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Morningstar downgrades two Vanguard funds to neutral

Two unlisted funds from Vanguard have had their retail share classes downgraded at Morningstar, with the ratings house bringing attention to the vehicles' higher fees compared to their listed or wholesale versions.

The lower-investment-minimum share classes of the $16.7 billion Vanguard Index Australian Shares Fund and the $2 billion Vanguard High Yield Australian Shares Fund were moved to a Morningstar analyst rating of neutral yesterday.

The first fund, which has been running since 1998, tracks the S&P/ASX 300 Index and over five and 10 years to March end had beat the average peer by "a small but convincing margin".

It has tracked its index efficiently and has a low portfolio turnover, giving it tax benefits over active strategies, according to Morningstar.

Yet on fees, the fund is more expensive than alternatives in the market.

"Fee competition is rife in the increasingly commoditised passives market-cap space. Vanguard reduced fees on their wholesale identical unlisted strategy from 18 basis points to 16 basis points in July 2019," Morningstar analyst Edward Huynh said in a research note.

"However, this version still retains its base fee of 75 basis points, and whilst that's still cheaper than most active rivals, it's significantly more than other passive offerings."

The $16.7 billion in the fund is split across two share classes -- the wholesale version, which has a minimum investment size of $500,000 and fees of 16bps has $11.9 billion of the assets. The smaller share class, has a minimum of $5000 and fees of 75bps.

The high-yield fund found itself pitted against its ETF version in the latest ratings review.

"This unlisted vehicle is far more expensive than comparable exchange-traded offerings, including Vanguard's listed version of this strategy VHY, which costs a low 25 basis points," Huynh wrote.

"Both the unlisted and listed versions track the same index, which aims to deliver a diversified portfolio of Australian shares with above-market dividends and franking credits."

This fund is also split across two share classes: the wholesale version has a minimum of $500,000 for 38bps, totaling about $821 million in assets while the other has $5,000 minimum for 90 bps in fees.

Huynh goes on to note that despite the two funds' other strengths, the fees are high for the share classes.

"It is critical to evaluate expenses, as they come directly out of returns," he wrote.

"The share class on this report levies a fee that ranks in its Morningstar category's second-cheapest quintile. Even so, based on our assessment of the fund's People, Process and Parent pillars in the context of these fees, we don't think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Morningstar Analyst Rating of Neutral."

In response, Vanguard called attention to its mutual structure, zero brokerage on wholesale funds and ETFs for individual investors via Vanguard Personal, and 25 fee cuts across its Australian offerings over the last decade.

"While our competitors have lowered expense ratios on select index funds and ETFs out of competitive necessity, Vanguard continues to lower costs across our entire fund and ETF line-up, index and active. We've been lowering the cost of investing for four decades and will continue to do so," a spokesperson for the company said.

"Fee changes are not decided overnight. Our process driven approach to determining which funds are eligible for fee changes takes time, as does ensuring all legal and investor obligations are met and communicated."

Read more: VanguardMorningstarVanguard High Yield Australian Shares FundVanguard Index Australian Shares Fund
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