Vanguard bends to RIAs, and John Bogle's ghost winces

Salim Ramji is about to cost Vanguard money on purpose. RIABiz reports that Vanguard will let RIAs remodel four of its model portfolios, dropping Vanguard funds in favor of a select list of outside managers. Orion, Black Diamond, and Vestmark get the overlay administration, for a fee. Ramji took the model portfolio unit as a direct report two months before the rollout. No previous Vanguard CEO has done this.

Vanguard's old logic was that its own funds were good enough, and RIAs should accept them as the cost of doing business. That logic is losing market share. The custom model market was $125 billion last September, according to Morningstar data cited by RIABiz. It now stands at $258 billion, roughly double. BlackRock and other model makers already know what Vanguard is testing now: advisors want the right to second-guess the models they pay for.

Vanguard is giving up the captive fund distribution that its model portfolios used to provide. It is adding the cost of third-party overlays. It is setting aside its own Bogle tenets. The alternative, as First Ascent founder Scott MacKillop told RIABiz, is worse: "Those who are slow to move or are stuck in the past will pay dearly."

Only four models are open to remodeling, and the outside fund list is selective. But the direction is unmistakable. Vanguard is positioning itself for the "Vanguard effect" in a market where it no longer controls the terms.

For decades, Vanguard's model portfolios came with a requirement. Advisors who wanted Vanguard's brand had to take Vanguard's funds. The firm forced its own funds into RIA portfolios as the price of its seal of approval, extracting a financial and fiduciary concession. That model made sense when Vanguard's cost advantage was the industry's strongest argument.

That cost advantage has weakened. RIAs now bring their own value to the table, and the custom model market is booming. Vanguard's tight grip on portfolio choices was losing ground to BlackRock and others who understood that advisors want to customize. Ramji, a BlackRock alum, knows this playbook. He is gambling that the revenue lost on fund selection will come back as volume.

The partner revenue share is the sharpest detail. On top of losing fund revenue, Vanguard is paying Orion, Black Diamond, and Vestmark to do work it once kept in-house. They get a cut of the overlay administration. That is a strategic retreat, executed deliberately.

John Bogle built Vanguard on the idea that costs, not selection, drive returns. Letting RIAs pick outside funds and paying third parties to run the overlay adds cost and complexity to a system built to remove both. Ramji is betting that the Vanguard effect, the gravitational pull of the brand and scale, will more than make up for it.

Vanguard has sixteen model portfolios. Four are now open to remodeling. That's a pilot, not a revolution. If it works, the other twelve open up. If it doesn't, Vanguard has contained the damage. Either way, Vanguard has admitted it no longer believes its own funds are good enough to impose on RIAs who know better.

Ramji came in from the outside to address a disconnect insider executives couldn't see. He is bending the firm to the will of its biggest customers, and doing it publicly, with named partners and a timeline. The old Vanguard would have kept this quiet. Now the firm's biggest clients have a lever they never had before: the right to say no to Vanguard's own funds.