Vanguard's effective expenses are lower than Vanguard's published rates

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tower
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Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

Here are two papers that find that Vanguard’s expenses are not as severe as they appear from Vanguard’s stated expense ratios. These are revised versions of papers I posted previously.

Vanguard's Active Funds Beat their Benchmarks by Edward Tower :: SSRN

https://papers.ssrn.com/sol3/papers.cfm ... id=4333103

Vanguard’s ETFs Returned a Substantial Proportion of Their Expenses to Investors by Edward Tower :: SSRN
https://papers.ssrn.com/sol3/papers.cfm ... id=4333163
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David Jay
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by David Jay »

One of the compounding factors for Vanguard is their corporate structure.

The management of the funds is “at cost”. The SEC quite specifically calls out expenses that must be included in the expense ratio, so I don’t believe that Vanguard is able to significantly lower their published ERs, even if they are achieving a better net result. For example, I don’t think Vanguard’s structure would allow them to show a “zero” ER, regardless of performance.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by petulant »

tower wrote: Tue Feb 07, 2023 9:14 am Here are two papers that find that Vanguard’s expenses are not as severe as they appear from Vanguard’s stated expense ratios. These are revised versions of papers I posted previously.

Vanguard's Active Funds Beat their Benchmarks by Edward Tower :: SSRN

https://papers.ssrn.com/sol3/papers.cfm ... id=4333103

Vanguard’s ETFs Returned a Substantial Proportion of Their Expenses to Investors by Edward Tower :: SSRN
https://papers.ssrn.com/sol3/papers.cfm ... id=4333163
This is not a hostile question at all. Are you, user tower, the same as the author of the two papers, Edward Tower?
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tower
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

Hi. Yes, I am the author. I think it will be fun to compare these results with Fidelity. That is next on the agenda. Ed
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by an_asker »

"Here are two papers that find that Vanguard’s expenses are not as severe as they appear from Vanguard’s stated expense ratios. "

I confess I didn't read the linked articles but I did read the blurbs associated with both of them. What I am questioning - and maybe I misunderstood it - is whether the research compares the expenses for the same time frame for which the expense ratios were published. In other words, are the costs for Vanguard's fiscal year of say 2020 compared with Vanguard's stated expense ratio during the same fiscal year?

I question this because my understanding is that expense ratios are actually a trailing statistic. In other words, you would need to compare the expenses for (their) fiscal year 2020 with Vanguard's stated expense ratio during the following fiscal year, i.e., 2021.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by petulant »

These are very interesting papers. I liked the one on the index funds especially. Is it fair to interpret the results in the following way? "The more international and small cap exposure (particularly the latter), the more Vanguard's securities lending and other activities offset, or even exceed, the expense ratio."
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tower
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

CRSP provides the time series on expense ratios, so i used the average expense ratios from those series. I have not tried to figure out what determines the gap between published and effective expenses. I am glad you did that. I wonder why that difference occurs. Ed
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by nisiprius »

Securities lending?

Bill Bernstein noted years ago that Vanguard's index funds lag the index by less than their expense ratios, but attributed it to "transactional skill." Active management at a microscopic level, I guess.
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tower
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

"active management at a microscopic level." I like the term. Bill Bernstein has just about finished the second edition of his "Four Pillars of Investment." It will be well worth reading when it comes out, as anyone who knows Bill would expect. I got to spend a few days with the current draft. Ed
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by asset_chaos »

I invested in total world fund since its inception, and it used to be a little sport to compare the actual and headlines expense ratios. As total world started with low assets, the change in expense ratio was large and noticable as assets increased. The actual expense ratio was observable as a footnote in the fund annual report, which came out October. In those days the actual expense ratio reported in the footnote was always 5 or 6 basis points below the headline rate, given in say the then current proseptus. This always foreshadowed a lowering of the headline rate in the new prospectus the following February.

I posted a graph of the actual expense ratio of total world investor shares vs assets in an old thread, which I repost here as possibly of interest to this thread.

Image

Although, the cause of the difference between actual and headline expense ratios in the graph may be different from the main points in tower's papers.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by petulant »

asset_chaos wrote: Thu Feb 09, 2023 5:21 pm I invested in total world fund since its inception, and it used to be a little sport to compare the actual and headlines expense ratios. As total world started with low assets, the change in expense ratio was large and noticable as assets increased. The actual expense ratio was observable as a footnote in the fund annual report, which came out October. In those days the actual expense ratio reported in the footnote was always 5 or 6 basis points below the headline rate, given in say the then current proseptus. This always foreshadowed a lowering of the headline rate in the new prospectus the following February.

