Updated Friday, August 29, 2014 as of 1:30 AM ET

Vanguard Takes Aim at U.K. as Fees Replace Advisor Commissions

Vanguard Group Inc. rose to the top of the U.S. mutual fund industry by preaching the merits of cheap index-tracking funds. Now it wants to convert U.K. investors as that country enacts new rules that may lower fund costs that are among the highest in the developed world.

The firm is seeking to expand its less than 1% share of the 629 billion pound ($998 billion) market in the U.K. by more aggressively courting financial advisors, who control much of the country’s fund distribution, and striking deals to make its products more broadly available. Vanguard last month won access to the 13,000 U.K. advisors who use Cofunds, a platform with 45 billion pounds under administration.

Vanguard, which is owned by its fund investors and passes on cost savings to them, is seeking to take advantage of changes next year that will ban advisors from accepting commissions from asset managers and require them to charge clearly delineated fees. The Valley Forge, Pennsylvania-based firm, which controls 17% of the U.S. market for long-term funds, is lagging behind U.S.-based rivals such as BlackRock Inc., the world’s biggest money manager, in expanding abroad.

“There’s an opportunity for Vanguard, but there are other players who are better known and already are competing aggressively on price,” Jason Hollands, managing director of London-based Bestinvest Brokers Ltd., an advisory firm that oversees 4 billion pounds for clients, said in a telephone interview.

‘Different Topsoil’

Vanguard’s experience will test whether the 38-year-old firm can expand an international business that accounts for 6% of its $2.2 trillion in assets. The company, which overtook longtime leader Fidelity Investments two years ago at home as fund buyers flocked to passively managed products, is short on history and name recognition in Britain, where it started selling index funds in 2009.

“It is not easy for a brand to put down roots in different topsoil,” Nancy Koehn, a professor at the Harvard Business School, said in a telephone interview from Boston. “How do you build trust when you are starting anew?”

The Financial Services Authority, the U.K.’s fund regulator, is responsible for the new rules known as the Retail Distribution Review, or RDR. The rules, completed in March 2010 and set to take effect Jan. 1, are designed to give consumers access to unbiased advice and to promote competition in the fund industry. Advisors in the U.K. will be paid by customers in exchange for the guidance they offer, while brokers can accept commissions from fund managers so long as they don’t provide investment advice.

Higher Expenses

The cost of investing in British funds is higher than anywhere in the developed world aside from Scandinavia and Canada, according to academic research published by the Review of Financial Studies in 2009. The average British mutual fund charged 2.21% of its clients’ assets in annual expenses, compared with 1.04% in the U.S.

Consumer advocates including Gareth Shaw blame the higher prices on an opaque fee structure that makes it hard for investors to make fair comparisons and a commission system that rewards advisors for selling products rather serving clients.

By separating all the elements that go into fees and banning commissions, the new rules “will put the power back into the hands of customers,” said Shaw, a financial specialist at Which?, a London-based consumer organization.

Greater transparency will trigger more price competition and heightened interest in funds that seek to duplicate the returns of benchmarks such as the FTSE All-Share Index, he said. The average annual fee on U.K. active equity mutual funds -- whose managers try to outperform indexes by selecting which stocks to buy and sell -- is 1.68% of assets, versus 61 basis points for equity index funds, according to data from Chicago-based Morningstar Inc. A basis point equals one hundredth of a%age point.

‘Pretty Confident’

“We are pretty confident our business model will play here,” Thomas Rampulla, head of Vanguard’s European operations, said in a telephone interview from London.

Vanguard became the largest U.S. mutual-fund company on the strength of its index funds and exchange-traded funds. Since the mid-1970s, Vanguard founder Jack Bogle, 83, has been telling investors that most active managers can’t beat the market consistently and that low-cost funds that mimic benchmarks instead of trying to beat them will outperform in the long run.

Vanguard funds in the U.S., including those that are actively run, charge an average fee of 16 basis points, compared with 79 basis points for the industry, data from Denver-based Lipper show.

U.S. Experience

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