Vanguard snags internal indexing crown

Worldwide index assets under management rose 16.2% during the year ended June 30 as Vanguard Group edged out long-dominant BlackRock to claim the title of world's largest manager of internally managed index assets.

That 16.2% increase to $21.13 trillion marked a resumption of a growth trend in index assets that was interrupted when assets fell nearly 13% in the year ended June 30, 2022, Pensions & Investments' annual survey of index managers showed. Index assets totaled $18.19 trillion as of June 30, 2022, down from $20.88 trillion a year earlier.

Prior to last year, index assets hadn't declined vs. the preceding year since slightly dipping to $9.86 trillion as of June 30, 2016, from $9.87 trillion a year earlier.

Vanguard reported $6.44 trillion in total worldwide index assets managed internally as of June 30, up 22.6% from $5.26 trillion a year earlier. BlackRock reported nearly $6.2 trillion in index assets managed internally as of June 30, up 12.1% from $5.53 trillion a year earlier. Vanguard hadn't topped BlackRock for managing such assets since the year ended June 30, 2009, prior to BlackRock completing its acquisition of Barclays Global Investors in December of that year.

Indexed U.S. equity assets accounted for $4.14 trillion, or 64%, of Vanguard's total worldwide index assets managed internally as of June 30. BlackRock's indexed U.S. equity assets totaled $2.54 trillion, or just 41% of its worldwide index asset total. The S&P 500 index posted a 19.6% total return for the 12 months ended June 30, outpacing the 12.7% return of the MSCI ACWI ex-U.S. index.

"Vanguard's index-based asset business is more U.S. equity centric than (BlackRock's) and likely benefited from the relative strength in the local market," said Todd Rosenbluth, head of research at VettaFi, a data and analytics provider. "BlackRock has greater exposure to non-U.S. equities and fixed income, providing diversification."

BlackRock had just over a quarter of its indexed AUM in bond strategies compared to 19% for Vanguard.

While Vanguard is gratified that investors continue to trust it with their savings, "we're not focused on who manages the most client assets," Dan Reyes, global head of portfolio review department at Vanguard, said in a statement.

Lindsey Shapiro, a managing director and chief operating officer of ETF and index investments at BlackRock, said in a statement: "In this challenging market environment, BlackRock has led the industry in asset gathering over the past year across ETFs and index mutual funds,"

John Delaney, senior director of investments and a portfolio manager at Willis Towers Watson, was not surprised that Vanguard surpassed BlackRock.

While both organizations obviously have significant capability when it comes to managing passive assets, Vanguard as a general rule has a bit more of a "familiar presence with more retail-oriented investors" than BlackRock does, Delaney said. That may give Vanguard "a slight edge as we move into a world where retail investors become a larger and larger portion of the pie in the investment world," he said.

"Corporate pension plans are, generally speaking, getting smaller, and (they) have been a sizable institutional asset owner for a long time," Delaney said. "So inevitably as you get sort of one huge part of the pie getting smaller, another part of the pie gets larger, and retail investors have become an increasingly larger part of the overall, let's call it, asset owner universe."

WTW provides advice as well as outsourced chief investment officer solutions to asset owners across the globe, Delaney said, adding that its clients include corporate defined benefit and defined contribution plans as well as endowments and foundations.

In a continuation of a trend seen last year, asset owners concerned about concentration risk in equity indexes are taking a harder look at their passive equity exposures and showing increased interest in active equity strategies, he said.

"I think my comments from last year are still fairly accurate in terms of the level of concentration risk in equity indices across the globe," Delaney said.

In particular, the so-called Magnificent Seven — Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta Platforms — currently "are responsible for a large portion of the market cap of the various … large developed public equity indices," he said.

WTW has engaged in "exploratory conversations" with clients interested in active strategies as a way to supplement existing passive equity exposures or to ensure that their portfolios have appropriately sized risk exposure to that level of concentration in equity indexes, Delaney said.

"So, we have seen those discussions and interest in active strategies continue as a trend from last year," he said.

