Vanguard Funds’ Chief Investment Officer George U. “Gus” Sauter is finishing up a quarter century with the giant investment company. In those years, he has been a big part of market structure changes. In the first part of a multiple part Q&A, Sauter told Traders Magazine how he views those changes. He also spoke about how he began in the business, a business in which he had no trading experience.
Traders Magazine: So you really didn’t have a big background as a trader when you came to Vanguard?
Gus Sauter: No, not as a trader. I was really more of a portfolio manager.
Traders Magazine: When you came to Vanguard in 1987 what your background?
Gus Sauter: I came from a trust investment department (First Bankcorp. Of Ohio), where I was a trust investment officer managing accounts.
Traders Magazine: You were managing money?
Gus Sauter: I had developed a quantative model to actually manage equities at the bank. And at the time, Vanguard was looking for someone to build out it quantitative capabilities both in indexing and active quantitative equity.
Traders Magazine: When you became a member of the Vanguard crew back in the late 1980s, creating equity index funds, it was very different.
Gus Sauter: We had one person in the equity department. And I was the second and I was brought in to run the department. We had a trader and I was basically in charge of building that business. We started about a billion and we went through a trillion two days ago.
Traders Magazine: What are your total assets now?
Gus Sauter: Yes, on the equity side it’s one trillion to the penny. And on the fixed income, it is roughly $600 billion.
Traders Magazine: How do you become Vanguard’s first chief investment officer in 2003?
Gus Sauter: It’s kind of interesting. Ian McKinnon started our fixed income group back in the early 1980s. He reported directly to the chairman. And I came in 1987 and ran the equity group. So we basically had different money management units that worked autonomously. And in 2003, Ian retired. Then Jack Brennan (John Bogle’s successor as CEO of Vanguard Funds) asked me if I would like to take on the responsibility for overseeing both. And I sounded like a pretty good challenge to me so I took it on.
Traders Magazine: The trading business has changed much over the past decade. For instance, off board trades changes represents about a third of all trading and dark pools constitute about 13 percent and wholesalers are doing more internalizing. How do you view these changes?
Gus Sauter: I would certainly say that if we were starting from scratch with the market, we would certainly not design the structure that we have.
Traders Magazine: You’d still want a CLOB.
Gus Sauter: I may be the last person who likes the idea of a central limit order book, but that is what Reg NMS is trying to do.
Traders Magazine: How?
Gus Sauter: Reg NMS is trying to put things back together again so we don’t have things trading in different venues at different prices. While we wouldn’t create the structure we have today, it is the structure we have today.
Traders Magazine: OK, so you go to market with the market you have, with all its good and bad points. So is it fair to say that you are an advocate of publicly displayed limit orders as opposed to dark pools.
Gus Sauter: Yes, that is how I would design a system if I was starting from scratch. I would prefer the lit markets.
Traders Magazine: However…
Gus Sauter: To the extent that dark pools are out there, I would be fighting myself if I didn’t use them.
Traders Magazine: How do you view trading in pennies and sub-pennies and the pilots in trading them?
Gus Sauter: I do worry about some of these incentives to basically pay for order flow. That usually ends up with some sort of conflict of interest. Obviously, they’re trying to incent liquidity. That’s a good thing. But paying for order flow is a conflict of interest.
Traders Magazine: What is best execution? Why is there such a debate about it?
Gus Sauter: The way I see it is, if you’re a portfolio manager and you want to own a security. You basically want to own it at the price at when you made the decision. So anything different from that will become your transaction cost.
Traders Magazine: So you hand the trade to a trader?
Gus Sauter: That, to me, is the start of your transaction costs. By the time the trader gets the trade to the exchange, and there is additional adverse movement, that again is part of the transaction costs.
Traders Magazine: So best execution becomes?
Gus Sauter: Best execution becomes the best price, or the closest price that you wanted to buy it. And to the extent that you can do that quickly, you certainly remove the risk of the trade. So ultimately it is a combination of price and speed.
Stay tuned for Part 2 of our Q&A with Sauter in which he discusses market makers and specialists.
