2006

A Life, a Career, and a Mission to Build A Better Financial World for Investors Remarks by John C. Bogle, Founder, The Vanguard Group at the “Fabulous Philadelphian Speaker Series” Merion Cricket Club Haverford, PA October 10, 2012 There’s a Biblical saying, from Mark 6:4, that “a prophet is without honor in his own country, and among society in his kindred home town.” There’s doubtless a lot of careers to which that message applies, but there’s surely no evidence of it here in this room tonight. A full house, so many friends of my long lifetime, members of my family. It is actually you who are the “Fabulous Philadelphians” for whom this speaking series is named. Thank you all for coming! I’m going to cover a lot of ground in my remarks. For those of you who are interested in the human side of business, I think you’ll like the first part of my talk; if you’re into finance, the middle part; and if you follow the stock market; the last part. And for the infinite number of subjects I haven’t touched, I’ll leave plenty of time for questions and answers at the end. Since my career, in a sense, began right across Montgomery Avenue from here almost 70 years ago, I decided to title my remarks this evening, “A Life, a Career, and a Mission to Build a Better World for Investors.” For I want to emphasize that, along with the eternal mathematical dynamics of our financial system, the human element inevitably plays a major role.

A Community of Character Remarks by John C. Bogle Founder and former Chief Executive, The Vanguard Group On receiving the 2008 Bonnell Award From the Community College of Philadelphia for “Embodying the Ideals of Innovation, Vision, and Determination” At the 2nd Annual Pathways Breakfast December 16, 2008 Thank you, Mayor Michael Nutter for that glowing and infinitely generous introduction, for your support of the Community College of Philadelphia, and for honoring us with your presence in what I’m sure is yet another busy day as you fulfill your awesome responsibilities as a big-city mayor in a tough economic environment. I’m deeply honored to accept the Bonnell Award from our Community College even as I fear you over-rate me in terms of my credentials as an innovator and a visionary. (Perhaps you’re right about the determination!) As most of you in this audience know, Dr. Allan T. Bonnell was the founding president of the college, and served as its leader from its inception in 1965 until retiring from that post in 1983. Dr. Bonnell is with us this morning, and I ask you to join me in recognizing his pioneering leadership of this great institution. Thank you, too, Dr. Stephen Curtis for continuing that leadership. In my effort to understand the work of CCP, I came upon the Summer 2008 issue of your Pathways magazine. There, I learned that I am but the second person to receive the Bonnell award.

Business and Its Publics Reflections by John C. Bogle, Vanguard Founder At the NYU Stern School of Business February 25, 2008 I’m delighted to have the opportunity to speak with you here at NYU/Stern, for a whole variety of reasons: ∑ First, because I’m fascinated by the subject of how business relates to its many publics, and in particular to the media. After all, the opinions held by the general public—the well-informed, if you will, “man on the street”—are largely shaped by what our magazines and newspapers, and our television sets and radios present to us. ∑ Second, because I’m honored to join my friend Tunku Varadarajan on the platform. You’ve seen one of his uncompromising articles (on the Murdoch family), and I’ve had the pleasure of writing twelve op-ed pieces for The Wall Street Journal, most under his aegis as opinion page editor. About half of them pressed my case to reform the industry (you’ve seen “The Spitzer Effect”); many others include pieces that he pushed me to write, often, truth told, when I wasn’t sure I had the ability to deliver. (“Don’t Look for Me at Davos” is a good example.) Hint: under the best of circumstances, some sort of mutual respect between businessmen and journalists result in a synergy that produces a powerful force for public knowledge and education.

Financial Management: Profession or Business? Keynote Address by John C. Bogle Founder, Vanguard Group CFA Society of Philadelphia – 70th Anniversary Gala The National Constitution Center, Philadelphia, PA September 25, 2013 It’s wonderful to speak before this capacity crowd as you celebrate the 70th anniversary of the CFA Society of Philadelphia’s founding in 1943. You are a Philadelphia financial institution that has been around longer than I have, but only a bit longer. In July of 1951, I started my business career at Wellington Management Company, so we go back a long time together— 62 years! The topic I’ve selected for my keynote remarks is “Financial Management—Profession or Business?”, a shared interest among all of us here this evening. Let me begin by totally endorsing the stated mission and values of the CFA Institute: “to lead the investment profession globally by promoting the highest standards of ethics, education, and professional excellence for the ultimate benefit of society.” This statement about professionalism and responsible behavior by CFA members reminded me of an article I read in Daedalus, the Journal of the American Academy of Arts & Sciences, in 2005.1 Its theme was that, over the previous 40 years, the nation’s professions had gradually “been subjected to a whole new set of pressures, from the growing reach of new technologies to the growing importance of making money.

