Here’s your mission: create an ESG version of a well-established active fund. It has to be scalable, and suitable for the core of clients’ portfolios. Oh, and the other fund has been running since 1929, so this version had better also last 93 years, at least.

Vanguard likes to use the term ‘enduring’, so in a market currently so characterised by change, answering the ESG call is no small task – even if the clamour for a product has become ‘overwhelming’.

The Vanguard SustainableLife range of funds and the Vanguard Global Sustainable Equity fund were launched in early December 2021, and are managed by Wellington Capital Management, which manages other strategies for the $7.8tn (£6.4tn) fund giant.

The range consists of three multi-asset sustainability funds, managed by Nataliya Kofman and Loren Moran. Since launch, the SustainableLife funds have taken in £245m.

In this long-read Q&A you’ll learn:

• The layers of the development process that go into a Vanguard product launch.
• How Vanguard worked with the Financial Conduct Authority to set the sustainability criteria including how it applied exclusions.
• The top-down principles and bottom-up client evidence that guide product development.
• How far Vanguard thinks sustainable versions of funds should diverge from the original product in terms of holdings.

The Sustainable Life fund is aimed at UK clients wanting a ‘low-cost multi-asset ESG solution’. The trick is satisfying that need with something durable. Asset managers are more than aware of how fast regulation is changing in this area, and how fickle markets can be. Article 8 funds, which under european regulations promote environmental characteristics, had negative net sales in Q1 2022, according to a report by Morningstar, which put the outflows at €3.5bn.

It also illustrates the difference between the UK and US markets. The Global Wellington fund also exists across the pond, but the American version has not yet added the same sustainability criterion. It is moving to a ‘net-zero-aligned methodology’, but sustainability is not ‘embedded’ in the prospectus in the way the UK SustainableLife range has done.

Amplify editor Will Robins sat down with Andrew Surrey and Mark Fitzgerald to find out more about the manager’s development methodology.

Lesson one at Vanguard product school

Will Robins: What’s your approach to product development?

Mark Fitzgerald: Products must be enduring – that word ‘enduring’ is critical – they must be core, long-term, diversified, liquid and low cost. In product development school at Vanguard, that gets drummed into you. It keeps us honest.

Now, apply that to product development. We’re broad, diversified and liquid; we will start looking globally. Then we come down from there, to regional, to in some cases single countries like the FTSE All-Share or the S&P 500. We don’t get much lower than that. You’re not going to see lots of thematic products in niche, concentrated areas that are not particularly scalable. As they grow in size, we can pass cost benefits back. You’ll have a European part and then you’ll have the other regions, and they form the global product plan.

Before we do anything, we must agree on what we want to research. The strategy team will create a prioritised list of things we should be looking at. As a consensus-driven organisation, we will go round to each of the key stakeholders and get an agreement.

With this particular fund, we started assigning researchers to look at each project or initiative in 2020. If it’s, ‘let’s just add another index fund to an existing umbrella’, you would expect that to be zero to three months. In this instance, it took several quarters because we were looking at evolving one fund and then adding sister funds around it. We aimed to come up with quantitative and qualitative assessments.

We looked at sizing the market: who’s out there at the moment? What are they doing? What’s gathering cashflow? How do they operate? A lot of discussions went on with Wellington, and a lot of analysis through our oversight and manager search team in the States, who have several hundred meetings with active managers every year.

We then tried to answer the question: could we build a viable, enduring product, at the right price, that will do what it needs to do? We then took that through the various internal committees.

We have the European investment committee. We have the European leadership team, where each of the key departmental stakeholders needs to agree. Then we got to a global forum to line up all the resources we needed and ensure we were aligned on the global product plan. Senior staff in the US also must agree this is something we want to pursue.

Once we got our ducks in a row internally, we then went through the governance structure – such as the UK or the Irish boards, depending on the domicile of the funds.

Then you had the implementation phase: opening accounts, creating the legal structure, etc. By then we know how long that’s going to take, and how much it will cost.

