1,000,000,000*.0005 = $500,000
For that level of expense, you could instead have a one-man office or other service provider that can buy the individual stocks comprising (or closely approximating) the index, and not have to pay any expenses other than his salary and trading costs. Meanwhile he can provide tax planning/philanthropic services as well.
It would be hard to find someone at this salary level who can match the tracking performance of Vanguard. If they achieve a tracking error that's 1% higher than that of Vanguard's, that would mean an annual loss of approximately $800k compared to Vanguard (1,000,000,000 * 8% * 1%).
[0] https://institutional.vanguard.com/VGApp/iip/site/institutio...
In the given scenario, you aren't just hiring a guy to buy stocks for the Vanguard expense ratio. You're also buying all their financial and information security processes. You're buying risk mitigations like regular audits and SOX compliance and SP800-53 controls. To safeguard a billion dollars, that overhead is totally worth it.
Most tracking indexes, especially the ones Vanguard uses, do not do that and thus do not allow the markets to front-run them. If you adopt the strategy of "do what Vanguard does" and you do it immediately after Vanguard says they did something, you are already too late to get the prices that Vanguard got and can kiss at least .05% goodbye just based on that. I would expect to under-perform by at least .25%, if not more.
Even at 5 bps on a billion, I think you'd be extremely hard pressed to do everything Vanguard does for you for $500K/yr.
I'm at least a factor of 500 away from having to consider this question, but if you told me it would cost me $500K to have one fewer critically important person on my staff to deal with, that would be a good tradeoff in itself.
"Because Vanguard charges too much" isn't one of them, IMO.
If so, not worth dealing with for a billionaire, but definitely an opportunity for a middle-class robo-advisor.
The likelihood of a single person delivering index tracking performance better than these giants is pretty slim. Better to drop the tranche designated for broad market passive indexing into one of these giants' funds as an institutional holder, then have the one-man office project-manage leading education of younger generations, help the family leader clarify the ongoing family mission the office supports, the accountants' filing tax compliance at the individual and trust/foundation levels (likely in many different jurisdictions), grooming a successor, updating processes and procedures to improve auditability/accountability/anti-fraud detection, assisting with legal compliance, helping out with financing approved moonshots, etc.
[1] https://riabiz.com/a/2018/12/13/vanguards-asset-machine-wobb...
But then you have to trust that guy not to fuck it up, while Vanguard has a stellar reputation and a whole office of people making sure things go as expected.
Honestly a much stronger argument is tax efficiency. If you're buying the individual stocks, then even when the index is flat you'll have some capital gains and losses. You can use both these to improve your tax efficiency - the losses can be harvested to offset realized gains elsewhere, while any appreciated shares can be donated to charity and repurchased with new money, effectively increasing your tax basis.
Still, you're likely better off just hiring people to do the tax planning, estate planning, and philanthropic services. It's essentially setting up a single family office with no control over your investments.
And once you talk about foreign stocks, you have different amounts of withholdings to account for, dividends that are not dividends (return of capital).
Family offices are more like endowments and follow similar strategies that will have a portfolio that includes a mix of public equities, bonds, private equity, hedge funds, and real estate. Many of these investments are illiquid and have long holding periods, so aren't available to normal investors but can provide much better returns than index funds.
In addition, when you have >$100m in wealth, consistent, predictable returns become very important and index funds don't give you that. It took 8 years for the S&P 500 to recover from the dotcom crash and 6 years for the 2008 crash.
They can also provide worse returns. You don't know which. You can guess that they'll provide average returns, because the average investment gets average returns. After all, not everyone can be above average.
Passive indexing guarantees average returns. Before costs, that is. So not only is the indexing approach cheaper, but it's also safer.
>In addition, when you have >$100m in wealth, consistent, predictable returns become very important and index funds don't give you that.
Quite the opposite, IMO. If you do something straightforward like dump 100% of that into the S&P 500 and spend the dividends, you're looking at something like $1.8 million this year. Less in a downturn, of course, but that's still pretty difficult to spend.
And if you have known large expenses, fixed income is really efficient at guaranteeing you the money needed to meet those expenses.
You do. That's the whole point. If you invest in a basket of top tier VC and PE funds, they will destroy indexes over the next 10 years. Yale is a great example of this; over the last 20 years their average returns are 12% which is 50% more than what an index did (7-8%):
https://www.institutionalinvestor.com/article/b17qpx3nyyqywd...
I'd happily do a total-return swap of the S&P 500 against any basket of VC and PE funds you'd care to name that are currently accepting new investments. Assuming, of course, that there's some reasonable way of collateralizing and settling things at the scale I'm willing to risk ($10k notional), which I honestly doubt.
If beating the market was that easy, then everyone would do it. So either the top tier funds become closed to new investment after becoming top tier, or they stop over-performing for idiosyncratic reasons, or something. I'm using outside view logic here, I really don't care at all for the stories they tell. It's honestly downright dangerous to pay too much attention to the marketing material of investment funds - after all, Bernie Madoff consistently showed 11% annual gains. At the end of the day, the average investment must achieve average returns.
It's not easy. You need $100m+ of capital and a long time horizon to implement it. Very, very few people have that. It's less than 0.0004% of the population.
I don't think active management makes sense for the majority of folks, but billionaires are exactly the kind of people that it does make sense for. With a billion or two you can probably get yourself into some pretty good closed-end funds (if you're savvy about it) that will probably deliver better risk adjusted returns than vanilla passive.
Personally, if I had the money, I would go with 2 Sigma or AQR. Both of their past returns streams are stellar and uncorrelated with the markets.
That's also a likely reason why family office holdings often look very odd as they often only provide a hedge in case the main source of income dries up. And therefore, they cannot have any connection with it. Pure performance on a standalone basis is often only second priority.
Why? A couple of billions should still be a tiny drop if compared to the market cap of S&P 500. What do those active portfolio managers provide to you?
I think the S&P500 is an entirely different beast to what it was 20 or even 10 years ago as a result of this.
If you were a family office your goal would be to get exposure to pre-IPO growth stage stuff as well as the public market.
With a couple billion you can get yourself some nice deals in a bunch of different asset classes. Also with that kind of money you can put a chunk of your money in illiquid investments that potentially could provide some great returns.
Also, when you get into aging family members and generational wealth issues, you want to have controls to reduce your immediate control. Decades of accumulated returns can be wiped out by a bad decision.
If I had billions to worry about, I’d want to make sure I had assets that were more diversified than what Vanguard offers.
You can also get into special sits and arbritrage ala Elliot and partners
https://www.fool.com/investing/2018/12/01/vanguards-founder-...
Governance concerns are not structural and addressable when it reaches a critical mass. I wouldn't be overly concerned, just put in a word when someone starts to lobby for regulation requiring delegating voting power back to index investors, and fund managers having to vote the preponderance of pro-rata voted shares.