What better pairing than two individuals who like to stir things up? Outspoken industry pundit Roy Weitz, publisher of FundAlarm.com, recently weighed in on some of the pressures facing the mutual fund industry with Jack Bogle, founder and former chairman of Vanguard and a notoriously outspoken defender of the investor.
Weitz: I think it's fair to say that you were the star of the recent Congressional hearings. But I think it's also fair to say that sometimes these hearings are used to score political points and for grandstanding.
Bogle: I think Chairman Oxley's and Chairman Baker's motives are the right motives, and the position put forth by the ICI seemed fairly weak.
We may think we've done a good job for investors. But, as I testified, the reality is in the last 20 years, the market has gone up at a 13% average annual rate, while the average mutual fund has returned 10%, and the average mutual fund investor's profits have increased an average of 2% a year.
A dollar in the market would have brought you a profit of $10.50, but the average fund investor would have realized a profit of 50 cents.
There's all this talk about the fund industry never having had a major scandal. You know, if that's not a major scandal I wouldn't know what was.
Weitz: How did the ICI respond to your comments?
Bogle: As far as I can recall, they made no response. They also made no response when I made probably my single most important recommendation, which is to separate the office of fund chairman and management company chairman, to make sure that the fund directors have a leader who's not basically on the other side of the table. To quote Warren Buffett's wonderful comment, "Negotiating with oneself seldom produces a barroom brawl."
Weitz: In your statement to the Congressional committee, you said that fund directors need to be "empowered" to negotiate lower management fees. What do you mean by empowered?
Bogle: Well, if I used the word "empowered," it might be an ill-chosen word. Fund directors have the power to do anything they wish. They have awesome power.
Weitz: In your Congressional testimony you also call for the disclosure of all mutual fund transaction costs, including commissions, market spreads, and market impact costs. The latter two, spreads and impact costs, are especially difficult to pin down, so you suggested that rough estimates would be necessary. Do we really want to encourage the fund companies to give rough estimates of anything?
Bogle: No. But I don't think we can do any better. Rough disclosure, call it rough justice, is better than no justice at all.
Weitz: So if this kind of disclosure were to go forward, it would be acknowledged as an experiment?
Bogle: Yes. But let me say further, I'm not sure that there isn't a little credibility gap here. If a fund manager told me as a fund shareholder that he had no idea what his transaction costs were, I would move my money to another fund.
Weitz: So you're suggesting that fund managers know these costs already?
Bogle: Right. There are already firms that analyze these numbers, so presumably the boards of directors of the funds already get them. And I make no argument there is perfect accounting for transaction costs. It's a very elusive area, but we owe it to shareholders to do the best we can.
Weitz: As estimates, it seems that those numbers could be shot down quite easily, and therefore might lose their impact. Is that something that concerns you?
Bogle: Well, let me ask you a simple question. How many numbers in IBM's audited financial statements are other than estimates? Appreciable life, debt chargeoffs, bad debts, useful life of a computer. Almost everything is an estimate, if you think about it.
Weitz: Just after the Enron and Tyco scandals broke, there was some indication that you and a couple of other industry leaders, specifically Bill Miller and Chris Davis, were going to try to become the conscience of the fund industry. You even had a meeting, or a couple of meetings, but nothing seems to have come of that effort. Can you tell us where that effort stands?
Bogle: The idea was to form what I called a Federation of Long-Term Investors. We got about eight of the biggest firms in the industry together, some of them indexers. Our idea was to develop a set of benchmarks. But when the New York Stock Exchange and Nasdaq developed a set of best practices and the Conference Board Commission on Public Trust and Private Enterprise was established, it occurred to me that we didn't really need another set of best practices.
Weitz: If you had forged ahead with the Federation of Long-Term Investors, what would your primary focus have been?
Bogle: When I started my career in 1949, this was an industry in which there were relatively small private firms, low-profile firms acting much more as trustee or fiduciary for the investor. So we had owners' capitalism then.
And almost contemporaneously, both public corporations and mutual funds have moved away from owner capitalism to manager capitalism. And their motivation is, as usual, money. Or, if you want to be a little tougher, greed.
Weitz: You're a tireless champion of good mutual fund practices and you regularly hold out Vanguard as an example of the best fund practices. Does it concern you that if everybody did indeed emulate Vanguard, that Vanguard would suffer competitively?
Bogle: I think, quite the contrary, we would prosper competitively. And the reason I believe that is this is a very competitive business, and one of the aspects of that competition is price competition. I would hope that there would be many, many Vanguards over the years.
Weitz: As you know, you were recently profiled in Fortune magazine, and I thought the article was very interesting. According to one of the anecdotes in the article, someone apparently called you a Bolshevik at an ICI conference in the early 1990s.
Bogle: That was both a funny and a true story.
Weitz: You've said your biggest complaint about the fund business is that it's run like a business to maximize returns to shareholders rather than to its customers. Do you ever feel that your strong opinions permit people to dismiss you and say, "Oh, John Bogle, he's just another anti-business crank"?
Bogle: People say I'm anti-business, yet I built one of the most successful businesses in the mutual fund industry. I'm not anti-business. I'm trying to make money for fund shareholders. It's just that people in the industry keep focusing on making money for themselves.
One of the Congressmen at the February hearings said something to me, to the effect that I'm saying one thing and the industry is saying another. And I replied, "Everyone in the industry understands what I'm saying. But as Upton Sinclair said, It's amazing how difficult it is to get a man to understand something if he's paid a huge salary not to understand it.'"
I'm not against business. I love business. Business is competition. And as everybody must know by now, there's nothing Bogle likes better than a good fight. But I'm also very comfortable with having a business in which the rewards go to the shareholders. If that's communism, so be it, but I'd say it's the essence of capitalism.
Weitz: But with rewards in any mutual fund company geared towards management, wouldn't that prevent the creation of another Vanguard?
Bogle: Not so. There will be another Vanguard. Maybe not in my lifetime, but let me tell you how I think it will happen.
First I think Vanguard proved that it's good business with a huge amount of momentum. I think people know where that momentum comes from, which comes largely from Vanguard's mutual structure and its low-cost orientation. So other fund companies will start to recognize that. At the same time, they'll fall short, maybe seriously, of the benchmarks that Vanguard has done more than maybe anyone else to establish.
So what I envision is a management company that is making very large profit margins, and has made them for maybe 25 years. But their cash flows are starting to turn negative, and they are starting to lose assets. But there's also a very strong lead director for the funds. And he says to the chairman of the board of the management company, "Look, you guys have been eating at the feeding trough for 25 years. You've got homes in Martha's Vineyard and in Spain and in Italy. You have yachts and you've got jets. It's over.
"We want you to stay here. We want you to make a good living. We want to put you on the fund payroll, and we're going to pay you really good money. But from now on, the entrepreneurial reward is going to go to people who put up the capital."
Weitz: And what if no board of directors ever has the guts to challenge the management company in this manner?
Bogle: Investors are not going to act contrary to their own economic interests forever. And as the Fortune profile on me said in its conclusion, "There's something that most capitalists and Bolsheviks can agree with."
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