IF.com: Can anyone match Vanguard's low costs?

GUS: Not unless you subsidize them. Some of our competitors have subsidized their funds through the money they make elsewhere. Their expense ratio is artificially low. For instance, if you had some index funds and also some actively managed funds, they make a tremendous amount of money on the actively managed funds and use the index funds as a loss leader. You just have to have an index fund nowadays. At the same time, there's no guarantee that the active managers will always subsidize their index rates. That's the danger of going with someone who is buying down their expense ratio. They could change the tables on you at any time, and if you've been there a couple of years you have unrealized capital gains and you kind of get locked in.

IF.com: Will the new SEC rulings on fair disclosure have any impact on Vanguard?

GUS: It will not have an impact on us but I think it's a good ruling. I think it's in the best interest of the markets and for investors overall. I think it's great, and I don't think it will impact us - certainly not in a negative way.

IF.com: Some managed funds today seem to act like venture capitalists by backing companies early on and matching them with complementary companies. Will the Reg FD have an impact here?

GUS: It makes it more difficult to try to game situations like that. To that extent, it makes the markets somewhat more efficient. For those who were trying to take advantage of slight inefficiencies in the marketplace, it ruins their game. I think any improvement in efficiency is a positive, although it is not absolutely necessary for indexing to have an efficient market.

Indexing is an interesting animal in that it's the only prudent way to invest if you have a perfectly efficient market. This is illustrated in an article written by Charles D. Ellis back in 1975 that appeared in The Financial Analysts Journal. It was called "The Loser's Game." He describes how outperformance is a zero-sum game. It means that if one investor outperforms the market, then another investor has to underperform. In aggregate, all investors have to get the market rate of return. In aggregate, they can't beat the market because they are the market. So that would mean half the investors will beat the market and half the investors will underperform it. However, we have costs of investing, and they're rather high costs. When you impose those upon investment returns it means the average investor no longer gets the market rate of return, he or she gets less than the market rate of return. That argument applies whether it is an efficient market or an inefficient market.

IF.com: How do you view the markets today?

GUS: We think the markets are expensive, which doesn't mean they can't go still further, but we don't think they have the amount of steam left in them that they had during the last five years. Right now, with interest rates easing, we have a fairly favorable market environment. It's hard to point to any clouds on the horizon.

Gus U. Sauter is Managing Director of The Vanguard Group's Quantitative Equity Group. He oversees the portfolio management of Vanguard's internally managed equity funds, including $250 billion invested in 28 index funds and $4 billion in four actively managed portfolios.

Mr. Sauter joined The Vanguard Group in 1987. Previously, he was a Trust Investment Officer with The First National Bank of Ohio.
Mr. Sauter is a member of the Trading Committees of the Securities Industry Association and the Investment Company Institute, and the Quality of Markets Committee of the NASD.

He received his A.B. in Economics from Dartmouth College and an MBA in Finance from The University of Chicago.

Printer Friendly Page