“Uneasy Lies the Head that Wears the Crown” Remarks by John C. Bogle, Vanguard Founder On Receiving the First FUSE Research Network Award For Lifetime Impact and Commitment to Investors Boston, Massachusetts October 26, 2010 Recent reports trumpeting Vanguard’s coronation as the world’s largest mutual fund manager was, for me, more a time for reflection than a time for celebration of the ascent to industry leadership of that little company that began in 1974 with $1 billion in assets under management and just 28 crewmembers. Even more, it was a time to place our firm’s achievement in the context of the mutual fund industry’s now-76-year history. Which firms preceded us in holding the industry’s asset-size crown? How long did they wear their crown? Why did they lose it? Who took it from them? Where do they rank today? My research led me to one clear conclusion: Uneasy lies the head that wears the crown. * The first fund firm to wear the crown was Massachusetts Investors Trust, America’s first mutual fund. Founded in 1924, MIT held the crown from its inception through 1953, a remarkable reign of 29 years of leadership. At its peak, MIT’s share of industry assets (including the assets of its sister fund, Massachusetts Investors Growth Fund) reached 15 percent in 1950. * Shakespeare wrote this phrase in a short soliloquy by Henry IV, in Part II of the play that bears his name. He was to wear the crown of England for only fourteen years, dying in 1413.management

In the Fund Industry, Mutuality and Indexing Rule the Seas A Conversation with John C. Bogle Founder, The Vanguard Group National Rural Utilities Cooperative Finance Corporation Conference on Capital Ideas: Powering into the Future Chantilly, VA November 13, 2012 As the founder of Vanguard way back in 1974, it’s a special honor for me to have this opportunity to discuss our truly mutual structure, and how it is at last beginning to reshape the mutual fund industry. And it seems particularly appropriate, for much like your organization, Vanguard is also a “cooperative.” Our vision, our mission, our principles, and our values are very much like yours. Paraphrasing CFC’s stated mission, “our goal is not to maximize our income, but to offer our shareholders affordable financial products and services, consistent with sound financial management.” So-called mutual funds—they’re not really mutual at all—are quite different; they are largely corporate shells, diversified portfolios of stocks and bonds with no employees of their own. Their few corporate officers usually hold the same posts with the funds’ management company, which organizes the funds, operates them, and provides, in return for a substantial fee, essentially all of the services necessary for the funds’ existence. These services include administration; portfolio strategy and investment selection; and distribution of fund shares to the public. The fund is, from birth, a captive of its management company/adviser.

When Yale's Nayan Chanda interviewed him in April 2006, Infosys was about to mark its twenty-fifth anniversary and had grown from a 1981 founding on two hundred and fifty dollars of capital into a firm with a market capitalisation of roughly twenty-two billion dollars. Murthy attributed the rise to luck, timing, and an early bet on two converging paradigms: the PC revolution and globalisation.

A Tribute to Bernard Lown, M.D. by John C. Bogle Boston, Massachusetts September 13, 2008 It would be impossible for me to cover the many highlights I found in Bernard Lown’s inspiring new book, Prescription for Survival. But one theme inspires my brief remarks this evening. In his book, Bernard cites one of my favorite passages from Shakespeare’s Henry IV, Part I. There Glendower boasts, “I can summon spirits from the vasty deep.” To which Hotspur replies, “Why so can I, or so can any man. But when you summon them, will they come?” Through Hotspur, the Bard is making the point that while many of us have the audacity to summon the spirits, precious few of us have the power to make them come. Bernard Lown, of course, is among that precious few. He has summoned the spirits of the world—let’s call them the public opinion of the citizens of the globe—to take arms against nuclear madness, and the spirits came. And our honoree, as much as any human being, has made our world a little better. But of course you all know the story of these remarkable macro-accomplishments in the name of mankind, and you’ll hear much about them on this fantastic evening. But as a two- decade patient of Dr. Lown, I’d like to speak of his micro-accomplishments: summoning the spirits of his patients and making them come. By dint of his powerful character and brilliant mind, Dr.

