Challenges prompt Vanguard to narrow China focus

Vanguard Group's decision last week to suspend its pursuit of a billion Chinese mutual fund investors reflects a business model whose time has yet to come on the mainland.

Vanguard's decision to focus instead on the joint venture it launched last April with Hangzhou-based Ant Group, offering portfolio advisory services, appeared to be the firm's only immediate way forward after Vanguard last fall stopped offering institutional separately managed accounts in the Asia-Pacific region and then concluded last week it was too soon as well to build a retail fund business there.

Structurally speaking, Vanguard's "ambition for China" — including direct-to-client sales — "is not at all where the market is at the moment," said Nicholas Omondi, director of data analytics with Shanghai-based financial sector consulting firm Z-Ben Advisors.

A Z-Ben news alert last week amplified that point: "At the heart of the matter is a fundamental disjoint between (China's) onshore market and the Vanguard business model" — an idiosyncratic situation rather than one with broader implications for foreign money managers there.

Market veterans had foreseen the chal-lenges Vanguard would face on the mainland — from the dominance there of intermediated distribution that would prove inhospitable for the firm's offerings of index strategies and exchange-traded funds to the strong ingrained preference Chinese individual investors have for actively managed products.

Even so, as recently as five or six months ago, Vanguard executives appeared confident they could overcome those obstacles.

Scott Conking, head of Vanguard Asia, said in an Oct. 16 interview that the continued opening of China's market had made the mainland's individual investor segment Vanguard's biggest opportunity to have a "positive impact on the way the world invests."

It could take considerable time to gain traction but with Vanguard ultimately owned by investors in its mutual funds, the firm was well placed to take the long-term approach needed to crack the market, Mr. Conking said.

Vanguard would take the first giant step in pursuit of that opportunity — applying for a license to set up a fund management company on the mainland — in early 2021, he said.

Five months later, those plans have evaporated, with Vanguard moving instead to focus its efforts on the 49%-51% joint venture it launched last April with digital technology powerhouse Ant, overseeing portfolios tailored to the needs of individual Chinese investors. Vanguard and Ant Group's portfolio advisory services joint venture last week said it has attracted more than 1 million users in less than a year, with the firm's client base more than doubling over the past 11 weeks alone.

"We have taken the decision to focus our resources in China on growing the JV advisory service and pause our application for a (fund management company) license," Vanguard said in an emailed statement.

The firm's resources could be stretched thinner now than they were at the end of August, when Vanguard was managing roughly $190 billion for clients based in the region.

Around that time, Vanguard decided to walk away from tens of billions of dollars of institutional separately managed accounts the firm had garnered over the previous eight years, to bring Vanguard's Asia-Pacific business in line with its global focus on individual investors and their advisers, Mr. Conking said.

A spokeswoman for Vanguard said last year's "decision around institutional assets," which helped trim the firm's Asia-Pacific AUM to $163 billion as of Jan. 31, had nothing to do with its decisions to stop pursuing a fund management company license and focus instead on its joint venture.

Market veterans said while the portfolio advisory services joint venture represents an intriguing business proposition, its potential pales in contrast to what a fund management company on the mainland could offer.

Portfolio advisory remains "an untested market ... without hard investment data from which we can extrapolate," noted Z-Ben's Mr. Omondi. But in absolute terms, a fund management business is clearly the larger opportunity and one that Vanguard may yet come around and pursue at a later date, he said.

If the portfolio advisory business is a consolation prize, the March 18 business update by the joint venture suggested it's one that nevertheless "could move the needle" for Vanguard, said a Hong Kong-based money management executive who declined to be named.

The Vanguard spokeswoman said the primary factor in Vanguard's business decisions on where and how to invest is their ability to have a positive impact on individual investors. For now, "we're adding tremendous value to investors through the JV advisory," providing them with long-term, diversified portfolios, she said.

"As for launching individual funds, investors' current preferences for trading actively managed funds and purchasing through intermediaries rather than direct is a challenge to our preferred business approach, coupled with a large existing field of local funds," she said.

"Our decision recognizes that at this time, Vanguard can bring more value to more investors through the JV rather than by launching funds," the spokeswoman said.

Potentially, the joint venture could prove a better value proposition for Vanguard as well by not taxing the firm's resources as much, considering the significant costs of establishing and staffing a local fund management company.

With a fee of 50 basis points on those 1 million or more accounts of at least 800 yuan ($123) each, even with a claim on only about half its revenues, the joint venture will deliver margins far in excess of the 7 basis points Vanguard highlights for its $4 trillion book of index fund and ETF business in the U.S.

One market source, who declined to be named, said the joint venture's assets under advisement stand now at just less than 7 billion yuan, or about $1.1 billion. That total would generate annual fees of almost 35 million yuan.

"The issue for me is whether Vanguard has the patience to stay the course because increasingly it's shrinking footprint in Asia would mean China will not be a needle-mover for this behemoth," said the Hong Kong-based money management executive. And "if it is not a needle-mover, than why bother investing for the long run," he said.

Still, at 50 basis points for advisory services, the potential for the joint venture to grow into a significant contributor for the money manager's global business can't be ruled out, the executive added.

Whether Vanguard will dust off its plan to seek a fund management company license over the mid to long term "is to be determined," according to the Vanguard spokeswoman.

But she said the success of the joint venture could move the day forward when Vanguard would have better prospects to build a fund business in China. "Our hope is that through the JV advisory we're preparing the ground for the future" - nurturing an environment where fee-conscious individual investors invest for the long term, she said.

For now, Dengpan Luo, the money management veteran Vanguard hired last year to oversee its planned fund management company business, will continue to head the firm's wholly foreign-owned enterprise in Shanghai, providing support for the firm's JV with Ant Group; conducting policy research; and continuing to evaluate business opportunities and partnerships in China, the spokeswoman said.