John Bogle on Shareholder Orientation

Headstrong, impulsive, and naïve, I found a merger partner—in Boston, of all places— that I hoped would do exactly that. Alas, despite the glitter, I found no diamonds there. The merger worked beautifully for about five years, but the investment managers who were my new partners let our fund shareholders down, the stock market dropped 50%, and the assets we managed plunged from $3 billion in early 1973 to $1.3 billion in late 1974. Not surprisingly, the new partners had a falling out. But my adversaries had more votes at the Company than I did, and it was they who fired me from what I had considered “my” company. What’s more, they intended to move all of Wellington to Boston. I wasn’t about to let that happen. I not only loved Philadelphia, my adopted city that had been so good to me, but by 1974 I had established my roots here, finding unimaginable diamonds, first, in my beloved wife Eve, who was born and grew up here, and then in six wonderful children. We intended to say where we were, and I had a plan to do just that. For when the door slammed, a window opened, and the acres of diamonds I had begun to discover in 1951 were to remain in Philadelphia. Pulling off this trick was not easy. But I was able to parlay a slight difference in the governance structure of the Wellington funds, owned by their own shareholders, and Wellington Management Company, owned largely by my former partners, into a new career—and with it more diamonds than I ever could have imagined.

Total Returns on Stocks, Past and Future 4.5% 3.4% 2.0% 5.0% 6.4% 6.0% -1.0% 2.7% 0.1% -2% 0% 2% 4% 6% 8% 10% 12% 14% Last 100 Years Last 25 Years Next 10 Years 9.6% 12.5% 7.0% Earnings Growth Dividends P/E Change Investment Return Speculative Return 4. Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient. Harvard Business School Professor Rakesh Khurana was right when he defined the standard of conduct for a true professional with these words: “I will create value for society, rather than extract it.” And yet money management, by definition, extracts value from the returns earned by our business enterprises. Warren Buffett’s wise partner Charlie Munger lays it on the line: “Most money-making activity contains profoundly antisocial effects . . . As high- cost modalities become ever more popular . . . the activity exacerbates the current harmful trend in which ever more of the nation’s ethical young brainpower is attracted into lucrative money-management and its attendant modern frictions, as distinguished from work providing much more value to others.” Yet even as I write these remarks, I read that this brainpower is pouring into financial services at the most breath-taking rate in history.

But during the 1964-1974 era, highly risky “Go-Go” funds came to dominate the mutual fund industry and manager profits soared. The conflict between fiduciary duties owed to the management company stockholders and the fund shareholders quickly surfaced. In 1965—a mere half-century ago—legendary Wellington founder Walter L. Morgan discussed with me the dire situation that our firm was then facing. Our flagship fund, the conservative and balanced Wellington Fund, was looking staid and out-of-step with the “new era.” Mr. Morgan, deeply concerned, told me—a kid, really, age 35—to take charge of his firm and “do whatever it takes to fix Wellington’s problems.” (To this day, I remember those words.) Loaded with unwarranted self-confidence—arrogance?—and ignoring the industry’s challenges that I’d recounted in 1951 in my Princeton senior thesis on the fund industry, I rose to the challenge! Before a year had passed, I’d put in motion a merger that would, well, “fix” Wellington Management Company. Our new, much smaller partner from Boston ran one of those Go-Go funds (Ivest Fund, now lost in the dustbin of history), and we were once again competitive in the marketplace.this

It is also the most widely traded stock in the world, averaging more than $20 billion of trading volume every day! Compared to 290 traditional index funds (TIFs),7 there are now 1,500 ETF index funds. With $2.1 trillion of assets, U.S. ETFs are now actually a tad larger than their TIF progenitors, and more of these new toys for investor speculation are created every week. The lesson: Never underestimate the power of a hot new marketing innovation (or, here, one-half an innovation). Paraphrasing H. L. Mencken, “no fund marketer ever went broke by underestimating the intelligence of the American investor.” You will hardly be surprised to know that when index funds are designed and used for short-term speculation, I am not amused. 6 The late Nathan Most was the creator of the first ETF. In 1991, he came to my office with an offer to partner with Vanguard in implementing his new concept. I declined the offer. Despite the SPY’s remarkable growth, I have zero regrets about that decision. 7 I created this acronym to simplify the distinction between the two types of index funds.

Let’s Hear From Some Other Critics Let me be clear here. While my voice may be strident, and my criticism of the field in which I’ve plied my long career is a distinct rarity among my colleagues in finance, I am not quite alone. Indeed, one of the most respected voices in finance, William C. Dudley, now president of the Federal Reserve Bank of New York, shares my concern. “There is evidence of deep-seated cultural and ethical failures at many large financial institutions.” Dudley added, “the trust issue faced by our nation’s giant banks, is one of their own doing—they have done it to themselves.” As a partner of Goldman Sachs before he became Fed president, Mr. Dudley would seem singularly qualified to comment on the ethical failures in finance that have been so rife. Another objective observer of the financial world is New York Times columnist David Brooks (my favorite opinion page writer). Here’s his overview, from a column that he wrote in 2008 entitled “The Great Seduction”: “The people who created this country built a moral structure around money. The Puritan legacy inhibited luxury and self-indulgence. Benjamin Franklin spread a practical gospel that emphasized hard work, temperance, and frugality. Millions of parents, preachers, newspaper editors, and teachers expounded the message. The result was quite remarkable. The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth.