Straight from the Heart “Efficiency and Humanity, in Medicine and Finance” Remarks by John C. Bogle, Vanguard founder as the Inaugural Recipient of the Bernard Lown Humanitarian Award at the Mandarin Oriental Boston, MA May 17, 2012 Thank you so very much, Dr. Lown—Bernard—for your generous introduction. It is an incredible (and, I fear, undeserved) honor to be named as the inaugural recipient of your Humanitarian Award. As my cardiologist from 1967 to 1987, you kept me alive, active, and engaged in life for most of the years between my first heart attack in 1961 and my heart transplant in 1996. Without your skilled care and caring I would not be here in Boston tonight, or even here—on this earth. Equally important, our friendship now goes back 55 years, during which you have been my confidante and my conscience, always calling on me to press on in my profession—struggling to make it a better, fairer, more sensible system for our nation’s citizen/investors. Strange as it may seem, both finance and medicine ultimately seek efficiency and humanity. The Oxford English Dictionary II defines a humanitarian as “one who devotes himself to the welfare of mankind at large.” And while your universe of devotion to medicine is far

Economics, Politics, and the Financial Markets Remarks by John C. Bogle, Founder The Vanguard Group Former Chairman of the Board of Trustees of Blair Academy Blair Academy Reception New York, NY October 14, 2008 I guess that it’s fair to say that the timing of this gathering is, well, fortuitous. Better, I suppose, that I should speak to you after a 900-point rally in the Dow Jones average than speak to you just a few days ago, after a precipitous seven day decline of 2400 points, the culmination of a 40 percent decline from last October’s high. But this evening comes not only in the midst of infinite turmoil in the financial markets, but at the confluence of profound economic challenges (the global banking crisis, the collapse in home prices, and the onset of recession), and the portent of profound political change (our presidential election is exactly three weeks away). One might think that this turmoil has captured the rapt attention—and deep concern—of the American public. But one might be wrong, too. Here, for example, are the hottest searches on NYTimes.com during the week of September 28-October 4. Steve Fossett Elisabeth Hasselbeck FDIC’s failed bank list Heather Locklear Guitars for sale Angelina Jolie

Thinking About What Lies Ahead For Investors Remarks by John C. Bogle, Founder, The Vanguard Group at the CFA Society of Washington Washington, DC June 13, 2012 I’m honored by your invitation to return to our Nation’s Capital to provide some perspectives on the current investment environment, and to offer some reflections on the challenges that lay ahead for investment professionals, and of course for our investors as well. I’ll begin by discussing one of the great basics of investing—the simple sources of stock returns—so often overlooked by the short-term horizon s that drive the strategies of so many investors (or is it “speculators”) today. Then I’ll present some reasonable expectations for future returns, and give you my blunt appraisal of the typical 8 percent return assumption that most pension funds are relying on to meet future benefit obligations. I’ll close with some reflections on the many difficult challenges that investors face today. I. The Basics of Investing Let’s begin with some fundamentals. Stock prices, in fact, are derivatives. True! Their value is derived from the present value of a corporation’s future cash flows, in which stocks represent an ownership share. In other words, stocks represent an investment in the intrinsic value of a firm. Sellers decide, in effect, that they will capitalize on the value of those future flows, and buyers use their capital to acquire those flows. In the long run, it is these economics that drive stock price returns.