When WTW looks at data for its client base, full-year 2022 data showed an increase in the level of manager search activity related to active management compared with 2021 and 2020, Delaney said. While the firm obviously doesn't have full-year 2023 data yet, "anecdotally, the trend has continued towards active," he said.

Increased volatility tends to lead investors to look toward actively managed strategies, Delaney said.

"When the S&P 500 is going up 20% every year, (there is) not a whole lot of need for active management to be frank," he said. "So, when we have more volatility, I think it gets asset owners thinking more about their actively managed exposure and where they think there is potential value-add in the space, which leads to potentially some flows from passive to active."

Looking ahead, Delaney expects to see "a lot of advancements in the types of products that are being offered to investors in the index space and particularly in the ETF space."

"I think that's an area that is ripe for investment and innovation," he said.

For example, Delaney sees room for growth in passive products that use custom-created indexes to give clients a cost-effective way to manage things like concentration risk.

Worldwide custom index assets totaled $989.6 billion as of June 30, up 21% from June 30, 2022, and up 55% from two years earlier, P&I's survey showed.

Calendar year 2022 was "a little bit of an anomalous year," given the strong sell-off seen in both the equity and fixed-income markets simultaneously, said Tyler Cloherty, a managing director at Casey Quirk, which is part of Deloitte.

"So that impacted both the levels of the market as well as flows across the industry, and this is agnostic of both index and active," Cloherty said, adding that market uncertainty during that period led many investors to move into cash.

"I don't think we're completely out of the window of full uncertainty here, but I think there's been more stability in the markets," he said. "You've seen a recovery in some of the equity index values, so I think you've seen more money continue to move back in."

Still, like WTW's Delaney, Cloherty mentioned the waning role of corporate pension plans. Those investors traditionally have been large holders of index strategies, where historically the overall share of assets has been tilted more heavily toward equities, he said. Many corporate plans have closed to new entrants and are focused on payouts to retirees, he said.

"So, at that stage of life in the pension plan, they move much more towards fixed income because they can plan out those cash flows and the risk becomes much, much less," Cloherty said, adding that the shift tilts such investors away from equities, a traditional "sweet spot" for index managers.

Index managers are big parts of the equity portfolios of corporate pension plans and the shift toward fixed income has proven "a little bit of a headwind," specifically within the corporate pension plan space, he said.

Cloherty added, however, that while index strategies have long been a popular tool to gain equity exposure, over time they have become "more and more heavily used to also participate in fixed income."

The jump in interest rates "opens up more of a market for the index managers on the fixed side," he said, adding that back when interest rates were much lower investors were turning to active managers to obtain the best possible yield in a low-rate environment.

Now that interest rates have increased, Cloherty said there could be "potentially a little bit more separation" where investors use index strategies to get exposure inexpensively and then if they want to seek a higher rate of return beyond that they can pay a little bit more for actively managed credit exposure.

Overall, when it comes to index strategies, "I'd say the outlook is still positive," Cloherty said. He cited relatively healthy growth in index funds geared toward use in defined contribution plans such as index-based target-date retirement funds. He also cited particularly strong demand for index products in direct-to-consumer channels as investors there look to pick up exposure relatively cheaply.

"And then I think you're seeing kind of greater and greater penetration across the intermediary and adviser space," Cloherty said.

Vanguard ranked No. 1 on the list of top managers of index assets for U.S.-based defined contribution plans, with assets totaling $1.74 trillion as of June 30, up 45% from nearly $1.2 trillion a year earlier, the survey showed. BlackRock was in second place with $836.2 billion, up from $710.2 billion. The top 10 managers of index assets for U.S. DC plans saw AUM increase by 28.5% to $3.77 trillion.

Still, another potential headwind exists for index assets, Cloherty said. Many institutions are "technically overallocated to alternatives," and because private market deal activity has been so muted, the capital that private equity funds have returned to those institutions "has been much lower," Cloherty said.

"So, one of the challenges that they face is a liquidity challenge," he said. "It's easier to liquidate something that's incredibly liquid like an index fund."