Vanguard, largest fund company, cuts fees for 2 million customers and puts pressure on rivals

By Mark Jewell, AP
Wednesday, October 6, 2010

Vanguard lowers mutual fund fees for 2 million

BOSTON — Think of Vanguard as the Wal-Mart of investing. It manages more money than any other mutual fund company, so it has tremendous pricing power. When it makes a move, competitors feel pressure to follow suit.

Vanguard said Wednesday that it would reduce fees for about 2 million of its individual customers, the latest in a series of cost-cutting moves that have turned up the heat on rivals like Fidelity Investments and Capital Group’s American Funds.

The change applies mostly to individual investors, not to institutional shares that are held by companies through their 401(k) retirement plans. Institutional shares already charge the lowest fees of any class.

“There is a race to the bottom on expenses, and Vanguard is winning huge,” says John Osbon, who manages about $40 million, much of it in Vanguard funds, at Boston-based Osbon Capital Management.

“It’s a low margin, high volume business, and Vanguard’s volume is going up, and for the others it’s going down,” he said. “It’s pretty simple.”

Vanguard said it would lower how much money customers need to invest to qualify for its Admiral shares, which have the lowest fees. For index funds, which track market averages like the Standard & Poor’s 500, the minimum will drop to $10,000 from $100,000.

For its actively managed funds, which are less popular, the new investment minimum will be $50,000, also down from $100,000. In all, Vanguard said it would bring in about $100 million less a year.

For example, investors who meet the minimum will now be able to buy shares of Vanguard’s flagship Total Stock Market Index Fund at a fee of $7 a year for every $10,000 invested. Investors who only have $3,000 with Vanguard would pay $18.

The difference may seem small, but the savings can add up if they are reinvested and earn compound interest.

Individual investors these days are voting with their dollars. Vanguard says its clients have put in $400 billion more than they’ve taken out of the company’s 170 U.S. funds over the past five years, boosting its U.S. fund assets to nearly $1.5 trillion.

This year, $36 billion more has been deposited into Vanguard stock and bond funds than has been taken out, according to Morningstar. More has been taken out than put in at Fidelity and American, which place more emphasis on actively managed funds.

Low costs don’t always translate into strong returns because the stock market is fickle. It’s also rare for a fund manager’s expert stock-picking to consistently beat the market and offset the higher fees.

But a wealth of independent research shows costs are key because they’re a definite and easily measured drag on returns, no matter whether markets are up or down.

Fidelity in particular closely watches Vanguard’s cost-cutting moves and is likely to cut fees itself to respond, said Doug Dannemiller, an analyst with the research firm Aite Group and former Fidelity employee.

Fidelity spokesman Vin Loporchio declined to discuss its next move, but said the company is always evaluating products and services, “including pricing, to ensure that we are competitive.”

Dan Wiener, editor of an independent newsletter called Independent Adviser for Vanguard Investors, said competition “is getting fierce. Vanguard is pretty much leading the charge with this move, and others it’s made over the past couple of months.”

In an interview, Vanguard Chairman and CEO Bill McNabb didn’t contest comparisons between his company and Wal-Mart.

“Wal-Mart is an organization that has created huge value for their clientele,” McNabb said. “We like to think of ourselves as doing the same thing.”

Fidelity and American Funds pride themselves of the depth of services they offer clients, while Vanguard takes a more basic approach to offering investment advice and research.

Vanguard can undercut rivals in part because of its structure. All three of the largest fund companies are privately held, but Vanguard is unique because it’s owned by its fund shareholders. Profits are plowed back into the company’s operations, and used to reduce fees.

“Vanguard is on a roll,” said Wiener of Independent Adviser. “And the competition, so far, has been left speechless.”

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