The Vanguard Group is the pioneer of exchange traded funds (ETFs), with the company introducing the world's first-ever retail index fund in 1976. Vanguard Investments Australia is a wholly owned Australian subsidiary of the Group, founded in 1998. It manages the Vanguard Australian Share ETF or V300AEQ ETF UNITS (ASX: VAS) ("the Fund").
This Fund is arguably one of the best index trackers for Australian shares, making it fit for any portfolio during times of volatility. Here is what you need to know:
What is an ETF?
An ETF is an investment fund which pools large sums of money together to invest in particular indices, commodities or bonds. The aim of an ETF is to provide access to the underlying asset class and track its performance by generating the same returns through careful investment selection.
Unlike the underlying asset class – such as physical gold or even the S&P/ASX 300 (INDEX: ^XKO) (ASX: XKO) – an ETF is listed on the stock exchange to allow ease of access to investment. It provides a simple mechanism for individuals to invest in a fund and instantly obtain diversification (without the need for relevant expertise).
An ETF is managed by a fund manager who actively selects the underlying investments required to generate/track the same returns as the asset class the fund is tracking. In return, the fund manager takes a small management and performance fee (if eligible) for providing its expertise. This means picking the correct fund manager is crucial.
Why Vanguard?
Vanguard is not the only ETF manager in Australia. Others include Black Rock which manages the iShares MSCI Australia 200 Index Fund (ASX: IOZ) and UBS which manages the UBS IQ Research Preferred Australian Share Fund (ASX: ETF). However, not all ETFs are created equally, and that is what sets Vanguard apart.
Vanguard prides itself on providing low-cost index trackers, so much so that the great Warren Buffett has endorsed them himself. In Berkshire Hathaway's 2014 annual shareholder's letter, the oracle from Omaha reveals his instructions for his trustee after he passes away: "Put 10 percent of the cash in short-term government bonds and the remaining 90 percent in a very low-cost S&P 500 Index. (I suggest Vanguard's)."
Buffett understands the power of compounding returns and believes stock selection is fraught with danger; he avidly believes a fund which tracks any index, and doesn't charge too many fees, should outperform any actively managed fund in the long-run. Accordingly, he supports Vanguard's investment mandate of providing low-cost index tracking.
How is the Fund managed?
As at 30 September 2015, Vanguard's Fund had 49.7% of its investments in 10 of Australia's biggest companies, comprising the big 4 banks, BHP Billiton Ltd, CSL Limited, Woolworths Limited and Telstra Limited (amongst others). The rest of its investments included smaller companies which are part of the S&P/ASX300 Index. Accordingly, buying into the Fund provides instant diversification as it seeks to track the general market.
For this privilege, Vanguard charges a management fee of 0.15% on funds under management which compares favourably to the ETFs managed by Black Rock and UBS (which charge 0.19% and 0.7% respectively). The Fund pays quarterly distributions equating to approximately 4.63% per annum and provides yearly capital growth of around 3.9% to provide a total return of 8.5% per annum (based on averages since inception in 2009). This compares well to its benchmark — the S&P/ASX 300 Index — which produced an average 8.7% return over the same period.
Comparatively, the iShares MSCI Fund and the UBS IQ Fund have underperformed their benchmarks by 0.24% and 0.67% respectively (since inception), demonstrating the long-term benefits of choosing a low-cost fund manager like Vanguard.
Beware the benchmark
It's also important to consider what the actual benchmark is. The UBS IQ Fund's benchmark is actually a selection of around 40 stocks researched by UBS, instead of a market index such as the S&P/ASX 200 Index. The ASX 200 index has gained more than 13% since the UBS IQ fund was established in October 2012, while the fund has significantly underperformed, returning -1%, according to Google Finance. That suggests the UBS IQ Fund is not a particularly great ETF and investors should avoid it.
Foolish Takeaway
Warren Buffett is a strong believer in index trackers as it allows investors to de-risk their portfolio. The Vanguard fund eliminates the need for stock picking and relies on the fact that over the long-term, shares return around 10% per annum. This gives it my (and Buffett's) tick of approval as one investment which should be a consideration for the passive investor.
