Vanguard & Private Equity: Optimistic or Cautious?

Therefore, I believe that Vanguard expanding into private investments which are considerably less volatile, less prone to market noise, and which constitute an industry which has had a positive cash flow exceeding $500 billion since the past four years, is a mere exercise of caution fueled by calculated pessimism.

By Anirudh Sharma

Right before a professional fight, an MMA fighter has to brutally cut weight while also conditioning to be powerful and energized. In other words, an MMA fighter that wants to compete has to optimize and respond to required standards, while still finding alternate avenues to maximize a return on their efforts in the cage. 

Vanguard appears to be in a similar fight – a price war to be exact – against top fund managers in the world. In this race to cut fees for investors, Vanguard, the second biggest investment group in the world, is looking towards private investments to juice-up their revenue streams. Vanguard’s  strategic partnership with HarborVest, a $70 billion private markets specialist, might even signal its motivations to diversify and provide another product offering to its larger institutional investors in a market now worth upwards of $4 trillion. Annie Massa, a reporter for Bloomberg, backed this explanation, stating that the partnership could be a product of current CEO Mortimer Buckley’s optimism towards breaking into the private equity market, in hopes of elevating the firm to the next level.

However, there are layers to Vanguard’s foray into private equity. Not only is the move risky for the massive asset manager, it is also a departure from its trusted and preserved philosophy of being a price competitor in terms of fees. Jack Vogel, Vanguard’s founder and ex-CEO, built the company into a lean, price-competitive machine that pushed competition out by providing investors cheap access to ETFs and index funds. Vanguard’s pricing tactics could almost be comparable to Amazon’s in terms of the sheer intensity that its business model places on winning the race to zero fees. Yet still, a move into the PE industry (which has traditionally followed an expensive premium focused 2 & 20 fee structure) is against the nature of the firm, and the exact intentions behind it are open for speculation. The Financial Times believes that one of the primary reasons driving this strategy to break into PE is that Vanguard recognizes that there might be another economic downturn that would be more detrimental to the world market than in the previous decade. 

Despite facing the longest bull market in history, the general public trust in the market has been lower than ever due to the financial crisis of 2008.  This has had a lasting impact on the performance of various indices. In fact, it might take only a single down quarter for the public to go into panic-mode and for the general health of the market to deteriorate. Therefore, I believe that Vanguard expanding into private investments which are considerably less volatile, less prone to market noise, and which constitute an industry which has had a positive cash flow exceeding $500 billion since the past four years, is a mere exercise of caution fueled by calculated pessimism.

Optimistic or not, I believe that expanding into PE is a wise move for the $6 trillion-managing firm. Morgan Stanley predicts that by 2023, private capital will account for about 20% of the entire investment industry’s revenues (up from 14 percent last year). This year’s pandemic has also pushed the global markets into a recession which means that PE firms can potentially capitalize on lower valuations and use the considerable dry powder in their reserves to go on a buying spree. Moreover, PE investment also emphasizes lower risks stemming from a philosophy that is rooted in articulate due diligence and close monitoring of long term investment performances. Vanguard can use this move not only as a shield against market volatility or a revenue booster to compensate for price cuts in fees but can also look to increase the accessibility of a PE fund to small-scale investors (not just large  institutions) as they become more experienced operating in an industry that has grown by 7.5x in just this century, anything can be possible.