)

I. Suitable asset allocation using broadly diversified funds/ETFs >0*

II. Cost-effective implementation (expense ratios) 131

III. Rebalancing 47

IV. Asset location 0 to 42

V. Spending strategy (withdrawal order) 0 to 41

VI. Total-return versus income investing >0*

VII. Behavioural coaching 150

Range of potential value added (bps) "About 3%"

Source: Ryan Rich, Colleen M. Jaconetti, Francis M. Kinniry Jr., Donald G. Bennyhoff, and Yan Zilbering, May 2015. Putting a value on your value: Quantifying Vanguard Advisor’s Alpha in Canada. Valley Forge, Pa.: The Vanguard Group, Inc. *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.


I. Asset allocation

Equities increase both expected return and volatility

8.0% 8.2% 8.3% 8.5% 8.6% 8.7% 8.8% 8.8% 8.8% 8.8% 8.8%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

100%Bonds

10%/90% 20%/80% 30%/70% 40%/60% 50%/50% 60%/40% 70%/30% 80%/20% 90%/10% 100%Stocks

Ann

ual r

etur

n

10%/ 90%

20%/ 80%

30%/ 70%

40%/ 60%

50%/ 50%

60%/ 40%

70%/ 30%

80%/ 20%

90%/ 10%

Source: The Vanguard Group, Inc.'s Investment Strategy Group. Data as of December 31, 2014. Notes: Bars represent the best and worst 1-year returns. Equities are represented by the S&P/TSX Composite Index. Fixed income investments are represented by the Citigroup World Government Bond Index from 1985 through 2001 and the Barclays Canadian Issues 300MM Index thereafter. Past performance is no guarantee of future results. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Average


NACUBO-Commonfund (2014) study on the performance of endowment portfolios

I. Asset allocation: Simplicity has been very competitive

0

2

4

6

8

10

12

3 years 5 years 10 years Since July 1, 1985

Ret

urn

perc

enta

ge (%

)

Large endowments 10% of endowments Medium endowments 39% of endowmentsSmall endowments 51% of endowments 60% stock / 40% bond portfolio

Sources: Vanguard and NACUBO-Commonfund Study of Endowments. Note: Data are as of June 30 for each year. Data through June 30, 2013. 60% stock/40% bond portfolio: Domestic equity (42%) is Dow Jones Wilshire 5000 Index through April 22, 2005, and the MSCI US Broad Market Index thereafter. Non-U.S. equity (18%) is MSCI World ex USA through December 1987 and MSCI All Country World Index ex USA thereafter. Bonds (40%) are Barclays U.S. Aggregate Bond Index. Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Large endowments (10% of endowments) Small endowments (51% of endowments)

Medium endowments (39% of endowments)


II. Cost-effective implementation (expense ratios)

Equities/fixed income 80/20 50/50 20/80

Asset-weighted expense ratio1 1.64% 1.46% 1.28%

"Lowest of the low"2 0.41% 0.36% 0.31%

Cost-effective implementation (ER) 1.23% 1.09% 0.96%

1 Asset-weighted expense ratio includes F Class shares which are only sold through fee-based advisors, and on average, contain lower management expense ratios. 2 "Lowest of the low" is the lowest-cost quartile of mutual funds and ETFs available for sale across Canada. Source: Vanguard calculations, based on data from Morningstar, Inc. as of December 31, 2014.


The goal of rebalancing is risk reduction rather than return maximization.

III. Rebalancing: Appropriately used as a risk mitigation technique

1960-2014 50% stocks and 50% bonds Rebalanced Non-rebalanced

Average annualized return 9.3% 9.2%

Average standard deviation 9.2% 11.5%

1960-2014 70% stocks and 30% bonds Rebalanced

Average annualized return 9.7%

Average standard deviation 11.9% Sources: The Vanguard Group, Inc., based on data from FactSet, FTSE and MSCI. Notes: Equities are represented by the S&P/TSX Composite Index through 1969 and MSCI Canada Index thereafter. Bonds are represented by FTSE TMX Canada Long Term Bond Index through 1979 and FTSE TMX Canada Universe Bond Index thereafter. Returns are in Canadian dollars, with income reinvested to December 31, 2014.


Purchasing actively managed equities or taxable bonds in taxable accounts may subject clients to:

• Ordinary income and interest tax rate on taxable bond income up to 29%

• Capital gains tax rate up to 14.50%

• Tax rate on taxable dividend income up to 19.29%

IV. Asset location: Add 0–42 bps in the first year…compounded

Notes: Tax rates are federal marginal tax rates for Canada for 2014–2015. Tax rate on dividend income applies to eligible Canadian dividends. Bps = basis points.


• Many clients hold multiple account types, creating complexity during drawdown phase.

• Informed withdrawal-order strategies can minimize total taxes paid over retirement.

V. Spending strategy: Withdrawal order

Taxable portfolio

Taxable flows

Required Minimum Withdrawals (if applicable)

Tax-free

Tax-deferred

Higher expected marginal tax bracket in the future

Tax-deferred

Tax-free

Lower expected marginal tax bracket in the future

Source: The Vanguard Group, Inc.