Paul Cabot did not approve of that change. For him, the private ownership of fund managers was essential. Indeed “it represented a moral imperative for him, and he sharply criticized firms that would sell out to insurance companies and other financial institutions. In 1971, he recalled the negotiations over the Investment Company Act of 1940: “Both the SEC and our industry committee agreed that the management contract between the fund and the management group was something that belonged . . . to the fund . . . and therefore the management group had no right to hypothecate it, to sell it, to transfer it, or to make money on the disposition of this contract . . . the fiduciary does not have the right to sell his job to somebody else at a profit.”11 Yet, ironically, in 1982, Paul Cabot’s successors did exactly that: the partners of State Street Research and Management Company sold the firm to the (paradoxically, then-mutual) Metropolitan Life Insurance Company for an astonishing (in those ancient days) profit of $100 million. The stated reasoning of the Fund’s board: “the affiliation of State Street with an organization having the financial and marketing resources of Metropolitan Life will result in the development of new products and services which the fund may determine would be beneficial to its (the fund’s) shareholders.”12 (Mr. Cabot, still a partner, was apparently enriched to the tune of $20 million, in 1982 dollars.)

Warren Buffett’s wise partner Charlie Munger lays it on the line: “Most money-making activity contains profoundly antisocial effects . . . As high- cost modalities become ever more popular . . . the activity exacerbates the current harmful trend in which ever more of the nation’s ethical young brain-power is attracted into lucrative money-management and its attendant modern frictions, as distinguished from work providing much more value to others.” But I’m not telling you not to go into the highly-profitable field of managing money. Rather, I present three caveats: * One, if you do enter this field, do so with your eyes wide open, recognizing that any endeavor that extracts value from its clients may, in times more troubled than these, find that it has been hoist by its own petard. It is said on Wall Street, correctly, that “money has no conscience,” but don’t allow that truism to let you ignore your own conscience, nor to alter your own conduct and character.

Fixing a Broken Financial System Remarks by John C. Bogle Founder and Former Chief Executive, The Vanguard Group Before A Stradley, Ronan, Stevens & Young Assembly Philadelphia, PA February 12, 2009 I’m so pleased with this wonderful turnout—surely an indication that many leaders in our Greater Philadelphia business and legal community are deeply concerned by the financial crisis that continues to unfold as we meet. And I thank Stradley Ronan for giving me the opportunity to present my views to you, as well as their presenting each of you with my newest book—number seven—published just a few months ago. As it happens, in many respects, ENOUGH, anticipated—some say, predicted—the crisis in our markets and our economy. But the book also sends a message about the decline in our society’s character and values that we have witnessed over the past few decades. No one would have been more appalled by what has gone wrong than Stradley’s former senior partner, the late Andrew B. Young, Esq. I benefited greatly from Andy’s mentorship as Wellington Management Company’s counsel during the 25 years we worked together, as well as from the insight and wisdom of this great man for the remaining 25 years of his long life. So I take the liberty of dedicating these remarks to his memory. (Stradley, Ronan, Stevens & Young people here: never forget your fine heritage.

The Age of Fiduciary Duty has Arrived Remarks by John C. Bogle, Vanguard Founder Before the Eastern Chapter of The National Association of Personal Financial Advisers Baltimore, Maryland November 8, 2012 Thanks to all of you for coming out to this important conference. And a special thank you to those of you who use our Vanguard funds with your clients (and often in your own investment portfolios). And thanks to all of you for working with investors—honest-to-God, down-to-earth human beings—and for helping them to meet their financial goals. The vast majority of investors need financial advisors, and you and your firms are likely the soundest approach to that mission. It’s a special honor to join you at your conference once again. On my previous visit in 1999, you honored me with your Special Achievement Award—the first time that your award had been presented to a fund industry executive (as distinct from an academic, regulator, or author). Deserving or not, I am both proud and humbled to hold that distinction. The fact is that I’ve always deeply believed that Vanguard is a natural partner for most independent registered investment advisers. My reasoning (perhaps like all of my reasoning) is simple, straightforward, and mathematical.

Warren Buffett, his partner Charlie Munger, Nobel Laureates Paul Samuelson, William Sharpe, and Gary Becker (Princeton’51); respected endowment fund managers from Yale (David Swenson) and Harvard (Jack Meyer). Innumerable financial professors including Burton Malkiel (Princeton ’64). Journalists, financial authorities—the list is almost endless. What’s more, the giant $140 billion Federal Thrift Savings Plan is invested largely in index funds, along with trillions of dollars in the nation’s public and private pension plans. But perhaps the crowning endorsement comes from investors who have actually owned Vanguard 500 Index Fund during its entire history. Let me present a specific example: at a dinner held in September, 2006, celebrating the 30th anniversary of the fund’s initial public offering, the counsel for the fund’s underwriters reported that he had purchased 1,000 shares at the original offering price of $15.00 per share—a $15,000 investment. He proudly announced that the value of his holding that evening (including shares acquired through reinvestment of the fund’s dividends and distributions over the years) was $461,771. Of course that was a year ago. At the close of business yesterday, the value was $543,657. There’s a number that requires no comment!

All I’m trying to do is make sure that those who earn their livings from work and from trade get a fair shake. Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient. Harvard Business School Professor Rakesh Khurana was right when he defined the standard of conduct for a true professional with these words: “I will create value for society, rather than extract it.” And yet money management, by definition, extracts value from the returns earned by our business enterprises. Warren Buffett’s wise partner Charlie Munger lays it on the line: “Most money-making activity contains profoundly antisocial effects . . . As high- cost modalities become ever more popular . . . the activity exacerbates the current harmful trend in which ever more of the nation’s ethical young brainpower is attracted into lucrative money-management and its attendant modern frictions, as distinguished from work providing much more value to others.” Yet even as I speak tonight, I read that this brainpower is pouring into financial services at a breathtaking rate. Today, the number CFAs (Chartered Financial Analysts) is at a record high of 78,000, and Barron’s recently reported that “no fewer than 140,000 new applicants—also a record high—from every corner of the earth are queued up to take the exams that will confer on the lucky ones the coveted (CFA) imprimatur.