Investing in Times of Market Turbulence Remarks by John C. Bogle Founder and former chief executive, The Vanguard Group The Millennium Lecture Series The Princeton Club of New York New York, NY January 28, 2008 These are turbulent days in the financial markets, and market participants are looking for answers about what they should do. But my answers depend on just who it is that is asking the questions. This distinction is as unique as it is self-evident. If the questioner is a speculator, buying and selling stocks with the focus on their momentary prices, inevitably acting on emotions, and guessing (usually fruitlessly) about how other investors here in the U.S. and around the globe will respond to unpredictable volatility in the world’s stock markets, I’m not sure I have the credentials to advise him. But if I did, I’d say— as I’ve been saying since early August when the U.S. market reached its high—“Get out. And stay out.” At least until the markets settle down a bit. (Of course, I have no ideas when that might be.) If, on the other hand, the questioner is an investor, holding a highly-diversified balanced portfolio that includes bonds and both U.S. and global stocks, with the equities focused on the economics of investing—the dividend yields and potential earnings growth of our corporations— not the emotions reflected in the actions of speculators, I’d say, as I also did last summer: “Don’t do something, just stand there.” Or, perhaps more graciously, “Stay the Course.

The Fiduciary Principle: “No Man Can Serve Two Masters” A Lecture by John C. Bogle Founder and former chairman, The Vanguard Group Columbia University School of Business New York City, NY April 1, 2009 This evening, we meet at a time of financial and economic crisis in our nation and around the globe. I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that “a man cannot serve two masters.” No thinking man can believe that an economy built upon a business foundation can permanently endure without some loyalty to that principle. The separation of ownership from management, the development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to that principle if the modern world of business is to perform its proper function. Yet those who serve nominally as trustees, but relieved, by clever legal devices, from the obligation to protect those whose interests they purport to represent, corporate officers and directors who award to themselves huge bonuses from corporate funds without the assent or even the knowledge of their stockholders . . .

John C. Bogle Opening Remarks The John C. Bogle Legacy Forum Museum of American Finance New York, NY January 31, 2012 I know of no precedent for Wall Street (as it were) honoring one of its own, marking a legacy of 60 years in the investment profession. (Not so many souls hang around that long!) So I’m greatly honored, truly humbled, and profoundly appreciative that so many industry leaders, financial and academic professionals, friends and colleagues, are joining in this wonderful day of celebration. I’ve done the best I could to build a better world for investors. Yes, in Philadelphia the press has described me as an entrepreneur, creator, inventor, and citizen, and even compared me—not unfavorably—with Benjamin Franklin . . . But Walter Isaacson, having completed his biography of Franklin some years back, next turned to Albert Einstein, and then, only a few months ago, to Steve Jobs. I’m not hanging by my thumbs awaiting Mr. Isaacson’s phone call (nor his note on my iMac). Yes, I did start the world’s first index mutual fund (though lots of people claim to have thought of it long before I did so). It is now the world’s largest equity fund . . . But the index fund concept represents the essence of simplicity, the triumph of Occam’s Razor. It required no genius, and so I’ve never won a MacArthur “Genius” grant (and don’t deserve one).

Aspiring to Build a Better Financial World Remarks by John C. Bogle Founder and former chief executive of the Vanguard Group at the 2009 Jake McCandless ’51 Princeton Varsity Club Speaker Series Princeton, NJ April 30, 2009 Honored as I am to be part of the Varsity Club Speaker series, I must confess that I have never been much of an athlete. Alas, my driving determination to compete and to win—whether in life or in business—was all too inadequate to overcome my lack of might and muscle and coordination on the fields of athletic combat. Yet for many reasons, I feel qualified to address you this evening. Even before I entered Princeton as a freshman in 1947, I’ve been a ferocious fan of Tiger sports, reveling in victory and disconsolate in defeat. (It is only in my later years that I came to understand, that, having been witness to both triumph and disaster, I should accept Kipling’s advice, and “treat those two imposters just the same.”) My claim to legitimacy is further buttressed by my credentials as manager of the Athletic Association Undergraduate Ticket Office during my final two years at Princeton. In the early 1950s, we fielded undefeated football teams, and apportioning tickets when Palmer Stadium was sold-out, Saturday after Saturday, was no easy task. But the pay was pretty good, and it was a job that played to my talents, however limited.

