Indexing a killer retail application: Vanguard

Indexing within retail investment portfolios is a “killer application” for fund managers, outperforming about two-thirds of traditional active managers, according to the principal of Vanguard’s US asset allocation group, Nelson Wicas.

Wicas, who is visiting the Australian offices of the index and active fund manager this week, said that the widespread availability of market data means managers need to work smarter to consistently deliver above-benchmark returns, with indexing one way of achieving this.

Initially developed for the US institutional investment market, the indexing strategy was first adapted for retail use by Vanguard.

“When it comes to the retail marketplace, indexing is an absolutely killer application for people who are taxed at the kind of rate that retail [investors] face,” he said.

According to Wicas, indexing’s role in taking different stock positions within various markets decreases the manager’s imperative to pick the right market cycle, and is the great strength of indexing.

He believes the increasing availability of market information is diminishing the skill required to identify the good opportunities, such that the only way to get high risk-reward ratios is to have skill and “lots of little bets that you’re placing”.

“Place lots of bets, as opposed to just a few, and at the same time it makes sense to think about introducing risk control,” Wicas said.

He said it make sense to have position limits on each security, so that you are placing several “bets” within an industry, ensuring no security is excessively over-weighted or under-weighted within the portfolio.

“Think about picking different managers that are in the value, growth and size spaces so that you’re controlling for those kinds of risk factors.”

Pointing to a chart demonstrating the indexing methodology, he said: “On an after-cost basis, [it] is going to outperform a fairly large chunk of the active money managers, and it does do that”.

The markets where this adds the most value for Vanguard clients are in fixed income and large cap equity.

“In mid cap and small cap, the probability of outperforming is greater, but the point is [without indexing], to build in any consistent outperformance you have to, year over year, be in [the right] part of the distribution cycle . . . indexing’s a powerful strategy for all markets, at all times.”