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Vanguard may be shorting much vaunted 'owners' of its low-cost index funds as it upshifts to more Wall Street-style exec-comp to thwart competitors and chase high-net-worth investors

Shareholder profits at the Malvern, Pa. company are being undercut by undisclosed millions in executive and staff pay raises as the company seeks to shore up its eroding value proposition.

Sunday, May 15, 2022 – 7:15 PM by Oisin Breen
Amy Lash: Like our clients, we think about performance over the longer-term.

Brooke's Note: Vanguard gets it from both sides. It got slaughtered last year when it launched a mobile app, Beacon, to boos. It also got hammered on service during the pandemic. Yet this article focuses on Vanguard, perhaps, taking the steps at modernizing its workforce that could lead to an overhaul of service and the digital experience. Still, the ways CEO Tim Buckley is channeling his inner BF Skinner to get better talent and better efforts out of them run smack into the other big new emphasis at Vanguard -- the cooperative "shareholder" structure.  In theory -- every investor is a virtual owner. The potential conflict is that when Vanguard chiefs pay themselves princely Fortune 500 wages, those dollars are subtracted from the shareholder take, at least in the short term. Yes, that's the way of the free (and not free) enterprise world. Get over it. But it doesn't really explain why -- if it's all good -- that Vanguard declines to share information about this giant expense item with its "owners." It also makes it harder to connect dots as an owner about strategic shifts that seem out of Vanguardian character. Are they being made to benefit downstream shareholders or upstream shareholders? Or do they give-or-take both about the same? And why is this conflict and opacity happening at a company that is seemingly a paragon of investor transparency?

Vanguard's secretive shift to a Wall Street-style business model is alarming longtime company watchers who fear its coming at the expense of  "owners" who invest in its traditional low-cost index funds.

Daniel Wiener
Daniel Wiener: Push up salaries or bonuses ... to astronomical levels [they are] still costs.

Evidence of the shift came to light when an internal memo surfaced in a newsletter, disclosing a 24.2% per-share bump in an employee dividend last year over the prior year -- the largest increase since 1987. Vanguard did not dispute the report. 

"If the rank and file knew how much these guys got paid while they were busting their butts ..." says Daniel Wiener, who publishes 'The Independent Adviser' newsletter for Vanguard Investors.

"With irate owners, it might be mutiny time," he adds, in an email.

But these days, Vanguard is on defense as well as offense because companies are stealing its playbook and even its culture and ethos, says Eric Balchunas, author of the just-released book, "The Bogle Effect."

The book charts how legendary investor John "Jack" Bogle upended Wall Street in 1975 with his radical idea to make investors the actual owners of his new fund company. 

For years, Vanguard's philosophy was to put "owners" of its low-cost funds first and reward them through the imputed profit-sharing of fee cuts.

But "a lot of companies are acting Vanguardian," Balchunas says. "There's a lot of Vanguard in Schwab these days. Vanguard is now as much of a concept as a company." 

Schwab has also been using "ownership" concepts in its taglines for about a decade, though with a less literal connotation. See: How Schwab's new 'owning it' advertisements position the firm to offer more advice -- and how RIAs factored into the brand rethink

Raising alarms

Vanguard's response to rising competition has been to move in the opposite direction -- upmarket. Among other things, it's begun courting high-net-worth investors with private equity and active management. Those offerings typically levy lower fees than products in their category but far higher than what Vanguard investors are accustomed to paying. See: Vanguard Group's private equity retail push gets real.

Eric Balchunas
Eric Balchunas: It's not your grandfather's Vanguard.

"Certainly, Vanguard has realized that it needs the stimulus of outside ideas, particularly in emerging areas of opportunity, like direct indexing. In this sense, it's moving away from the homespun, middle America ethos," says Will Trout, director of wealth management at Livonia, Mich., consultancy Javelin Strategy and Research, via email.

Vanguard has also done its first gimmicky promotional deal with American Express to attract high volumes of mass-affluent investors. See: Vanguard, American Express INVEST deal hits a wall--of hard numbers--shattering its supposed value amid one glaring 'fine print' disclosure-- it’s a huge conflict of interest for Amex

The moves, however, have raised alarm among long-time company watchers because they suggest Vanguard is selling short its owners to compete at a higher level with Wall Street firms. 

"The executive team has put growth above performance. Certainly the deal with American Express is an asset-gathering deal and not in keeping with [Vanguard's] lowest-cost mantra," says Wiener, via email. 

High profits

To make matters worse, Vanguard is hiding key data -- like operating expenses tied to human talent -- from shareholders, which is probably counterproductive, Balchunas says. 

"When you close off information, people think the worst."