I posted a graph of the actual expense ratio of total world investor shares vs assets in an old thread, which I repost here as possibly of interest to this thread.

Image

Although, the cause of the difference between actual and headline expense ratios in the graph may be different from the main points in tower's papers.
If I'm reading the index fund paper right, tower is saying that Vanguard has completely offset the headline expense ratio on the total world fund with securities lending and other activities for years. That's wild.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by retiringwhen »

Based upon the several excellent podcasts with Vanguard Index Managers over the years, the main thing I learned is that they have a lot of leeway at the very bottom of the MarketCap range to opportunistically buy into the smaller names. This allows them to be "micro" efficient as described earlier.

The other thing is there are many small cap stocks and a wide range of ex-US stocks that are very lightly offered for securities lending. Vanguard can lends those out at much more attractive terms than the US Large Cap that are very competitively lent.

This is a major reason a total market index fund like VT or VTI can be so successful at outperforming the index. They have ready tools and a fairly unique position for security lending.

VSS has far outpaced its index net of ER most of the last decade for similar reasons, some years by as much a 0.05%. It is almost the perfect tool to make money on the lending.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by Northern Flicker »

Most fund companies cover their expenses for index stock funds with securities lending. This is not anything new nor is it unique to Vanguard. Some fund companies keep a percentage of SL revenue, doing more lending (taking more lending risk) to cover expenses.

There are a number of other points:

Vanguard does not lend fixed income assets.

ERs are projections. If Vanguard expenses turn out to be lower than projected, Vanguard in the past has lower the projected ER and has essentially retroactively lowered ER by not taking the savings as profit.

Fund companies often use soft dollar arrangements with brokers to pay for goods and services beyond transaction costs through excess transaction charges commensurate with the value of the additional goods and services received. This hides some admin costs outside of ER so that a larger fraction of ER corresponds to profit.

Fund companies may allow for funds to make loans to other funds in their product suite. This lets one fund offer an attractive yield to another fund as its place to park cash it holds. This provides a mechanism through which some of the de facto ER of fund A can be hidden in fund B.

Securities lending can be done to cover above costs to avoid having them show up in tracking error.
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tower
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

Petulant, Nice graph. Yes, the complete offset was a surprise to me. Ed
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by petulant »

tower wrote: Thu Feb 09, 2023 9:00 pm Petulant, Nice graph. Yes, the complete offset was a surprise to me. Ed
tower, that was asset chaos's graph that I was quoting.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by afan »

Somehow I got the idea that the securities lending revenue of VTI returned to the fund exceeded the total expenses. Was that my imagination? I tried to pull that figure out from what appeared to be the share of lending revenue I could attribute to the etf, based on its fraction of the total fund and the costs, by applying the expense ratio to the VTI component of the fund.

There was an interview with the CEO of Vanguard at the time in which the expense ratio came up. He said that Vanguard attempts to keep expenses low but there would always be a cost to run the index funds. He noted that as the costs became lower, it would be possible for the lending revenue to be greater than the total expenses. Thus, the net cost would be less than zero-Vanguard would be paying investors to let the company invest the money. Even under those circumstances, he said, they would report the expense ratio as the actual cost, before the effects of lending.

I note that for some funds the share of expenses returned to the fund has gone down over time as the expense ratio has not changed. I found this puzzling. Again using VTI, I thought that its expense ratio was higher than 0.03% 10 years ago. I am pretty sure it was 0.04 in 2018, and there were reductions before and after that drop.
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by asset_chaos »

The last time I bothered to post on security lending for Vanguard's small cap funds was 2020. At that time securities lending income as a percentage of total expenses listed in the annual report (ie not including trading costs) was

Small Cap 109%
Small Cap Growth 67%
Small Cap Value 77%

The ratios had been lower in previous years. But it is certainly possible for securities lending to cover most, and even sometimes all, expenses for a low cost Vanguard fund.

When I first noticed the lending income, I was just astonished at how large it was. In 2020 just these three funds received $78 million between them in securities lending fees. As others in that thread educated me, the shorting world is just a lot bigger than we buy-and-hold investors generally understand.
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tower
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Re: Vanguard's effective expenses are lower than Vanguard's published rates

Post by tower »

The VTI expense ratios are
2001-2003 0.15%
2004 0.13%
2005-2009 0.07%
2010 0.06%
2011-2015 0.05%
2016-2017 0.04%
2018-2020 0.03%
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