Tom Rampulla, head of Vanguard’s UK operation, spoke to Paul Amery, editor of www.indexuniverse.eu, about his firm’s expansion plans, in an interview conducted earlier this week.

IU.eu: Tom, most European readers will be familiar with Vanguard as one of the world’s largest fund managers and as the pioneer of index investing. But fewer, perhaps, will be familiar with your ownership structure. Could you elaborate?

Rampulla: In the US, the Vanguard group is owned by the investors in our mutual funds, collectively and more or less proportionately to the size of each fund. The group then provides services to the funds. This helps us operate very efficiently, and any profit is returned to fund shareholders, effectively driving costs down. This also helps us avoid the potential conflict of interest between customers – the investors in the funds – and the shareholders in the management company. The structure allows us to plan very long-term, as we’re not under pressure, as a publicly-quoted company would be, to match or exceed Wall Street’s quarterly return targets.

The non-US businesses of Vanguard are not owned by their mutual fund shareholders – it’s more complicated to do this from a regulatory standpoint, but it’s something we would like to explore in the future. So as of now the Vanguard group owns the UK subsidiary. But the Vanguard Investments UK fund shareholders still benefit greatly from the mutual structure, as we manage the business in exactly the same way.

IU.eu: We reported last week on your current index fund launch. Why have you decided to start with index funds, rather than ETFs, since in the US you run both?

Rampulla: As you may know, in the US our exchange-traded funds are actually structured as share classes of our mutual funds. We decided to file for index funds here, as we wanted to start with the basic building blocks of a fund business, and then decide later what is the most appropriate legal structure to use, whether that is a UCITS, a local ETF, a combination of both, or a share class of an OEIC (open-ended investment company), assuming that we can do one of those here.

IU.eu: I noticed that you’ve chosen to start your fund range with a mixture of Irish-domiciled UCITS and UK OEICS – what was the thinking there?

Rampulla: We wanted to bring to market for UK investors, since all the funds are designed for them, the best products available. We looked at things like tax efficiency and how best to track the relevant index at low cost. There was also the question of scale, since we already had a Dublin-based UCITS range in place, and in some cases it was most efficient to utilise the funds available there.

IU.eu: What are your plans for expanding into other parts of Europe?

Rampulla: We are following a two-pronged approach for business expansion outside the US. We want to build a global institutional funds business, which we are doing right now across Europe, and in certain countries, where we feel the market is big enough to be meaningful for us – we already manage US$1.1 trillion, worldwide – we are pursuing a deeper and broader strategy, with more investment products designed for the local market. In these countries we also look at whether we feel we have a competitive advantage, whether we can differentiate ourselves, and whether we feel we have expertise to bring. The two countries where we are currently pursuing such a strategy are the UK and Australia, though we are looking at other places as well.

IU.eu: What opportunities do you feel, then, that the UK investment advisory market offers to you?

Rampulla: It’s certainly a very different business model to that in the US. Before moving to London, I spent six years helping establish our advisory business in the US. One of the reasons why Vanguard was very successful there is that there are a lot of fee-based investment advisors. In the UK, we estimate that the proportion of fee-based advisors is 10% or so, representing around 10-15% of assets. We’re hoping to help grow that segment of the market, and we want to help to educate people about the benefits of fee-based advice. Whether the UK regulator’s Retail Distribution Review helps drive the market towards fee-based advisory work or not, we still feel that there are a lot of inefficiencies in the market for retail investment products. There are layers of extra costs, many of which are not transparent. This is obviously not in the best interests of the investor, and we’re hoping to highlight that.

I find that, when I have conversations with some investors here, they still don’t really think about the impact and importance of fund costs. In the US market, this message is more broadly known, so we have to focus on that here as well.

IU.eu: On the subject of costs, the index funds you are launching are cheaper in terms of annual charge, or total expense ratio, than competing investment products, such as ETFs, where they exist. But what about the overall cost to an investor of buying your index funds via a “platform”, since most people won’t have the £100,000 necessary to deal directly with you? The platforms charge their own fees, and the investor will also have to pay his IFA (independent financial advisor) for advice.

Rampulla: Our funds are available via such IFA platforms, but we’re also in discussions with providers of other retail distribution routes. For example, Alliance Trust Savings is going to offer online trades in our funds for £12.50 per transaction. Broadly speaking, though, while there will undoubtedly be some extra costs for most investors when buying a Vanguard fund, we think that, all things being equal, we are going to give people a much better deal, since our expenses are so much lower. Over time, we’d love to see all the costs of investing come down, and we’ll do what we can to help influence that.

I don’t want to suggest, though, that it’s not worth paying for a good fee-based advisor. They earn their compensation if they’re doing their job well, helping with financial planning and, for example, saving investors from themselves if they want to sell at the wrong time. We think that’s money well spent, but the fees need to be fairly disclosed, and often that isn’t the case as things stand.

IU.eu: Do you undertake securities lending within your index funds and, if so, how are revenues split between Vanguard and fund investors?

Rampulla: That’s a very topical question. From day one we won’t be lending securities, but we plan to do it in future, under Vanguard’s general securities lending philosophy, which has been called boring by some, but which has served us well for a long time. We insist on highly-collateralised lending, using cash or government bonds, and we only reinvest collateral overnight, so we don’t take duration risk. All the revenues from the lending operations, net of the costs of running them, go back to shareholders, so we’re not in a position of taking risks with someone else’s money and keeping a good chunk of the profits for ourselves.

IU.eu: What are your future product launch plans?

Rampulla: If you look at what we currently have in place, a UK investor can already build a diversified global portfolio. Advisors do like to slice the market up in different ways, though, whether by size or style, so we’ll look to add some funds there, and also in some additional foreign markets, and areas of the fixed income markets. We’ll also add some low-cost actively-managed funds. And, as I’ve mentioned, we’re interested in a European ETF range, though there’s no date set yet for their launch.

IU.eu: What have been your overall impressions since moving to Europe with Vanguard?

Rampulla: I’m pleasantly surprised at the reaction of people within our target market to our arrival, and more people seemed to know Vanguard over here than I had expected. But there are still big differences in the way the investment advisory markets work here and across the Atlantic, as I’ve mentioned. The average member of the general public in the US is much more used to the idea of running his or her investment portfolio, since 401k, defined contribution pension plans have been around for so long. There are many US publications devoted to helping people invest their retirement assets in this way. Here, by contrast, self-directed investing is a relatively much smaller part of the market, though it feels as though things may be beginning to head in the same direction as in the US. It’s a big challenge, but a very exciting time to be here.