Vanguard’s dominance in the defined contribution world is well recognized. Many recordkeepers/custodians have made Vanguard funds available under their open architecture platforms for plan fiduciaries to elect as investment options under their plans. However, for asset manager-owned recordkeepers, such as Fidelity, the inclusion of Vanguard is increasingly becoming a challenge. This is understandable for a number of reasons:
- Asset managers did not get into the recordkeeping business because it was viewed as a great stand-along business. Rather, it was an alternative way to distribute their proprietary investments and gather sticky assets. Today, in the post fiduciary world, stuffing a plan with proprietary investments as a part of a fully bundled recordkeeping offering is viewed with a jaundiced eye, and increasingly core menus are filled with non-proprietary offerings. This has an immediate and negative impact on the recordkeeper’s bottom-line let alone its very premise to be in the recordkeeping business.
- The Vanguard business (not-for-profit) model is to deliver their investments and services without profit (does not mean free) after expenses. As such, it is considered a sound choice in the retail and retirement space as fiduciarily sound (in terms of controlling expenses). Couple this with the wide adoption of passive equity investing (a gift from the post Global Financial Crisis of risk-on and risk off environment) as active funds consistently underperformed as a whole with much higher expense ratios, Vanguard has become the object of desire. Plan sponsors, participants and advisers are also influenced by their brand and look to include Vanguard in their menu construction consideration if not selection. This seemingly unstoppable desire for the brand bleeds into every recordkeeper, and the more Vanguard choices are selected, the less revenue, per se, is generated “naturally” to the recordkeeper. Vanguard basically has the demand pull distribution system at almost no cost to them.
- Making available Vanguard funds on the one hand accommodates plan sponsors and fiduciaries and for recordkeeper to promote their open architecture, non-biased approach for optics and competitive reasons. On the other hand, for Fidelity, Principal, Schwab, and the other asset manager based recordkeepers of the world, the availability of Vanguard directly competes with the asset manager owned recordkeepers’ proprietary index tracking passive investment offerings. After years of lowering their own index fund expense ratios, Vanguard remains the preferred option for most plans. As the Vanguard presence grows in a shrinking core menu environment, asset manager owned recordkeeping is feeling the heat. Additionally, Vanguard is now also a preferred choice in the largest growing segment in any DC plan – Target Date Funds. Adding insult to injury, this seemingly unstoppable onslaught of anything Vanguard is eating into the recordkeepers who are thinly disguised distribution systems for proprietary investments at a time of ever increasing fee compression.
As an outside observer, Fidelity’s action of assessing 5bp on all things Vanguard going forward is a first punch in its attempt to slow down the Vanguard onslaught. The added fee is both defensive and offensive:
- Defensive from a recordkeeping standpoint – Fidelity suggests that it does not earn any fees from making Vanguard funds available on its platform. This is true since Vanguard does not offer any compensation for Fidelity to custody and service their funds. However, Fidelity’s recordkeeping revenue is not limited to third party fees from Vanguard. Fidelity can and does charge recordkeeping fees on an asset or per capita basis. Nonetheless, Fidelity is now directly linking a 5bp revenue stream to Vanguard assets.
- Offensive from an asset manager standpoint – Assessing a 5 bp surcharge (I suggest this could go higher) makes Vanguard’s funds a bit less competitive and begins to level the playing field for Fidelity. It is a clever way to directly push the competitor’s investments cost higher and make Fidelity’s own index-based offerings (including index-based TDFs) more price competitive without lowering its own fees. The added fee will not have much impact initially as it is only applied to new plans, but it does place a line in the sand. Moreover, being the largest recordkeeper, it gives shelter to other recordkeepers and the opportunity to take similar actions in an overall effort to beat back Vanguard. I suspect Vanguard at this point is too big and too comfortable about itself to care about Fidelity’s actions. Fidelity remains an “open architecture” platform while making a case for its own passive alternatives.
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