Vanguard’s Gain Is Wall Street’s Pain as Billions Leave the Financial Industry

Vanguard’s Gain Is Wall Street’s Pain as Billions Leave the Financial Industry

Are the HEDGE FUNDS the only one able to keep their EDGE, thanks to their long-short strategy meaningful for investors?

Are the Smart Beta ETF the best alternative to the capital weighted ETF, thanks to their multi factors strategy and methodology, giving higher return with mild expenses ratio to be fruitful for investors?

Passive investing popularized by Vanguard has removed a chunk of Wall Street’s revenue.

While Washington has long been debating how to reform big Wall Street banks, Vanguard Group is quietly doing just that as the company and its army of index funds remove about $20 billion a year in revenue from the financial industry.

So far in 2015, Vanguard is leading a record $365 billion in net flows into low-cost and passively managed index funds and exchange-traded funds (ETFs), according to Bloomberg data. Meanwhile, the active mutual funds that constitute some of Wall Street’s best customers have lost $147 billion, according to the Investment Company Institute. That adds up to about a half-a-trillion-dollar swing so far in 2015, which will be the most ever in a year.

Vanguard’s take of this is a phenomenal $185 billion, or about 55 percent of the total inflow, which puts it on pace to bring in more money in one year than any asset manager in history, according to Barron’s. The rise of Vanguard and other passive managers comes at a time when Wall Streeet is under intense pressure to boost its collective profits.

Vanguard’s assets now stand at $3.1 trillion, which effectively means that this year alone it will have removed more than $16 billion from the financial industry just through fees. That figure is based on the average asset-weighted fee of a Vanguard fund of 0.13 percent, compared with the 0.66 percent average asset-weighted fee of an active mutual fund.

Of course, $16 billion is merely a dent for a financial service industry that generates approximately $200 billion a year in global trading and asset management revenue, per figures from Bloomberg Intelligence. But the dent gets bigger once it includes the “hidden fees” that active managers rack up from continuously tweaking their portfolios.

Active mutual fund managers are some of Wall Street’s best customers because they spend money through trading commissions and research as they attempt to outwit the market and turn over the securities in their portfolios.

On average, an active manager has turnover that is 10 times more than a Vanguard index fund, where average annual turnover is about 3 percent to 4 percent.* One extra percent of turnover translates to about an extra basis point in cost, equating to another $3 billion or so a year in lost trading revenue.

This $20 billion dent is only expected to grow larger. It took Vanguard 32 years to reach $1 trillion in assets, eight years to get to $2 trillion, but then just three years to get to $3 trillion. At this rate, Vanguard will be removing $40 billion in revenue each year from the financial industry by 2020, equivalent to a 20 percent hit to revenue based on today’s numbers.

But it gets worse, or better, depending on which side of the active vs. passive divide you stand.

Beyond Vanguard’s direct effect, there is also a revenue decrease caused by the so-called Vanguard Effect, which sees other funds lowering their fees to compete with the rock-bottom prices on offer from the company.

Like Walmart arriving in a new town, the entry of Vanguard into a particular investment area causes a collective gnashing of teeth as other fund managers are forced to drop their prices to compete. That dynamic is borne out in the table below, which shows the cheapest ETF fees for products that do or do not have a Vanguard-provided equivalent.

All of which raises the question of how Vanguard manages to make its own profit in the face of ultra-low fees.

Vanguard’s ability to achieve extremely low costs can be traced back to the way founder John Bogle formed the company in 1975. He set it up as a “mutual ownership structure,” which basically means the shareholders are the fund investors. So while Vanguard does make profits, those profits don’t go to shareholders, they go back to investors by lowering fees. The foundation on which Vanguard is built is what makes it so different and ultimately gives the company its edge.

Until now, the asset numbers probably weren’t big enough to trouble Wall Street, but as Vanguard is now on pace to add a cool $1 trillion in assets every few years, it is effectively becoming a massive wealth transfer machine funneling money out of the financial industry and into individual investors’ accounts.

So how does this story end? Right now, passive products, such as index funds and ETFs, have about 30 percent of the $16 trillion in total investor assets, compared with active products, which still have 70 percent. If the balance of power were to shift firmly in passive’s favor, one might expect extra opportunities for stock- and bond-picking active managers to emerge, since there would be more inefficiencies in a market where the majority of investors are invested equally.

If active managers exploited those inefficiencies—a valuable role played by traders and portfolio managers—and outperformed the market, some money would inevitably move back to them.

So while Vanguard has enjoyed a stunning run in recent years, there are arguably natural limits to its dominance.

Still, the effects of Vanguard’s rise have been far-reaching on Wall Street, prompting fees to come down across the industry. It is a major reason why Vanguard is now pushing more reform on Wall Street than all the political rhetoric in the world.

*Of course, this applies only to Vanguard’s index funds, which account for about two-thirds of its total assets, or $2 trillion.

