Mutual Funds

Indexing Helps Vanguard Top Fidelity in Fund Assets


John Bogle has preached the virtues of low-cost indexing since the 1970s, arguing that it doesn't make sense for investors to pay higher fees for big-name money managers at firms such as Fidelity Investments. His advocacy of investors' interests earned him the nickname "Saint Jack," and his persistence paid off this year when Vanguard Group unseated Fidelity as the largest U.S. mutual fund company by assets, a distinction the Boston firm had held for more than two decades.

Bogle, 81, founded the Valley Forge (Pa.)-based firm in 1975 with the idea that most professionals can't beat the market, so it's not worth paying them to try. Edward "Ned" Johnson, 80, took over Fidelity two years later and built the family business by betting on star stockpickers such as Peter Lynch. Index funds mimic the benchmarks they are designed to track, while active managers pick securities based on research. In the 10 years ended Aug. 31, domestic equity index funds posted an annual loss of 2 percent, Morningstar data show, while actively run stock funds returned 0.9 percent a year. Many active managers, of course, returned less than the average.

Fidelity Magellan (FMAGX), run by prominent managers including Johnson, Lynch, and Jeffrey Vinik, was once the world's largest mutual fund, peaking at $110 billion in August 2000. It is now one-fourth the size of the $87 billion Vanguard 500 Index Fund (VFINX). Vanguard has benefited as the stock market floundered, says Michael Miller, a managing director at the firm. "People pay more attention to costs when returns are less," he says. Fidelity spokesman Vincent Loporchio says his firm's "focus has never been on being the largest company, but on providing the best products and services for our customers."

"It is possible investing has changed for good," says Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, which manages $55 billion. "People don't want to rely on stockpickers who have not earned their keep." Stock index funds charge an average of 29 cents per $100 invested, compared with 95 cents for active funds, data from research firm Lipper show.

Vanguard snatched the No. 1 ranking from Fidelity in March and has maintained it. Vanguard had $1.31 trillion in fund assets as of July 31, compared with $1.24 trillion for its main rival, according to the most recent data from the Investment Company Institute, a trade group. Fidelity has topped the list at the end of each year since 1988, when the firm overtook Merrill Lynch (MER).

In the 10 years ended Dec. 31, Vanguard's stock and bond funds took in $440 billion, compared with $101 billion for Fidelity, Morningstar estimates. This year through August, Vanguard drew $49 billion while Fidelity had withdrawals of $2.8 billion. Almost 80 percent of the money flowing to Vanguard's stock and bond funds this year went to indexing, according to Morningstar (MORN).

The tally includes stock, bond, and money market funds. The figures do not count exchange-traded funds, a variation of index funds whose prices change as they trade through the day like stocks. Vanguard had $113 billion in ETF assets at the end of August, according to State Street. Fidelity has largely ignored that business. Vanguard also benefited from the popularity of its bond funds, which pulled in $134 billion from Jan. 1, 2008, through Aug. 31, 2010, a period in which Fidelity's attracted $33 billion.

Bogle has long criticized the financial industry for its supposed excesses, says Nancy Koehn, a professor at Harvard Business School. "The world has changed profoundly," she says, "and Vanguard is sitting right where the market has arrived."

The bottom line: The growing popularity of low-cost index funds, a Vanguard specialty, has helped the company overtake Fidelity, known for stockpicking.

Stein is a reporter for Bloomberg News in Boston.

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