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Over 20 years: A shift to discretionary advice with an outsourced chief investment officer

The appetite for advice among defined benefit (DB) pension plans, endowments, and foundations has grown and evolved in surprising ways since we introduced Vanguard Institutional Advisory Services® (VIAS™) 20 years ago.

Arguably the biggest change has been the shift among service providers—including Vanguard—to a full discretionary relationship, from more of a non discretionary relationship, said Chris Philips, who leads VIAS.

"For our original clients, we were providing an execution-based service," Mr. Philips said. "With the growth of discretionary advice in the marketplace, we have evolved to be a primarily discretionary advisor, perfectly willing and able to provide ongoing advice to the full range of institutional clients."

VIAS's outsourced chief investment officer (OCIO) service is now a key offer of Vanguard's Institutional Investor group. An extension of the board and investment staff, the OCIO determines an asset allocation strategy, selects investment managers to implement it, and oversees its operation and execution.

The growth of discretionary advice

The evolution owes largely to economic and regulatory pressures faced by nonprofit organizations and defined benefit pension plan sponsors. Such organizations have increasingly turned to service providers to assist with the day-to-day administration or completely take over the investment management responsibilities facing these institutions, Mr. Philips said.

Assets in VIAS alone have increased 21% year-over-year for the last five years.

Annual growth of VIAS client base

Source: Vanguard.

Mr. Philips attributes Vanguard's success to its unique approach.

"What sets us apart is how we align to Vanguard's core purpose, how we help enable clients to achieve their best outcomes by focusing on what matters: cost and discipline," Mr. Philips said. "They are some of the biggest levers anyone can pull, but so few actually do."

Vanguard's principles for investing success

Representing two of Vanguard's four principles for investing success, clients should seek to minimize cost and maintain a long-term discipline. We also believe they should create clear and appropriate investment goals and develop a suitable asset allocation—things often easier said than done.

Although we offer many specific strategies through both internally and externally managed funds, these four principles run through the investment guidance we provide to clients, the overarching theme of which is to focus on those things within your control.

Many institutions focus on the markets, the economy, manager ratings, or the performance of an individual asset or strategy, overlooking the fundamental principles that we believe can give them the best chance of success.

VIAS strives to counteract this tendency by serving as a "behavioral coach," keeping clients focused on what they can control, Mr. Philips said. Whether the markets have been performing well or poorly, we help investment committees cut through the noise.

"We (investment committees and asset managers) want to believe we have the ability to demonstrate consistency over time through cyclical markets, through a dynamic economy, through all the noise that we see in the market place, but the reality is that we cannot," Mr. Philips said. "At Vanguard, our discipline focuses on remaining true to what matters and taking a big step back from all the goings-on in the daily environment that everyone else reacts to."

Seeking solutions specific to the situation

It's a flexible discipline. We're able to incorporate both index and active management and, when appropriate for the objective, certain alternative investments.

"We're in the business of creating solutions that we believe can give each client the best chance for success," Mr. Philips said. "In some cases that means an all-passive portfolio, but in most cases it means some blend of active and passive for our clients."

Vanguard offers two liquid alternative funds (Vanguard Alternative Strategies Fund and Vanguard Market Neutral Fund) we can use for a client who either requires or desires a return that is uncorrelated to traditional capital markets. And if a client comes to us with an alternative position they would like to maintain, we can build a portfolio around it.

"That said, we believe many of the new products that incorporate alternatives such as private equity, private debt, and private real estate, introduce unacceptable levels of risk. In fact, one of the reasons VIAS has been so successful is that we have avoided such products," Mr. Philips said.

Looking into the future

What do the next ten years hold for VIAS?

"We're looking to get the word out," Mr. Philips said. "It's getting boots on the ground to get out and talk to the committees and the consultants, to help them think about some of these issues.

"Nonprofits continue to grow and evolve, continually faced with new challenges in pursuing their mission and with challenges to maintain historic spending rates in today's turbulent return environment. The DB market is very broad, containing pockets of both growth and contraction.

"For example, there's small- to mid-sized public DB plans—fire, police, municipal townships—that need responsible guidance," Mr. Philips said. And there's a growing cash balance market—hybrid DB/DC plans designed to fulfill the retirement needs of employees without adding additional pension funding risk to the employer.

Vanguard can help organizations by applying lessons learned since launching VIAS 20 years ago. We can leverage our deep experiences to provide you with guidance and ongoing support. Please don't hesitate to reach out and consult with your Vanguard team.

Notes:

• For more information about Vanguard funds, visit institutional.vanguard.com to obtain a prospectus or, if available, a summary prospectus. Investment objectives, risks, charges, and other important information about a fund are contained in the prospectus; read and consider it carefully before investing.

• Advice services offered through Vanguard Institutional Advisory Services are provided by Vanguard Advisers, Inc., a registered investment advisor.

• All investments are subject to risk, including the possible loss of the money you invest. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

• Diversification does not ensure a profit or protect against a loss in a declining market.

• Costs are one factor impacting total returns. There may be other material differences that must be considered prior to investing.

• The investment strategies to be utilized by Vanguard Alternative Strategies Fund are complex and an investment in the fund may involve greater risk than investing in a traditional portfolio of stocks, bonds, and cash. There is no guarantee that the performance of Vanguard Alternative Strategies Fund will have low correlation with the returns of traditional capital markets. An investment in the fund could lose money over short, intermediate, or even long periods of time. Returns may vary substantially over time, and there is no guarantee that the fund will achieve its investment objective or that any of its investment strategies individually or collectively will succeed. The fund's strategies involve the use of leverage so its investment program may be considered speculative and is expected to involve considerable risks. The fund could lose money at any time and may underperform the markets in which it invests during any given period, regardless of whether such markets rise or fall.

• An investment in Vanguard Market Neutral Fund is subject to strategy risk, short-selling risk, manager risk, and investment risk. It is possible that the stocks the fund holds long will decline in value at the same time that the stocks it holds short increase in value, thereby increasing potential losses to the fund. The fund's loss on a short sale is potentially unlimited because there is no upper limit on the price a borrowed security could attain. As with any actively managed fund, investors face the possibility that decisions made by the fund's advisors may not succeed, potentially causing the fund to underperform other funds with a similar investment strategy.

• © 2017 The Vanguard Group, Inc. All rights reserved. Vanguard Marketing Corporation, Distributor.

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