Morgan Stanley Dumps Vanguard Mutual Funds -- Update

By Michael Wursthorn and Sarah Krouse Features Dow Jones Newswires

Morgan Stanley will soon prevent its clients from buying Vanguard Group's mutual funds, the latest big Wall Street brokerage to mostly shut out some of the index giant's funds.

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Starting next week, Morgan Stanley brokers will no longer be able to sell their clients new positions in Vanguard mutual funds, including its popular index offerings, the bank confirmed. Merrill Lynch, meanwhile, already doesn't allow new clients to purchase new shares of Vanguard's mutual funds, said Merrill brokers familiar with the matter, adding that it has been a longstanding policy of the Bank of America Corp.-owned brokerage.

The brokerage arms of Wells Fargo & Co. and UBS Group AG, two of the other big traditional brokerages, haven't dropped Vanguard's funds, people familiar with their sales practices said.

The restrictions come as Vanguard has boomed amid investors' embrace of funds that mimic broad indexes for a fraction of the cost of actively managed funds. The Malvern, Pa., firm brought in $289 billion last year, or 54%, of the $533 billion that flowed into all mutual funds and exchange-traded funds, according to research firm Morningstar Inc.

Michael Wong, a wealth-management researcher with Morningstar, said he was surprised by the Morgan Stanley move. "Vanguard, among the fund world, is a household name, so I would assume there would be some client demand for it," he said.

Morgan Stanley, which oversees $2.2 trillion of client assets, says Vanguard's funds are unpopular with its clients. Vanguard's mutual funds represented less than 5% of Morgan Stanley's total mutual-fund assets, said bank spokesman Bruce Dunbar.

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Morgan Stanley clients currently invested in Vanguard mutual funds won't be forced to sell, and they can add to those positions through early next year. The brokerage will continue to offer Vanguard exchange-traded funds, said Mr. Dunbar.

Vanguard is unusual among fund firms because it has a policy of not paying other firms to sell its funds. Many fund firms have long paid for shelf space on platforms or had revenue-sharing agreements with brokerages.

A spokeswoman for Vanguard said, "We share in the disappointment of advisers who are not able to access conventional shares of our mutual funds," adding that it doesn't pay any brokerage firm or its advisers for the distribution of its funds.

Merrill, meanwhile, has for some time restricted the sale of new shares of Vanguard mutual funds to clients who don't have an existing position, said Merrill brokers familiar with the matter. Clients who come to the firm with existing positions can add to those, as long as they have research coverage by Merrill's chief investment office or a Morningstar analyst, they added.

As at Morgan Stanley, Merrill Lynch's ban on buying Vanguard mutual funds doesn't apply to Vanguard ETFs. And investors who direct their own investments through Merrill Edge, Bank of America Corp.'s self-service investment platform, can buy Vanguard mutual funds and ETFs without restrictions.

Brokers at both firms say they usually favor ETFs, including Vanguard's, for investors who want a passive investment strategy because they tend to be cheaper and more tax efficient than mutual funds.

Morgan Stanley, which has more than 15,000 brokers, said it is removing the Vanguard funds as part of a broader overhaul of its mutual-fund offerings. Over the past several months, the firm has been cutting 25% of funds it deems less popular or underperforming, a process it kicked off to help it comply with the Labor Department's fiduciary rule requiring brokers to act in the best interest of retirement savers.

"This reduction will allow us to increase our research coverage and due diligence on the funds remaining open," said Mr. Dunbar, adding that the firm offers more than 2,300 funds to its clients.

AdvisorHub earlier reported Morgan Stanley's removal of Vanguard funds.

Morgan Stanley's move shows that the economics of fund distribution -- what fund firms must pay large financial firms to sell their products to investors -- are in flux. Gatekeepers like Morgan Stanley are using their muscle to protect their own revenue even as disrupters like Vanguard gather assets at a fast clip.

Brent Beardsley, managing director at Boston Consulting Group, said as brokerage firms trim the number of funds they sell, asset managers that remain "are going to get a lot of flows, but I suspect they are going to have to pay more."

At the same time, the money-management industry is contending with changing investor preferences as lower-cost index-tracking funds become more popular. Cost-sensitive investors have poured hundreds of billions of dollars into lower-cost index-tracking funds in recent years.

Managers of many index and actively managed mutual funds have trimmed their fund fees to better compete. Still, paying platforms and advisers for distribution at a time when fees are falling squeezes the revenue fund firms collect.

Ben Phillips, principal at Casey Quirk, a Deloitte Consulting LLP practice focused on the asset-management industry, said that industrywide, "the large distributors in the mutual fund world are centralizing their powers as gatekeepers and using it."

Write to Michael Wursthorn at Michael.Wursthorn@wsj.com and Sarah Krouse at sarah.krouse@wsj.com

(END) Dow Jones Newswires

May 04, 2017 15:53 ET (19:53 GMT)