Bitcoin ETFs Struggling To Take Off in Europe

Bitcoin ETFs Struggling To Take Off in Europe

Digital currency bitcoin surged in value to around $359.65 as of 2 December from just $209.13 on 24 August, and the rally left cryptocurrency investors gleefully patting their pockets. For those wanting a piece of the action, access is possible through a U.S.-listed ETF, meanwhile in Europe investors have to sit tight until bitcoin ETFs have been approved by regulators.

ARK Invest recently added bitcoins to one of its ETF portfolios. The group has gained exposure to bitcoin through the purchase of shares of Grayscale’s Bitcoin Investment Trust which is the first publicly traded bitcoin fund.

Bitcoin Considered A Commodity?
Firstly is bitcoin considered a commodity? It is, at least according to the Commodity Futures Trading Commission, but other institutions take a different view and there remains confusion among the industry.

ARK Investment Management founder and CEO, Catherine Wood said, “In contrast, the Internal Revenue Service classifies it [bitcoin] as property and the U.S. Securities and Exchange Commission considers Bitcoin to be a currency.”

Wood stressed that bitcoin should be a currency serving the three main functions of money: a means of exchange, a store of value and a unit of account. For those who are concerned about the volatility of the currency, ARK’s Wood does not believe that Bitcoin is volatile. She highlighted gold and the U.S. dollar have also gone through periods of volatility.

Wood explained bitcoin was in the $200–300 range for nearly a year back in September, when ARK invested in the cryptocurrency, before it soared to around $376 on 30 November.

She said, “Given its upside potential in the remittance market and as a store of value, ARK Invest liked the tradeoff between risk and return and felt confident in it as an investment decision for the ARK Web x.0 ETF and now the ARK Innovation ETF.”

The ARK web x.0 ETF (ticker ARKW) is a U.S. listed ETF and was launched in September 2014 and has an expense ratio of 0.95 percent, with an average market cap of $67 billion. Since inception the fund has returned over 18 percent this year.

New Entrants

The Winklevoss twins are keen to launch and get the go ahead for their Bitcoin ETF which is currently in the process of receiving Securities and Exchange Commission clearance.

Laurent Kssis, director at CEC Capital and an ETF trading consultant, is currently setting up a bitcoin exchange traded note. He explained that one of the main reasons why investors would be keen to invest in a bitcoin exchange traded vehicle is that it would give investors access to the performance of bitcoin using a regulated market environment.

Kssis said, “With an investment fund vehicle (such as an ETN) it would provide some liquidity via market makers and intraday accessibly, and you give investors the option to participate in the performance of bitcoin without having to go into all the registrations.”

UK Bitcoin Regulatory Issues
The U.S. is more advanced when it comes to both bitcoin and ETFs launches. Europe remains sceptical of the currency as there is plenty of uncertainty when it comes to passing bitcoin as a qualified and trusted asset class.

Kssis explained no one has yet received regulatory or tax approval [in the U.K.] to promote bitcoin under the exchange traded commodity / ETF structure and therefore does not qualify as an investment under certain tax jurisdictions. As a result, those retail investors and advisers keen to get their hands on the cryptocurrency in a passive fund format are still waiting.

Bitcoin Concerns

There are many concerns when it comes to bitcoin and digital security and having online protection in place. Due to these concerns players like IBM are adopting new technology such as Blockchain.

Blockchain is a distributed database that maintains a continuously growing list of data records that are hardened against tampering and revision, even by operators of the data store’s nodes. A node is a computer connected to the Bitcoin network using a client that performs the task of validating and relaying transactions. The more nodes there are the more secure the system.

Wood said, “Bitcoin is still very new and often misunderstood or met with skepticism, like most other disruptive innovations in their early stages, similar to the internet in the 1990s.”

She explained ARK Invest focuses on disruptive innovations that they believe will change how the world works. When asked what kind of investors would bitcoin be suitable for, Wood said, “Bitcoin is for those investors looking to make a long-term commitment to a currency that should appreciate over time.

“Bitcoin is part of the ARKW and ARKK ETFs because we have every reason to believe bitcoin and blockchain, the technology underpinning bitcoin, will revolutionise the way the internet is utilised.”

“While the internet decentralised the dissemination of information, bitcoin and blockchain are decentralising the securitization of information.” added Wood.

Obstacles For Investors

Michael Sonnenshein, sales and business development at Grayscale, a sponsor of the Bitcoin Investment Trust, said that purchasing bitcoin outright can be a harrowing experience for investors.

“More often than not, they don’t know who to purchase bitcoin from. Are there counterparties they trust? What price should they pay? They don’t know how to handle bitcoin safely and securely,” added Sonnenshein.

He explained that even if investors can overcome these challenges, storing bitcoin on one’s own can be a liability.

