Vanguard may be shorting much vaunted ‘owners’ of its low-cost index funds as it shifts to Wall Street-style exec-comp tactics to thwart competitors…

Posted: May 15, 2022 at 9:30 pm

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.

Brooke's Note: Vanguard gets it from both sides. It got slaughtered lastyear when it launched a mobile app 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 channelinghis inner BF Skinnerto 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 virtualowner. 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 -- thatVanguard declines to share information about this giant expense item with its"owners." It also makes it harder to connect dots asan owner about strategic shiftsthat 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 at a company that is seemingly a paragon of investor transparency?

Vanguard'ssecretive shift to aWall Street-style business model is alarming longtime company watchers who fearits coming at the expense of"owners" who invest in its traditionallow-cost index funds.

Evidence of the shift came to light whenaninternal memosurfaced in a newsletter, disclosing a 24.2% per-share bumplast yearover the prior year in anemployee dividend-- 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 ..."saysDaniel Wiener, whopublishes "The IndependentAdviser" newsletter for Vanguard Investors.

"With irate owners,it might be mutiny time."

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

The bookcharts how legendary investor John "Jack" Bogle upended Wall Street in 1975 with hisradical 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 profit-sharing.

But "alot 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."

Vanguard's response to rising competition has been to move in the opposite direction--upmarket. Among other things, it'sbeguncourting high-net-worth investors withprivate equity and active management. See: Vanguard Group's private equity retail push gets real.

"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," saysWill Trout, director of wealth management at Livonia, Mich., consultancy Javelin Strategy and Research, via email.

Vanguard has also done its first gimmicky promotional dealwith 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-- its a huge conflict of interest for Amex

The moves, however, have raised alarmamong 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 Weiner, via email.

To make matters worse,Vanguard is hiding key data -- like operatingexpenses tied to human talent -- fromshareholders, whichis 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. Its all in how you parse the language.

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

Vanguard's value proposition is anchored by the VanguardPartnership Plan, whichunderscores the value of investor-ownership. Instituted in1984, the planfurther aligns "our crews interests and our clients long-term success," saysspokeswoman, Amy Lash, via email.

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

The dividend increase, from roughly $352 to $437.56,primarilyalsoreflectsVanguard'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 dividends size. The other factor ... is the "cost savings" accrued by comparing Vanguards 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.

"Howdoes Vanguard fund its partnership plan if not with profits? Well, then I guess [its] not a non-profit. Its a bit circular, its perception, andopacity around it," Wienersays.

Paying top talent

"While the nuances of the Partnership Plan arent public, the overall goals of encouraging asset growth and efficiency to produce cost savings are clearly in the best interests of shareholders," saysScott Smith, director of advice relationships at Boston, Mass. consultancy Cerulli Associates, via email.

"Dont let the perfect be the enemy of the good."

The big proof pointis 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, saysVanguard can not be expected to walk on eggshells when it compensatesto 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 individuals role."

Competitive pressure

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

"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 Vanguardin 2022, Wienercalculates.

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," countersWiener,chairman of RIA Adviser Investments in Newton, Mass.

"Vanguard is the prototypical aircraft carrier, a change of course takes time, and its 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," saysBalchunas.

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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Vanguard may be shorting much vaunted 'owners' of its low-cost index funds as it shifts to Wall Street-style exec-comp tactics to thwart competitors...

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