VI. Total-return versus income investing

Income-only strategy

Impact on a portfolio (compared with capital-weighted portfolio

at the sub-asset class level)

Overweight credit bonds Credit risk

Downside protection

Overweight dividend-centric equity

Concentration risk

Tax efficiency Diversification



• Numerous studies1 conclude behavioural coaching adds 1% to 2%.

• 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.

VII. Behavioural coaching

1 Studies include the Investment Funds Institute of Canada's The value of advice: report (2011) and Past performance is indicative of future beliefs. (Philip Maymin and Gregg S. Fisher, 2011). Source: The Vanguard Group, Inc.


40

50

60

70

80

90

100

110

120

130

140

Bal

ance

d po

rtfol

io v

alue

(in

dexe

d to

100

as

of m

arke

t pea

k)

100% Stock50% stock/50% bond100% Bond

VII. Behavioural coaching: Staying the course is difficult

A balanced, diversified investor has fared relatively well

Peak-to-trough return

–48.48%

–23.36%

9.02% + 17.99%

+ 31.37% + 34.32%

Peak through December 31, 2014

Source: S&P/TSX Composite Index and Citigroup World Government Bond Index Canada (rebalanced monthly). Data provided by Barclays and Thomson Reuters Datastream, as of December 31, 2014.

100% equities

50% equities/50% fixed income

100% fixed income


The result of these behaviours is that investor returns lag the returns of the markets and the funds in which they invest.

VII. Behavioural coaching: Where performance chasing can lead

-3%

-2%

-1%

0%

1%

Ann

ualiz

ed d

iffer

ence

in re

turn

s

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.

Difference between 10-year investor and fund returns in Canada

Canadian equity

Canadian small/

mid-cap equity

Real estate equity

International equity

Emerging markets equity

Fixed income

High-yield fixed

income

Equity balanced

Fixed income

balanced

U.S. equity


VII. Behavioural coaching: Index as the core has many advantages

Percentage of active funds underperforming benchmark

0%

20%

40%

60%

80%

100%

Based on survivors plus funds closed or merged during period

Sources: Vanguard using data from Morningstar, MSCI, and Barclays. Data cover the periods ended December 31, 2014. Notes: The number of index funds in Canada was insufficient for a direct comparison of active funds to index funds. An approximation was made by comparing each active fund to an appropriate benchmark. The benchmarks were adjusted downward by 25 basis points to approximate the return of a low-cost index fund tracking the same benchmark.

Large-cap Canadian

equity

Small-cap Canadian

equity

International equity

U.S. equity Intermediate-term bond

Short-term bond


Advisor's alpha win-win


Extremely high hurdle

Result: Low achievement = lower asset retention rate

Vanguard Advisor's Alpha model emphasizes more reliable benefits • Asset allocation and diversification

• Financial and wealth planning

• Long-term discipline and behavioural coaching

• The comprehensive service model — T.W.A.

Traditional value proposition: Outperformance


Minimize the risk of losing clients by "shrinking the distribution"

This hypothetical illustration does not represent the return on any particular investment. Source: The Vanguard Group, Inc.


• Working with an advisor can add "about 3%" in net returns following Vanguard's Advisor Alpha framework.

• While the value of this wealth creation is certainly real, it does not show up on any client statement.

• The Vanguard Advisor's Alpha framework is not only good for your clients but also good for your practice.

Conclusion



Important information

Commissions, management fees, and expenses all may be associated with investments in a Vanguard ETF™. Investment objectives, risks, fees, expenses, and other important information are contained in the prospectus; please read it before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated. Vanguard ETFs™ are managed by Vanguard Investments Canada Inc., an indirect wholly-owned subsidiary of The Vanguard Group, Inc.

Date of Publication: June 2015

The opinions expressed in this presentation are those of the individual representative and do not necessarily reflect the opinions of Vanguard Investments Canada Inc. No implied or express recommendation, offer, or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy is made in this material. This presentation is not research, investment and/or tax advice and it is not tailored to the needs or circumstances of any individual investor.

Information, figures and charts are summarized for illustrative purposes only and are subject to change without notice. While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use. Information regarding third party investment fund managers is solely for educational purposes.

All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While Vanguard ETFs are designed to be as diversified as the original indexes they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment.

In this presentation, references to "Vanguard" are provided for convenience only and may refer to, where applicable only to The Vanguard Group, Inc. and/or may include its affiliates, including Vanguard Investments Canada Inc.

Notes on risk: All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market. While Vanguard ETFs are designed to be as diversified as the original indexes they seek to track and can provide greater diversification than an individual investor may achieve independently, any given ETF may not be a diversified investment. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.


Important information (continued)

No part of this presentation may be reproduced, distributed, disseminated or referred to, in whole or in part, in any form, including to any investor, without prior written and express permission by Vanguard Investments Canada Inc.

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