• Against an uncertain market backdrop, fund manager expertise can identify overlooked and undervalued opportunities.
• In our assessment of external fund manager partners, we aim to distinguish between skill and luck. 
• Ultimately, we are looking to find external partners that we believe share our values and can help deliver long-term outcomes for investors.

Against an uncertain market backdrop, equity valuations are looking stretched and central banks are sending mixed signals around the timing of interest-rate cuts. In the US, the S&P 500 index surged to record highs¹ in March as robust earnings from mega-cap technology companies and swelling enthusiasm for artificial intelligence propelled share prices sharply higher.

It’s a tale of unusually concentrated returns from a sector which has gone by many different nicknames in recent years. The Magnificent Seven², as the group of seven of the world’s largest technology stocks are currently known, have seen their share prices rise by nearly 70% over the past 12 months to the end of March 2024³. The group’s dominance has driven the returns of the broader market as the S&P 500 index returned less than 30% over the same period⁴.  

It’s in markets like these where fund manager expertise can identify overlooked and undervalued opportunities. At Vanguard, we use our ability to ‘pressure test’ a fund manager’s individual skill set and the cohesion of the broader investment team to help improve the odds of success for our actively managed equity funds. 

This includes our assessment of a firm’s ability to provide an environment that fosters collaboration, innovation and continuous learning. Firm size notwithstanding, there is no such thing as the perfect fund management firm and both boutiques and behemoths have their advantages. Neither automatically leads to better performance outcomes. 

Vanguard’s Oversight and Manager Search (O&MS) team looks beyond the more obvious measures of success to find external fund manager partners that we believe share our values and can help deliver successful long-term outcomes for investors. A total of 22 members of staff with an average of 18 years’ experience⁵, the team focuses on the drivers of success for our external managers – firm, people, philosophy and process – rather than performance outcomes alone. 

When it comes to assessing a firm, the O&MS team analyses the following elements: resources, culture and incentives. 

Ultimately, the team wants to understand if a firm has the resources, culture and incentives in place to help to attract, retain and motivate talented portfolio managers. 

Resources: The quality of a firm’s research resources is a distinguishing factor. Do they perform proprietary research or rely on outside sources? At Wellington Management Company (WMC), one of our largest external advisory partners, we consider its proprietary research capability to be the most significant factor in the investment process. WMC’s research resources consist of 280 analysts⁶  complemented by portfolio managers and their supporting investment teams who are also actively involved in the evaluation of specific companies.

Culture: How well does a firm rate on ethics, stability and the diversity of its client base? We’re looking for how well a firm’s culture aligns with that of Vanguard. Collaboration is an important aspect. On our many visits to WMC’s offices, we have seen successful collaboration displayed in a number of different ways. This includes the sharing of research and investment ideas at the firm’s daily Morning Meeting, held in impressive and identical lecture-style auditoriums globally. It’s a practice which was established over 50 years ago to ensure the robust evaluation of every security and as a forum designed to empower and create a culture of healthy debate and challenge.  

Incentives: We look at a firm’s ownership structure and remuneration policies. While various ownership structures can be effective, we have found that employee ownership tends to correlate with better firm profitability and growth⁷. However, what matters most to us is that our interests are aligned with the firm and that there are no conflicting loyalties that could impact our clients. 

We also prefer firms that evaluate their results over longer time periods, similar to how we evaluate our managers. Incentive fees should align with our long-term approach to investing. At WMC, a fund manager’s earning capacity is driven significantly by their individual or specific team performance. We would also highlight how any individual making substantial contributions to client outcomes has the potential to become a partner of WMC. 

Ultimately, Vanguard is looking to distinguish between skill and luck in its assessment of our external partners. We have found that firms with the right infrastructure and systems in place to support fund managers in making informed investment decisions tend to be aligned with our values of prioritising long-term investment outcomes for clients.

¹ The S&P 500 Index returned 3.22% for the month of March and 29.88% during the 12 months to the end of March. Source: Vanguard, USD, as at 31 March 2024.

² The “Magnificent Seven” refers to a group of US stocks, namely Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla

³ Source: Factset, USD, as at 31 March 2024. 

⁴ Source: Factset, USD, as at 31 March 2024.

⁵ Source: Vanguard, as at 30 June 2023. 

⁶ Source: Wellington Management Company, as at 31 December 2023. 

⁷ Ernest O'Boyle, Pankaj Patel and Erik Gonzalez‐Mulé. “Employee Ownership and Firm Performance: A Meta-analysis,” Human Resource Management Journal 26, no. 4 (2016): 425–448. https://doi.org/10.1111/1748-8583.12115.