Vanguard could face challenge down the road

The world’s largest investor of pension funds has launched a web-based service for small institutional clients that could serve as a test run for a move into the retail market.

If it strikes off in that direction, Barclays Global Investors, the institutional money manager of London-based Barclays PLC, could pose a rare challenge to the Vanguard Group’s stranglehold on funds that have deeply discounted management fees, according to pension fund and financial advisory consultants.

“The industry has arbitrarily delivered itself as retail and institutional,” says Stephen C. Winks, former head of investment management consulting for Prudential Securities and publisher of the Senior Consultant in Richmond, Va. “But the truth is, there’s no difference. It’s about turf and organizational structure. [Barclays’ move downmarket] is about the commoditization of the business.”

Making a foray

Barclays’ presence in the retail market began to heat up when it launched its domestic iShares program in May.

iShares is Barclays’ brand name for its index funds, which trade like stocks. The exchange-traded funds, or ETF, program already has attracted $8 billion in assets despite launching into the teeth of the past year’s dismal market.

The latest move came in January when Barclays launched ClientConnect, which allows investors to purchase 20 different Barclays institutional index funds with as little as a $5 million investment.

In contrast, the typical investment in those funds runs into the billions, and Barclays’ previous minimums for its index funds ran from $100 million to $500 million.

While ClientConnect is aimed at smaller institutional clients, such as endowments, Barclays’ move could eventually take it into the retail market for index funds.

But Barclays executives acknowledge that ClientConnect still must scale several hurdles before it can begin to compete.

First of all, Barclays’ offerings are not registered as mutual funds. That severely limits how aggressively the firm can market them; for example, the word “fund” can’t be used in advertisements.

Price advantage

Michael E. Fisher, the managing director with San Francisco-based Barclays Global, whose primary responsibility is to make ClientConnect click, says his company is considering all its options.

“That could include dealing with the question of converting commingled trust funds to ’40 Act [i.e. mutual fund] offering status,” he says.

One of the early promoters of ClientConnect, Brady P. O’Connell, a pension fund consultant with Ennis Knupp & Associates in Chicago, says that Barclays’ offering fills a void.

“There’s an advantage for BGI over Vanguard in client service and fees,” he says.

Mr. Winks agrees.”I think Vanguard’s pricing is too high,” he says.

Barclays has a pricing advantage with regard to its index fund that tracks the Standard & Poor’s 500 stock index. For a $5 million investment, an investor pays 0.05%. Vanguard Group charges a fee of 0.12% for the same-size investment in its S&P 500 index fund.

An investor pays 0.12% for a $5 million investment in Barclays Russell 2000 index fund. An investor pays 0.20% for a $5 million investment in Vanguard’s equivalent small-cap index fund.

Brian Mattes, spokesman for the Vanguard Group in Malvern, Pa., says few investments are made at the $5 million level and that once the $10 million threshold is crossed, his firm’s fees are more competitive with Barclays’.

Vanguard is unaccustomed to receiving criticism for its pricing. The firm and its founder, John Bogle, are renowned for advocating lower fees for the mutual fund industry, and the firm says it operates all its funds at cost.

Mr. Mattes of Vanguard says looking at management fees alone oversimplifies the matter.

“Our returns outpace Barclays’ by a wide margin over time,” he says.

The Vanguard 500 Index Fund had a five-year return of 18.45% for the period ended Dec. 31, 2000, while Barclays’ S&P 500 Index Fund returned 18.35%, according to the companies.

Mr. Fisher says that the Vanguard 500 fund is not strictly comparable to Barclays’ because it is not a pure index fund. Vanguard managers use”enhancement” strategies, he says. For instance, the Vanguard 500 fund currently holds 508 securities.

With $494 billion in index assets in the United States alone, Barclays has the heft and efficiencies of scale to challenge Vanguard on fees. Vanguard Group has about $237 billion in domestic index assets, according to sister publication Pensions & Investments’ latest survey.

Still, Mr. Winks says, Barclays – if it hopes to make a dent in the lower-end market – is far too tentative in coming to market with a $5 million minimum.

The segment of investors that buys in those denominations is “crowded” and slow growing. The least crowded and fastest-growing segment is wealthy and ultrawealthy individuals, he adds.

Mr. Fisher says his company is exercising caution. If the attempt at serving customers works with the $5 million minimum, Barclays could conceivably go to $1 million.

“You crawl before you walk before you run,” he says.

Mr. Winks disagrees.

“This is a time for bold moves, and equivocation doesn’t work,” he says. “If they were betting their jobs on this, they’d have a much different strategy.”

Mr. Fisher arrived at Barclays from Strong Capital Management of Milwaukee in 1999. In one of his first acts, he had analysts research his firm’s index fund business. The bottom 52% of his institutional customer base was producing just 8% of the company’s revenues.

Mr. Fisher says the results left him with two choices: either eliminate Barclays’ low-end business or embrace it more decisively.

ClientConnect resulted from his decision to take the latter route.