ETF IQ: Vanguard's $106 million fine

Unpacking the SEC's decision.

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Welcome to ETF IQ, a weekly newsletter dedicated to the $14 trillion global ETF industry. I'm Bloomberg News reporter and anchor Katie Greifeld. Naughty List The Securities and Exchange Commission delivered some surprising news on Friday: Vanguard will pay $106 million to resolve violations related to capital-gains distributions in their target-date funds. Here's a quick synopsis of what happened, according to the SEC's order: Vanguard lowered the minimum initial investment amount to $5 million from $100 million on its Vanguard Institutional Target Retirement Funds in December 2020 An avalanche of retirement investors switched to the Institutional TRFs from the Investor TRFs, because the institutional funds had lower fees The Investor TRFs were forced to sell underlying assets with gains to fund those redemptions, leaving those in the Investor TRFs in taxable accounts with "historically larger" capital gains distributions As a result, the SEC says that those investors were robbed of the opportunity of compound growth, and that the $106 million will be distributed to those impacted. Vanguard signage outside the company's campus in Paoli, Pennsylvania, US. Photographer: Hannah Beier/Bloomberg What could Vanguard have done differently? Lowering the initial investment minimum doesn't seem malicious, though the SEC faulted Vanguard for not mentioning these risks in its prospectus. Maybe a solution would have been to lower the fees on the Investor TRFs to match those on the Institutional TRFs to discourage a mass migration? But I am just a humble newsletter writer. At first blush, $106 million may seem inconsequential to a firm that manages $10 trillion in assets, but consider the fact that Vanguard charges rock bottom fees. Let's assume Vanguard charges an average fee of 10 basis points across its $10 trillion of assets, generating about $10 billion in fee revenue per year. Napkin math suggests that a $106 million fine amounts to about 1% of revenue. "That's not nothing," said Bloomberg Intelligence senior ETF analyst Eric Balchunas, referring to the fine itself. As for reputational damage? "It would take a lot more than this to damage the goodwill and trust they've built up over decades, but it certainly isn't their best moment." A Vanguard spokesperson said the following: Vanguard is committed to supporting the more than 50 million everyday investors and retirement savers who entrust us with their savings. We're pleased to have reached this settlement and look forward to continuing to serve our investors with world-class investment options.

Model Behavior

As documented by this newsletter, industry leader BlackRock Inc. had a fantastic 2024. Following BlackRock's earnings report this week, we got a little more detail about why that was the case.  BlackRock's expansive ETF lineup garnered about $390 billion last year, pushing its global assets above $4 trillion. Roughly half of that haul is thanks to model portfolios, according to a firm spokesperson: Notably, approximately half of BlackRock's 2024 ETF growth came from model portfolios used by wealth clients, with a growing share of these flows coming from third-party model managers. This highlights the increasing reliance on iShares as the essential building block for wealth managers' home-office models and customized client solutions. Model portfolios — which package together funds into ready-made strategies to sell to advisers — are a big business. BlackRock estimates that the model industry currently clocks in at $4 trillion, and could boom to $9 trillion by 2027. Such growth would translate into continued mega flows into BlackRock's ETF lineup, given that the company buys its own ETFs in its models. The firm's model portfolio team oversaw about $131 billion in assets as of mid-November, and has funneled billions into the likes of Rick Rieder's now-$7.2 billion iShares Flexible Income ETF (BINC). The upcoming US administration change has fueled speculation that two of BlackRock's big pushes may soon be intertwined: alternative assets and model portfolios. On this week's earnings call, BofA analyst Craig Siegenthaler asked whether we might soon see alts added to the US retirement system. Here's what finance chief Martin Small had to say: We'd also think about things like managed accounts and models, where we've been working on including public-private models as we announced with the Partners Group model portfolios, which we think can make their way into retirement accounts as well. In Other News The chief executive office of FTSE Russell says increased volatility and massive trading activity helped spur the index giant's decision to move from an annual to semi-annual reconstitution schedule. Nasdaq and Canary Capital Group submitted new filings to the US Securities and Exchange Commission this week that are key to gaining the regulator's approval for a spot Litecoin ETF.

Drill Down

In this week's Drill Down on Bloomberg Television's ETF IQ, VanEck CEO Jan van Eck stopped by to talk about the VanEck Real Assets ETF (ticker RAAX). The fund invests in other ETFs that track — as the name implies — real assets, including commodities, real estate and infrastructure. A VanEck broad commodity ETF and another VanEck product focused on energy are its top two holdings. So, what's the pitch to financial advisers to buy a fund like RAAX as a portfolio diversification tool, in a world where stocks are near all-time highs? Here's what van Eck said: You should think about commodities, but you don't, you're too lazy to. So let VanEck do the thinking about the commodity allocation — is it gold bullion, like last year, that helped the fund up 600 basis points in contribution, or is going to be MLPs and energy?... We're hoping that the laziness factor kicks in, and we offer this both as a model and an ETF. RAAX charges 0.77% and has about $100 million in assets.

Next Week on ETF IQ

Cathie Wood of Ark Investment Management joins me, Eric Balchunas and Scarlet Fu on Bloomberg Television's ETF IQ. We'll be live at noon on Wednesday given Monday's US holiday. Watch on Bloomberg Television's ETF IQ, on the Bloomberg Terminal at TV <GO> and on YouTube.

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