Vanguard's got its own 'Apple' problem

At first glance, the largest company in the world and the largest mutual fund company in the world wouldn't seem to have much in common. Apple Inc. grew to the biggest company on the planet by pumping out hip and sexy products that were gobbled up by the masses despite their hefty premiums. In the mutual fund world, The Vanguard Group Inc. climbed to the top on the back of plain old index funds that keep expenses to a minimum. But both companies face the same challenge: Replacing a legend. Gus Sauter isn’t as widely known or lauded as Steve Jobs, but during his 25 years at Vanguard he did as much for the investor as Mr. Jobs did for the consumer. Vanguard had only two index funds when Mr Sauter started at the company in 1991. Under his leadership as chief investment officer, the number of index funds offered by Vanguard has jumped to 75. Assets in the funds grew from $1.2 billion to more than $1.15 trillion. He also was responsible for the company’s push into exchange-traded funds, a product founder Jack Bogle still openly questions. That business has grown to $171 billion, despite Vanguard’s being fashionably late to the party. Mr. Sauter retired at the end of last year, placing Vanguard in the same position Apple found itself in after Mr. Jobs died in 2011. Apple has obviously had some mixed results under its new chief executive, Tim Cook. Vanguard is no doubt that hoping new CIO Tim Buckley has a much smoother first year. But like Mr. Cook, the Vanguard investment honcho is facing his fair share of challenges. Mr. Buckley doesn’t come with the investment pedigree Mr. Sauter had. His previous roles include head of Vanguard’s retail group and chief information officer. He’s never worked on a trading desk. Then again, that's what chief executive William McNabb likes about him. “We didn’t want someone who looks like Gus,” he said. “You can never have a second Gus. We were looking for someone who’s process-driven and a good developer of talent.” Vanguard needs to focus on developing talent simply to keep up with its ballooning assets under management. Last year, it set a record for most net inflows for a single company by taking in $130 billion. Its mutual funds took in $24 billion more than Pacific Investment Management Co. LLC, its nearest competitor. “The bigger you are, the more you need a strong pipeline,” Mr. Buckley said. “It always starts with the shareholders. The No. 1 objective is performance — tight tracking or appropriate risk-adjusted alpha. To get there, it starts with talent.” Giving its success, you’d think it’d be easy for Vanguard to recruit a more widely known executive. But finding someone who fits the culture is tougher than it sounds, Mr. Buckely said. “We have to find people that are happiest when they put the client first,” he said. “They can’t just really love the stock market or getting excess returns.” Mr. Buckley got a crash course in Vanguard’s culture while working as Mr. Bogle’s research assistant, his first job at Vanguard. “I’ve been well-indoctrinated with the philosophy,” Mr. Buckely said with a chuckle. “It’s a point of pride here on who saved money on something.” Saving money was the driver of Mr. Sauter’s final major move as CIO: the changing of 22 funds’ underlying indexes. The changes are still under way, so blame will fall to Mr. Buckley if the changes are an iPad mini-like dud with the marketplace. The biggest wild card? The CRSP indexes, which 16 U.S. stock funds will begin to track. The benchmarks, which were developed by the University of Chicago's Center for Research in Security Prices, have no history. “If someone was starting from scratch and used CRSP indexes, no one would go to them,” said Matt Hougan, president of IndexUniverse LLC. Advisers probably will be much more willing to give the indexes a shot, given that it’s Vanguard’s project, Mr. Hougan said. “Vanguard has this golden halo effect around them right now,” he said. In fact, no other company has as much momentum with investors these days, according to Cogent Research Inc. When Cogent last year asked ETF users how likely they were to increase investments with a particular provider, Vanguard came out on top and it wasn’t close, said principal John Meunier. “Vanguard is by far ahead of any other providers,” he said. All that momentum just ups the stakes for Vanguard. “If they screw up now, it’s a much bigger hit than when they were smaller,” said Daniel Wiener, editor of The Independent Adviser for Vanguard Investors newsletter. “Buckley’s biggest challenge is not to screw it up.” Apple’s Tim Cook has the market to tell him when he’s screwing up. Mr. Buckley has an even harder investor to please: Mr. Sauter himself. “As long as Gus leaves his money here," Mr. Buckley said, "I’ll take that as a nice vote of confidence."