“If bitcoin holders are hacked or lose the private key to their bitcoin wallet, they have zero recourse,” said Sonnenshein.

One way around this could be by purchasing shares of the Bitcoin Investment Trust which gives investors the ability to gain exposure to bitcoin without the aforementioned challenges and through a titled security in the investor’s name.

Sonnenshein said Grayscale are seeing an influx of investors with various mandates looking to add bitcoin exposure.

“These range from gold investors (there are many overlapping attributes between bitcoin and gold) to investors who are involved with every type of asset ranging from currencies to commodities to those involved with or exposed to the payments space.”

Even hedge funds and family offices are looking to get in on the bitcoin action, added Sonnenshein.

Read here for US

If you have an online brokerage account, you can now buy shares in a fund that aims to track the price of the digital currency called bitcoin. Just don’t expect a smooth ride.

Bitcoin is a highly speculative investment—the kind most financial advisers say investors should only buy into with money they can afford to lose. But some analysts think the new fund could bring the digital currency a step closer to broader acceptance by investors. For that to happen, the fund will have to overcome some early difficulties.

Bitcoin Investment Trust started trading on the OTCQX market on May 4 under the ticker symbol GBTC. It isn’t technically an exchange-traded fund, but it’s designed to work like one. (The Securities and Exchange Commission is reviewing an application for what would be the first official bitcoin ETF, the Winklevoss Bitcoin Trust.)

Bitcoin Investment Trust is small, with a net asset value of only $35.6 million at the end of June and only 1.4 million shares outstanding. Its tracking of bitcoin’s price has been inconsistent, and there is a wide spread between the share price and the value of the underlying assets. Oh, and by the end of last month the share price had fallen 28% from its $42 close on the first day of trading, to $30.12.

Sparking interest?

Still, some analysts think the fund could prompt some speculative interest in bitcoin, like the launch of gold ETFs did in precious metals a decade ago.

Gil Luria, an analyst with brokerage firm Wedbush Securities who has followed the bitcoin market since its infancy, sees Bitcoin Investment Trust as part of bitcoin’s move toward the mainstream of finance. Other recent signs of acceptance on Wall Street include the decision of the New York State Department of Financial Services to regulate itBit Trust Co., a small bitcoin exchange, and research from Goldman Sachs Group Inc. claiming a place for bitcoin in “the future of finance.”

“The OTCQX listing is also a very big step forward,” says Mr. Luria. “It has made at least a proxy ownership stake in bitcoin available to practically every institutional and retail investor.” Anyone can buy bitcoin directly, but it involves headaches including the need for specialized software for secure transactions.

When the SPDR Gold Shares ETF launched in November 2004, gold futures were trading at about $400 an ounce. The popularity of the fund was part of a gold craze that saw prices quintuple over the next seven years. “Investors historically have chosen to offload the friction of buying and securing gold directly for a reasonable fee,” says Cameron Winklevoss, one of the founders of Winklevoss Bitcoin Trust. “We believe some investors will behave the same with regards to bitcoin and a bitcoin [exchange-traded product].”

Bitcoin is even more volatile than gold in its speculative heyday, and even trickier to buy and sell directly. And the bitcoin market is far smaller and younger than the gold market was in 2004. But there are reasons to believe bitcoin usage could increase. In a recent Goldman Sachs survey of 752 millennials, 44% said they have used, do use or will use bitcoin. And well over 100,000 merchants world-wide, from individuals to corporations, accept bitcoin for at least some payments, the firm says.

Share shortage

In addition to investors’ attitudes about the digital currency, Bitcoin Investment Trust is wrestling with some practical issues. For one, the fund’s shares trade at a sizable premium to the underlying assets—19% on July 1. That’s because of the fund’s origins as a private trust.

Investors in the private trust could sell their shares on the public market after a 12-month lockup. Those sales began May 4, but shares have only become available gradually as the private investors liquidate their holdings. The shortage of shares has boosted their market value.

The bitcoin fund has high fees by ETF standards, at 2%.
The bitcoin fund has high fees by ETF standards, at 2%. PHOTO: ISTOCKPHOTO/GETTY IMAGES

But Mr. Luria expects nearly all of the original trust investors to sell their shares publicly by September, creating what he calls a “critical mass” of shares on the market—or enough to bring the price of the fund’s shares more into line with prices on the bitcoin market.

The fund also has high fees by ETF standards, at 2%. And it may soon have competition from the proposed Winklevoss fund. Already, Nasdaq has launched an exchange-traded note that tracks the price of bitcoin on its Stockholm exchange.

However investors come to view the fund, some veteran money managers see it as the latest in a long line of tenuous and risky investment products.

“I think a bitcoin ETF says as much about the popularity of ETFs as it does about the popularity of bitcoin,” says Eric Marshall, a portfolio manager for mutual-fund firm Hodges Capital Management in Dallas. “Now there’s an ETF for everything.”