Hoist the Red Flag – Vanguard Bids on iShares

by James & Miel on June 15, 2009 · 0 comments


Hi All,

If you own Vanguard mutual funds, you should probably read this.

Jason Zweig of the Wall Street Journal is reporting that the Vanguard Group recently bid for the iShares family of exchange traded funds last month (1). This doesn’t seem like a big deal, but it it signals potential problems.

Now, if you’ve spent some time reading about mutual funds, you’ll see Vanguards name crop up as one of the industry’s cheapest providers of index and targeted mutual funds. They run a number of very well known index products including the famous S&P 500 index fund.

Vanguard was founded by John Bogle. Bogle was an astute businessman who understood that bringing value to customers could be achieved by offering them efficient and low cost products. Bogle also pioneered the concept of indexing, or creating products that matched the overall performance of the stock market using weighting and averaging. He is a flexible and nimble thinker. As a result Vanguard now enjoys a reputation as having some of the best low cost mutual funds around and has grown from a small company to a giant with over 10,000 employees.

Unfortunately, Bogle retired a number of years ago, leaving John Brennan in charge of the company (1). This recent move by Brennan should raise concern. It is essentially a shift away from Vanguards core business strategy. Its true they already issue a high number of ETFs, but their core business is selling really cheap index funds. When businesses start to move away from their core mission, bad things can happen.

I’ve seen this several times.

A few years back, TIAA-CREF started to “diversify” outside of their core business of selling variable retirement annuities to offer retail mutual funds. As part of their expansion, their fee structure doubled while at the same time their performance of some of their key funds lagged the overall market. The bottom line was because of TIAA-CREF’s silly management decisions their customers had to take a hit.

In 1999 the Washington Water and Power Company changed their name to Avista. The name change signaled a change in core business activities from providing water and electrical services to include in the CEO’s words “a focus beyond our traditional business roots within the Pacific Northwest” – or in plain language trading energy to make a fast buck. What was the end result? You guessed it. The shares of Avista promptly lost 75% of their value after the name change due to bad energy bets. They also cut their dividend from 40 to 13 cents to add insult to injury.

Bottom line: when a company even hints at changing their core business activities, you’d better hoist the red flag. Typically it introduces a number of additional risks and signals a change in executive culture that’s not always for the better. You could lose a significant portion of your wealth if you do not get out before the boat sinks.

Full disclosure, we have over $10,000 worth of Vanguard funds, primarily their S&P 500 funds, bond market index and inflation index bonds funds.

Best,

James

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