Buy-side Awards 2016
The Vanguard Group has sustained its pedigree as a provider of passive investment products since 1975 when then chief executive, John C Bogle, created the first index fund for retail investors. Now, the firm is making moves to influence the active investment landscape.
A third of the firm's $3.8 trillion in assets under management is now in active funds and, over the past five years, Vanguard's active funds have been in the top decile of respective fund peer groups.
This year, the firm launched a range of actively managed exchange-traded funds (ETFs), which aim to hybridise the active and passive approach by creating a fund tied to a benchmark but allowing managers to deviate from the index if they believe doing so to be appropriate.
All of this has been underpinned by Vanguard's global risk management framework, which is designed to give portfolio managers and traders real-time indications of where they are taking on risk.
Positions and risk numbers are updated in Vanguard's proprietary portfolio management tool at five-minute intervals, or upon manual refresh.
The firm's risk group is physically located on its trading floors in Pennsylvania, Melbourne and London, meaning interaction between the portfolio managers and traders is possible throughout the day. Vanguard did not always take such a global approach to risk management, but this year it has extended the same risk models, metrics, setting of risk limits, reports and access to shared systems in all three of its trading locations, to align how it manages risk.
There has also been a shift in mentality from reactive risk management where risk analysts generate reports, to proactive risk management, such as real-time monitoring of inefficiencies in the portfolio construction process, performing stress tests on regular intervals, and tracking regulation, rather than running reports that track the impact of events after the fact, says Manish Nagar, Vanguard's global head of investment risk, based in London.
To make that possible, the firm has automated non value-added processes such as data cleansing and report generation, and has invested heavily in systems and new hires to support the transition.
The firm applied this proactive approach to its planning for the UK's referendum on membership of the European Union in June, carrying out five months of preparation ahead of time to prepare a playbook of foreign exchange, equity market, rates and spreads stress tests and liquidity scenarios in the case of a vote to leave.
The firm avoided the worst of the Brexit fallout. "Heightened volatility contributed to a slight uptick [in tracking error] in a handful of index portfolios, though they were still within tolerance," Nagar says. "The majority of clients left allocations untouched."
While Vanguard has seen some outflows from equity funds invested in the eurozone, it has seen cashflows of about $175 billion year-to-date compared with a net cashflow of about $250 billion last year.
In the past 12 months, Vanguard has also launched a range of European-, Canadian-, and Australian-domiciled single-factor ETFs, the firm's first internally managed active equity funds, which Andrew Hedley, manager of operational risk in the firm's investment management group describes as "index at the core then supplemented with active management".
"We want to have a low-cost active investment offering and influence the active investment landscape in Europe," Hedley adds.
To support these new active products, Vanguard has built a risk framework from scratch adopting a new set of reports and risk models. These include third-party fundamental and statistical risk models, along with several proprietary models developed by the risk management and quant research teams, that capture and monitor risk on a day-to-day basis, allowing the firm to oversee portfolio construction and get comfortable with a product's diversification and risk factors.
Also this year, Vanguard has developed a tool to allow its operational risk team to verify in real time forex hedging trades processed through the firm's order management system with the goal of cross-checking that hedge rolls and trades around large flows have been applied correctly. Since February, Nagar says the firm has cut errors in this area by more than half.
"This is an operational control that we decided to implement due to the magnitude of trades and potential for significant impact ... particularly in the current environment where forex volatility is heightened," he adds.
The week on Risk.net, December 2–8, 2017Receive this by email