Critics say it won’t help retail investors; Vanguard says Jack Bogle would approve
Vanguard built its reputation on democratizing investing, bringing institutional products to the masses and doing so cheaply. Its retail-investor-friendly moves – index funds and low fees — have endeared it to millions of investors.
But the asset manager’s recent push into private-equity markets is giving some fans pause.
The $7 trillion asset manager began providing institutional clients – pension funds, endowments and the like – access to private-equity investments in 2020 through HarbourVest Partners, an $85 billion, independent global private markets investment firm. It expanded into wealthier individuals earlier this year.
Vanguard wouldn’t disclose how many clients have invested in its first offering for individuals, the Vanguard HarbourVest 2021 Private Equity Fund, or the dollar amounts, but Fran Kinniry, global head of private investments for Vanguard, said the fund giant has exceed its goals “by quite a far margin.”
Private equity is a very different than the stock market — notoriously expensive and opaque, with little regulatory oversight and often requiring individuals to lock up money for a decade or more. It is open to individuals who are qualified purchasers—those with $5 million or more in investments — or accredited investors — a net worth of at least $1 million, or more than $200,000 in annual income.
Vanguard’s foray into this market comes as the Labor Department allowed plan sponsors to add private-equity investments to defined-contribution plans as part of professionally managed asset- allocation funds, generally known as target-date funds. None have done so yet, but private-equity proponents are pushing for this to become reality. Vanguard is a top choice in 401(k)s and runs one of the biggest target-date fund businesses.
Vanguard’s first offering to individuals set a $500,000 minimum investment, made over three years, and the term, or lockup period, is 14 years. Many of Vanguard’s mutual funds have a minimum investment of just $3,000, and few have any minimum penalty-free holding periods.
Jack ‘will roll over in his grave’….
Some advisers think Vanguard’s entry into private equity underscores that the firm is no longer the firm founded by Jack Bogle in 1975.
“I suspect [Bogle] will roll over in his grave” if he was asked about the private-equity foray, said Allan Roth, certified financial planner and founder of Wealth Logic, an investment advisory and financial planning firm in Colorado Springs, Colo.
Roth said he understands Vanguard is pursuing private equity for competitive reasons; money managers like Goldman Sachs and BlackRock are already in the space. “But I don’t necessarily agree with it.”
Rick Ferri, an investment advisor at Ferri Investment Solutions in Georgetown, Texas, also hosts the Bogleheads on Investing podcast, where he spoke at length with a guest about his worries. He’s particularly concerned about private equity’s high fees and whether these investments can be opened up to the masses the same way index investing was while still commanding high returns.
“That’s not how Jack thought of things. But then again, you know, when Jack was there, they had $150 billion under management. So it’s a different company for sure,” Ferri said.
Kinniry said Vanguard’s move into private equity follows in Bogle’s footsteps and giving individual investors access to markets traditionally open only to institutions. “What Jack stood for was taking a stand for all investors, especially retail investors. We find that this entry into private equity follows that exact template that he launched indexing with,” he said.
Vanguard led the charge to lower fees for its mutual funds and exchange-traded funds, causing a ripple effect across the industry. That led to the term “the Vanguard effect,” meaning costs often fell in whatever sector of the market the fund giant entered. In August, Morningstar said in its annual U.S. Fund Fee study that the average expense ratio paid by fund investors is half that of 20 years ago.
Both Ferri and Roth said they don’t know what Vanguard is charging investors for this private-equity fund, and Vanguard’s Kinniry wouldn’t disclose it, only saying that the fees are higher than the costs for Vanguard’s actively managed mutual funds, which are around 0.40% to 0.50%.
Private-equity fees typically are not disclosed, but they are often hefty, typically 2% of assets under management and 20% of the profits, dubbed “2 and 20”.
Vanguard chose HarbourVest because of the company’s long-term performance record and its philosophy of putting client outcomes first, which Kinniry said was most unique among the managers interviewed.
Will strong returns continue?
Citing the usual caveat that past performance doesn’t equal future results, Kinniry pointed out that HarbourVest outperformed the MSCI ACWI index, which tracks about 3,000 stocks in 49 developed and emerging market countries, by 700 to 800 basis points net of all fees in the firm’s 35-year-plus history. Vanguard has a more conservative estimate of expected outperformance, and returns may fall of if private equity becomes more democratized, as the firm expects, he said.
“We’re somewhere thinking that net returns over public markets will be 300 to 400 basis points,” Kinniry said, while stressing the lockup period of this type of investment repeatedly to investors. “If the future is anywhere, even half of its past with HarbourVest, we believe investors will have higher net outcomes even though they have higher costs,” he later added.
Another concern Roth and Ferri have is whether the high returns will remain if more investors are fighting over the opportunity to invest in good private companies. Consultants at Deloitte forecast increased interest could boost private-equity assets under management to $5.8 trillion in 2025 from $4.5 trillion in 2019.
That also could shrink the illiquidity premium—the reward private-equity investors traditionally have received for locking up their money for years. Kinniry said the illiquidity premium should fall to about one-third or one-half of the 3 percentage points it’s been historically as more investors enter the market, but it won’t disappear.
Investors should focus on private equity’s demand side, not supply, he said. There are many more small, private companies than public firms, and these are small companies without private backing. “As private-equity supply grows, we’re seeing more and more of the demand side. And so I think the two will very easily equate to each other,” he said.
Kinniry also suggested that investors who may be saving for children or grandchildren may not need to put all of their money in easy-to-sell assets like stocks and bonds.
“If I have a 30-year horizon, and I can get 100 to 200 basis points in illiquidity premium, why wouldn’t I want 20 or 25 or 30% of my portfolio (in illiquid assets)? You don’t want to go too far. You don’t want to be 80% illiquid. But I would argue that investors are probably too liquid given their time horizon,” he said.