Next Tuesday, Jan. 31, a former Federal Reserve chairman and three former heads of the Securities and Exchange Commission will join a dozen other financial luminaries to honor the contributions of a man who has done more to rein in the excesses of Wall Street than any of the drum-beating occupiers who jammed into Liberty Square.
He is John Bogle, founder of Vanguard, one of the largest U.S. mutual fund companies and the brains behind the phenomenally successful concept of index funds. This simple innovation is credited with helping both individuals and big institutions wean themselves off Wall Street’s costly and usually futile scramble for “hot stocks” and an obsession with celebrity money managers who soar one year only to crash the next. The index fund restored the luster of systematic, long-term investing and has saved investors many billions of dollars in management and brokerage fees—and underperformance—in the nearly 40 years since Bogle first introduced the concept to the public.
Federal Reserve Chairman Paul Volcker observed that Vanguard’s first index fund was “supported by plain evidence: that most active money managers most of the time will not be able to “beat” the market… very few funds can consistently outperform the averages.
“That not an easy conclusion for money managers to accept,” noted Volcker dryly. “Bogle has not won many popularity contests among his professional colleagues.”
True, but the Jan. 31 event at the Museum of American Finance, ironically enough on Wall St. itself, is a reminder that Bogle’s concept has over the years assembled an impressive army of support among serious scholars of markets and finance. On Tuesday, Volcker and former SEC Chairman Arthur Levitt will convene a meeting of highly respected former regulators and financial market academics to discuss Bogle’s innovations and how the principles he enunciated over the years can be applied to restore investor confidence to a market decimated by the credit crisis of recent years.
Bogle first met Paul Samuelson at Princeton when he took his first economics course, and enjoyed a rapport for 61 years until the death of the Nobel laureate economist. Bogle credits Samuelson with playing a major role in “in precipitating the index fund’s creation.”
Samuelson returned the compliment when, in 2005, he said in a speech to the Boston Security Analysts Society, “I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese: a mutual fund that never made Bogle rich but elevated the long term returns of mutual fund owners. Something new under the sun.”
Levitt says simply, “Jack Bogle has given investors throughout the world more wisdom and good financial judgment than any person in the history of markets.”
Looking at the Dollars and Cents
Is this praise over the top? That depends, perhaps, on your perspective. Here’s an investor’s perspective: As of the end of 2011, the share of equity fund assets that were invested in index funds (mutual funds and ETFs) was 25.8%. The average expense ratio for Vanguard funds, for example, in 2010 was 0.21%. If Vanguard had charged the industry average expense ratio of 1.15% in 2010 on shareholders’ average assets of $1.43 trillion, their net returns would have been $13.4 billion less.
These savings have endured over time. Kenneth French, professor of finance at the Tuck School of Business at Darmouth, released a study in 2008 that compared the “fees, expenses and trading costs society pays to invest in the U. S. stock market with an estimate of what would be paid if everyone invested passively.” Averaging 1980 to 2006, French found investors paid 0.67% by not investing actively. In 2006 alone, the total cost of active management was $101.6 billion. French explains the $100 billion cost of active management is “probably low, but I am trying to be conservative.”
French received four emails challenging his results—all from industry professionals who complained his estimates were too low. “I am happy with that outcome,” he says.
Samuelson’s assessment of the index fund may well be, in the parlance of fiduciary law, “fair and reasonable”, indeed. Index funds have arguably democratized the capital markets, and fundamentally changed how individual investors think about investing. No small accomplishment. Bogle’s greater challenge now is to change how the investment industry thinks about investors.
In a forward to Bogle’s book, Don’t Count on It, Princeton Economist Allan Blinder notes, “The duties of a fiduciary have always commanded a central place in the Bogle pantheon of virtue and vice.” As Bogle says, quite simply, the interests of shareholders must come first, ahead of the interest of agents and managers. As he also reminds us, the Investment Company Act of 1940 states “Mutual funds should be managed and operated in the best interests of their shareholders, rather than in the interests of advisers.”
Bogle contends, strenuously and cogently, that they often do not. He calls for Congress to pass a federal fiduciary duty standard, and “demand that fiduciaries act with due diligence and high professional standards. That doesn’t seem too much to ask.” Bogle says we must require our agents to “relearn what being a fiduciary means.”
In 1976, some called the index fund, “Bogle’s Folly,” others said it was, “Un-American.”
Its one thing to build a better mousetrap; it’s quite another, as Bogle aspires, to build a better society, a “Fiduciary Society.” When Paul Volcker notes the premise of the index fund means Bogle doesn’t win any industry popularity contests, he underscores how fundamentally at odds Bogle remains with prevailing industry views. Overcoming this prevailing view and changing how the industry views investors may yet be Bogle’s greatest accomplishment to come.
Knut A. Rostad is president of the Institute for the Fiduciary Standard, lead organizer of the Jan. 31 gathering to honor John Bogle.