MALVERN, Pa. -- Vanguard's strategy for its first foray into the European market has observers puzzled, and predicting difficulties.
While pension fund consultants abroad welcome a U.S. firm with Vanguard's heft and reputation, some are puzzled by the mutual fund company's approach to the European retirement plan market.
Among the potential problems with Vanguard's approach, observers noted:
* The use of U.S. dollar-denominated mutual funds for European clients;
* The narrow range of funds initially offered;
* The choice of the "wrong" Europe and global index for U.K. plan sponsors;
* The tendency of British plan participants to choose the default option -- lifestyle funds -- which Vanguard will not initially offer;
* The embryonic stage of defined contribution plan development elsewhere in Europe; and
* Intense competition from existing passive players, making success dependent on pricing.
One market observer said he sensed a "disconnect" between common practices for retirement plan design in Europe and Vanguard's approach. The consultant preferred not to be identified.
"For a company that has been so astute in its handling of the U.S. retirement plan market, I find it amazing that they are taking this approach in Europe," he said.
"It seems like they are offering what they feel comfortable with, rather than what the market needs," the observer said.
The Vanguard Group of Investment Cos., Malvern, last week announced it will market three indexed equity mutual funds and an actively managed cash fund directly to institutional clients in the Netherlands, Belgium and the United Kingdom.
The mutual fund company is concentrating on defined contribution plans, but is staying out of the record keeping and administrative side of the business.
The marketing operations will be based in Belgium. Frank Satterthwaite will head the European operation and hire and train local staff in each market to build relationships with both pension fund clients and consultants.
The equity funds track the Morgan Stanley Capital International Europe index, the MSCI World index and the Standard & Poor's 500 stock index.
The funds are registered in Dublin and will be managed in the United States. They carry total expense ratios between 30 and 50 basis points, putting them on a par with existing index funds, consultants said.
SCRATCHING THEIR HEADS
All four funds are U.S. dollar denominated, which has left consultants scratching their heads.
"I can't understand the logic of marketing a U.S. dollar-denominated fund in the U.K. and Europe. Pension funds will likely want to take advantage of the currency exposure associated with investing in a U.S. S&P 500 fund. I do not see why a European plan sponsor would buy a European index in U.S. dollars." said Ken Ayers, a spokesman for the London office of consultants Frank Russell Co.
And Vanguard's decision to offer equity funds based on the MSCI indexes in Britain also perplexes many U.K. consultants: Most U.K. pension funds prefer to use the Financial Times/Standard & Poor's -- Actuaries World Indexes for Europe and World.
"There's no regulatory bar to a pension fund to using an index other than the FTSE, but why would they want to," said Chris Erwin, spokesman for London-based consultants Bacon & Woodrow.
Also, the impending introduction of European monetary union continues to confuse the situation.
"With the EMU coming, it's really not clear what equity indexes people will choose in the end," said Philip Robinson, a consultant at Watson Wyatt Worldwide in Reigate, England.
Michael S. Miller, managing director-planning and development at Vanguard, said, "We don't expect any of this to be easy. We are trying to bite off as much as we can at one time."
In the initial offerings, the European and global equity index funds will track the MSCI indexes because staffers in Pennsylvania felt more comfortable managing these indexes, he said.
Vanguard may be waiting for some time for a defined contribution plan culture to evolve, although all observers agreed it will grow to some extent in most developed Western countries.
"The U.K. and the Netherlands still look a lot like the U.S. defined contribution plan market did 25 years ago. . . . The plans are pretty simple -- in-house administration and record keeping, or through a third-party administrator," said consultant Ron Bush in the Windsor, Conn., office of Spectrem Group.
New defined contribution plans in the United Kingdom have been developing faster than defined benefit plans are growing, but still represent only between 6% and 7% of the roughly $1 trillion U.K. pension market, said Mr. Bush.
In the Netherlands, supplemental defined contribution plans are beginning to appear, but have had a very small impact on pension assets -- not much more than $2 billion of more than the $500 billion market total, according to Mr. Bush's estimates.
Belgium is even further behind in market development. Of the $35 billion to $40 billion pension market, defined contribution assets account for less than 3%. But observers agree such plans might develop quickly because the country will not be able to afford to provide its current rich state pension system for much longer.
Mr. Robinson pointed out one other symptom of an evolving defined contribution system in the United Kingdom that might trip up Vanguard's efforts to penetrate the market: More than 70% of defined contribution plan participants who have investment choice choose the default option -- lifestyle or balanced funds. Vanguard's initial lineup lacks this option.
Until its product line is broadened to include more country-specific core equity and bond index funds, Vanguard likely will find itself at a disadvantage, at least in the more developed U.K. retirement plan market. There, a defined contribution plan sponsor usually uses record-keeping services from a consulting actuary or third-party administrator and investment products from a single company, or at most from one active management and one passive specialist.
Mr. Erwin of Bacon & Woodrow said that in the United Kingdom the choices offered to plan participants tend to be more limited in number than in U.S. 401(k) plans and those options tend to be in core asset classes. It would be "very unusual" for a consultant to recommend that a plan sponsor offer options from two index fund managers.
Vanguard officials seem unconcerned. F. William McNabb, managing director of Vanguard's institutional investment group, said the company has had much interest from existing foreign clients who for tax purposes want to invest in offshore versions of the Pennsylvania-based funds they now use.
"There are sizable investments by foreign investors in the U.S. versions of these funds and they want to move them directly into these (new) funds. And there is a very large market now for dollar-denominated offshore mutual funds from multinational corporations, wealthy individuals, endowments and foundations," he said.
He did not specify how much money existing clients likely would move into the new funds.
In discussions with multinational corporations, European consulting firms and large pension funds, Vanguard got positive reactions, he said.
"We think the overall philosophy of high-quality service at rock-bottom prices makes sense globally. . . . Our basic strategy is not dissimilar to what we used in the U.S. There is going to be some segment of the institutional universe that wants to deal with us directly to get funds with impeccable track records at low prices," Mr. McNabb said.
Watson Wyatt's Mr. Robinson said Vanguard was "following a well-trodden path," in focusing on its existing clients and on multinational corporations. "The U.S. managers which come to Europe all call immediately on multinational corporations. They beat a path straight away to their doors."
Vanguard's timing regarding indexing in general is good, Mr. Robinson said, because passive management is growing by leaps and bounds in both the United Kingdom and the Netherlands.
"The amount of money indexers are winning lately is embarrassing," he said.
In the United Kingdom, 20% of pension assets are passively managed; in the Netherlands, 15%; and in Belgium, 9%, he estimated.
U.K. actuarial consultants welcome the competition in indexing.
"As investment consultants, we welcome any increase in competition because it's good for our clients. However, if they (Vanguard) can add anything new to indexing, it would surprise me. Because the performance is such a commodity, it all comes down to pricing. And they will not find it easy," Mr. Erwin said.
Joel Chernoff contributed to this story