The Culture That Gave Rise To The Current Financial Crisis Presented by John C. Bogle, Founder and former Chief Executive The Vanguard Group At the Seventh Annual John M. Templeton, Jr., Lecture on Economic Liberties and the Constitution National Constitution Center Philadelphia, PA May 13, 2009 I recently received a letter from a Vanguard shareholder who described the current global financial crisis as “a crisis of ethic proportions.” Substituting ethic for epic is not only a fine turn of phrase; it accurately places a heavy responsibility for the meltdown on a broad deterioration in traditional ethical standards. In fact, The Wall Street Journal retained that phrase as the title of my op-ed essay that was published just three weeks ago. Relying on Adam Smith’s “invisible hand,” through which our own self-interest is said to advance the interests of our communities, our society had come to rely less on strict regulation to govern conduct in the field of free enterprise—in commerce, business, and finance—and to rely more on open competition and free markets to create prosperity and well-being, and to add value to our society. But that self-interest got out of hand, and it spread to the very core of our national culture. Simply put, we became what has been called a “bottom line” society, one in which progress and success are largely measured in monetary terms.

Zhang was born Zhang Xiuhua in 1957 in Shaoguan, Guangdong, the eldest of eight children; her father, a Red Army lieutenant, was jailed for three years during the Cultural Revolution for 'rightist activity,' which meant Zhang never attended college and began working young to support her family.

“When a Man Comes to Himself” A Commencement Address by John C. Bogle Founder and former chief executive, The Vanguard Group1 at The Williamson Free School of Mechanical Trades Media, PA May 28, 2009 First of all, hearty congratulations to each one of you on graduation from this wonderful school. I imagine that Isaiah Vansant Williamson, the man of Scots heritage who founded your school some 120 years ago, is looking down on you from above on this bright afternoon, quietly reveling as 61 of those whom he called “his boys” are handed the diplomas that recognize that you have stayed the course; you have completed it successfully; you now begin a new course in your life. You are no longer boys; you have become men. And somewhere along the long road of life that will follow, each of you will “come to yourself,” an expression that, sadly, has fallen out of use. That is my theme today, inspired by an essay entitled “When a Man Comes to Himself,” written in 1901 by Woodrow Wilson, shortly before he became president of my own alma mater, Princeton University. In 1912, Wilson would become the 28th president of the United States of America. When does a man come to himself? When do you learn who you are? When do you find your place in society? There is no fixed time; we come to ourselves on our own schedule.

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.

Comments by John C. Bogle, Founder and Former Chairman of The Vanguard Group On the Concept Release on Auditor Independence and Audit Firm Rotation Submitted as Written Testimony for the PCAOB Public Hearing March 21, 2012 * * * I’m pleased to have this opportunity to comment on my general views on auditor independence and specific views on audit firm rotation. I have been an observer of and participant in auditing issues throughout my 60-year career, most recently as one of four independent members of the Independence Standards Board (from 1997 to 2001, when it ceased operations), appointed by SEC Chairman Arthur Levitt, where we worked with the four CEOs of the major accounting firms to establish more rigorous standards for assuring that our public accountants remained truly independent of the firms that retain them for attestation services. (As it quickly became obvious, that was no mean challenge!) Earlier in 1991 I was named by SEC Chairman Richard S. Breeden to The Market Oversight and Financial Services Advisory Committee. In the private sector, as Vanguard’s chairman, and earlier, as CEO of Wellington Management Company, I was responsible for recommending the appointment of the auditor for our management company and the mutual funds we manage to our Board, and did not do so casually. Along the way, we replaced our long-time auditor Main & Co., with Price Waterhouse. (No enviable task!) But the process was smooth and essentially cost-free to our firm.

In a 2006 Wharton interview Nadar framed HCL's beginning at DCM's calculator division, where he and fellow engineers noticed that the programmable calculators of the day were the forerunners of personal computers; convinced they could build an eight-bit machine, they pitched the idea to India's Electronics Commission, which asked them to write a feasibility report.