We have something called a go-to-market sleeve, which brought in the product specialists and the marketing team. You’re constantly checking back on dates to make sure everything is running smoothly.

Inside the SustainableLife launch

Will Robins: Why was this the right time to launch the fund?

Andrew Surrey: The most important fund launch for this was in 1929, with the original 60% equity, 40% bond fund, which became the Vanguard Wellington fund.

The second iteration was making that global – the Vanguard Global Balanced fund, launched in 2016. That fund is now the SustainableLife 60-70% fund. This is the third evolution of the same product.

It was by far the number one product asked for by our client base. Whenever we did a webinar, on virtually any topic, the vast majority of the questions would be: when are you going to give us a low-cost, multi-asset ESG solution? It was overwhelming.

The original fund, the Global Balanced fund was 65% equities and 35% fixed income. The initial thinking was to do a mirror version. Then we spoke to some clients and some of the sales team and they said: ‘We need broader options than that so that clients with low, medium and high risk appetites can use the product.’

It was in 2019 that it started in earnest.

Will Robins: Are you seeing people who have had the existing product move money from one to the other?

Andrew Surrey: We’re not aware of a single client leaving the old product for this. The main flows have come from competitor products, where advisers are already in an ESG multi-asset solution. We were fortunate with the timing in coming out with a very balanced ESG product at the time growth and value switched around.

Advisers weren’t getting much diversification benefit from [blending sustainable solutions] because they were investing in similar ideas, similar industries, similar sort of growth.

‘This fund was one of the regulator’s first reviews’

Will Robins: How different should the holdings be between a sustainable version of an existing fund and the original?

Mark Fitzgerald: One thing that’s often not appreciated is that this is a very legalistic process. The prospectus is a legal document. We will have very detailed conversations with the relevant regulator – in this case, the FCA.

There’s a lot more attention now than there was two to four years ago on exactly this question around funds that are evolving or changing. That was a very important part of the launch process. This fund was part of one of the FCA’s first reviews after it tightened up its requirements. We were very pleased to have that discussion with them because we want robust products that are fit for the future. But what you won’t see is us making lots of changes just to meet a particular regulatory label.

Andrew Surrey: The way that sustainability works is that there are four pillars.

Explicit net-zero: a science-based target, not a press release net zero. Then ESG risk exclusion, so the controversial weapons etc. Then engagement and, finally, great governance.

Wellington is explicitly engaging about net-zero. Remember, the net-zero initiative kicked off in December 2020. When we launched the original Global Balanced fund in 2016, that didn’t exist yet, so we wanted to be explicit.

On ESG risk exclusion, we said we’d like there to be no tobacco in the portfolio. Well, there isn’t any! Some controversial weapons manufacturers were removed for involvement in nuclear weapons or what were deemed to be controversial weapons.

The stock example that I love talking about is Michelin tyres. Michelin tyres won’t score great on ESG metrics. Rubber plantation is where deforestation comes from, and then you have labour challenges. But Michelin genuinely is a leader in using technology like satellites and drones to make sure that there’s no deforestation on their plantations, and on the way that they use blockchain to check the source of all the rubber they use and the labour conditions.

The managers are not selling down industries and buying media, technology and healthcare firms because they happen to have a light environmental footprint. Wellington’s bar around what is acceptable and good governance is extremely high – and has been for decades. The engagement was already happening.

Will Robins: Is regulation in the driving seat?

Mark Fitzgerald: Regulation is evolving and changing because of the commitments made by governments, and the need and desire to address climate change. We want to provide input when regulators and governments consult, such as on taxonomy or reporting standards.

There is only so much asset managers can do. We need, and want, direction from global regulators so that when we engage with companies we know we’re getting comparable information back.

There is a lot of competing regulation, but the general direction is to try to bring some standardisation. We need directives that are going to apply across a country or a region or globally – things like the Task Force on Climate-related Financial Disclosures or the Sustainability Accounting Standards Board, as a materiality framework.