Unlike shareholders in public companies -- or even most private nonprofits -- Vanguard shareholders are denied access to finances, including how, and  by how much, staff and top executives are compensated.

Wiener says the company has also blown a hole in the much vaunted meaning of ownership. 

"Vanguard is not, and has never been, a non-profit, though much of the language [used is] around 'operating at cost' … [it is] exceedingly profitable.

"If I push up salaries or bonuses ... to astronomical levels [they are] still costs. It’s all in how you parse the language.

"Is a  $20 million bonus a cost? I kind of believe it is," says Wiener.

Slicing the pie

Vanguard's value proposition is anchored by the Vanguard Partnership Plan, which underscores the value of investor-ownership. Instituted in 1984, the plan further aligns "our crew’s interests and our clients’ long-term success," says spokeswoman, Amy Lash, via email.

Will Trout
Will Trout: Vanguard has realized that it needs the stimulus of outside ideas.

"The Partnership Plan is based on the value created for clients over a rolling three-year period. The performance calculation shared with crew this year was for the three-year period ended Dec. 31, 2021," she adds.

"And it’s been a good three years for Vanguard, with assets up about 76% over that period -- the best rate since 1999 --the Partnership Plan’s dividend has increased 54%," Wiener explains.

The dividend increase, from roughly $352 to $437.56, primarily also reflects Vanguard's ability to control costs relative to peers in the industry,  Wiener adds. 

"[AUM] growth, rather than fund performance, [is] a key factor determining the dividend’s size. The other factor ... is the "cost savings" accrued by comparing Vanguard’s average operating expense ratio to industry averages."

Vanguard caps most employee bonuses – except those awarded to its top brass – to a level calculated based on their job ‘grade’, tenure, and the percentage rise of the dividend, according to Wiener's research.

Usually paid out between April and June, Vanguard's partnership plan once paid tenured employees up to 30% of their salary as a bonus. Yet by 2010, the company restructured its partnership, and cut payout levels, according to the Philadelphia Inquirer.

In 2015, Vanguard reclassified 2,100 staff as hourly workers, removing them from its bonus scheme, according to the Philadelphia Inquirer newspaper. 

"How does Vanguard fund its partnership plan if not with profits? Well, then I guess [its] not a non-profit. It’s a bit circular, its perception, and opacity around it," Wiener says.

Paying top talent

"While the nuances of the Partnership Plan aren’t public, the overall goals of encouraging asset growth and efficiency to produce cost savings are clearly in the best interests of shareholders," says Scott Smith, director of advice relationships at Boston, Mass. consultancy Cerulli Associates, via email.

Cecile Munoz
Cecile Munoz: We all know they're not a non-profit, just like the rest of Wall Street

"Don’t let the perfect be the enemy of the good."

The big proof point is that Vanguard manages about 25% of industry assets but collects about 5% of total revenues.

Cecile Munoz, founder and president of U.S. Executive Search, says Vanguard can not be expected to walk on eggshells when it compensates to attract and retain talent.

"We all know they're not a non-profit, just like the rest of Wall Street ... [but] they can operate at cost and still pay their talent top, competitive compensation," she explains via email. 

"It's right and logical for a meritocracy to [match] compensation in direct correlation to the responsibility, risk, and contribution of an individual’s role."

Competitive pressure

Vanguard, as Munoz notes, may have little choice but to pay out fat bonuses to remain competitive, given those available on Wall Street.

Scott Smith
Scott Smith: 'Don’t let the perfect be the enemy of the good.'

"It can't afford to lag on the compensation front, particularly as it seeks to open up to the outside world, both in terms of using outside technology and in cultural terms," says Trout. 

"Executive compensation is driven by competitive pressures, from which Vanguard is not immune," he says.

Goldman Sachs paid CEO David Solomon $35 million last year, and JP Morgan paid CEO Jamie Dimon $34.5 million.

Jack Bogle would have earned at least $41 million were he still running Vanguard in 2022, Wiener calculates.

Vanguard emphasizes that paying staff more results in investors getting greater 'shareholder' benefits over time.

"Vanguard says it's owned by its shareholders yet provides zero disclosure on ... how much it pays its executives, [or] what its bonuses are based on," counters Wiener, chairman of RIA Adviser Investments in Newton, Mass.

"Vanguard is the prototypical aircraft carrier, a change of course takes time, and it’s important that all initiatives focused on reinvention be coordinated," Trout explains.  See: Vanguard makes mockery of 'digital' myth by reporting $1.3 trillion after its new mobile app's panned debut.

"It's not your grandfather's Vanguard, but it's still Vanguard,"  says Balchunas.

Although Vanguard no longer shares details of its payout system, Wiener uses an old share count it provided for Jack Bogle to calculate an approximate number.

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