If You Can Trust Yourself . . . Remarks by John C. Bogle, Founder and former chief executive, The Vanguard Group To the Student Body at the Roxbury Latin School Roxbury, MA March 30, 2009 It’s a special honor for me to have the opportunity to speak to you young gentlemen of Roxbury Latin School. I hardly need tell you that your school is widely considered to be among the best schools—some say the best—in America. I’m particularly proud to have your schoolmate, my grandson and namesake, John Bogle III, here in the audience. Believe it or not, gentlemen, we have a lot in common. I was once your age—yes, once a seventh-grader, and finally a twelfth grader, and there is much about those years that I carry in my mind to this day—memories of my classmates and especially of my teachers, whom I’ve come to describe as “characters who had character.” They demanded of us boys not only that we study and learn, but that we held high values and developed in ourselves the kind of character to which we were witness every day. I have no doubt that you are finding the same experience right here. What’s more, like Roxbury Latin, Blair Academy, the superb school in New Jersey where I spent my final two school years, was an all-boys school. And so, for that matter, was Princeton University (I guess I should say, “all-men’s school”), where I spent the following four years.

Ethical Principles and Ethical Principals Remarks by John C. Bogle, Founder and former chief executive The Vanguard Group ∞ ∞ ∞ Upon receiving The Exemplary Leadership Award from The Center for Corporate Excellence at The “Charging the Game” Forum Denver, CO November 1, 2006 I’m deeply honored to receive your award. During my now 55-year career in the mutual fund industry I’ve done my best to meet your standard of “consistent ethical leadership.” But I freely confess that, perhaps like all of us, I could have provided even more leadership toward a better corporate and investment America. In whatever years may remain, I pledge to you this evening that I will “press on, regardless” in this quest.1 The title of my remarks this evening arises from, of all things, a typographical error. In a mailing sent out by the Center for Corporate Excellence earlier this year to announce that General Electric would receive your Long Term Excellence in Corporate Governance award, you quoted GE President Jeffrey Immelt on the importance of “sound principals of corporate governance.” But while the quotation said, yes, principals, it clearly meant principles. I can’t help myself from noticing that sort of stuff (query whether it’s a strength or a weakness!), and as I did, it occurred to me that there might be a speech in that distinction.

The Joy of Writing— Books, Ideas, Advocacy, and Idealism Remarks on “The Battle for the Soul of Capitalism” by John C. Bogle Founder and former chief executive The Vanguard Group Chairman of the National Constitution Center The Free Library of Philadelphia Philadelphia, PA November 20, 2006 Only a few weeks ago, following my regular completion of the Sunday crossword puzzle in The New York Times Magazine, I worked my way through the acrostic puzzle immediately below it. (The acrostic is a tougher challenge, so I rarely take it on.) I got lucky, completed it, and found in the solution a quotation that provides a nice way to introduce my remarks this evening. 1 The quotation is from Umberto Eco’s The Name of the Rose. Here’s how it read: “A book is a fragile creature. It suffers the wear of time. It fears rodents, the elements, and clumsy hands. So the librarian protects the books against nature and devotes his life to this war with the forces of oblivion.” This quotation seemed particularly appropriate for my own books. For they are not only my way of fighting a war against the forces of oblivion but even more, to change the way that investors think about our financial system. So, I’m deeply honored to be here at the Free Library of Philadelphia to talk about why I love to write, with the focus on my latest book, The Battle for the Soul of Capitalism. 1 I also learned one new word. The definition of “handy manual, from the Greek.

America’s Financial System—Powerful but Flawed A Lecture By John C. Bogle, Vanguard Founder The Phi Beta Kappa National Lecture Series Temple University, Philadelphia, PA November 3, 2010 In all of the talk about the causes of the deep-seated challenges facing our nation— globalization, enormous indebtedness, huge unemployment, the severe recession from which we are now only tentatively emerging, and the stock market crash of 2008-2009—too little attention has been paid to the critical role played by our financial system. Classical economics has tended to make a distinction between the real economy—the production and consumption of goods and services—and the paper economy—the vast network of financial assets and liabilities that is, finally, supported by the productive economy. The fact is that our productive economy and our financial economy are closely, indeed inextricably, interlinked. The principal role of our nation’s financial institutions is to allocate scarce investment capital among our corporations and economic sectors in a way that maximizes the growth potential of our economy. But changes in our financial sector have undermined this goal.

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.

WESCO FINANCIAL CORPORATION LETTER TO SHAREHOLDERS To Our Shareholders: Consolidated net ""operating'' income (i.e., before realized investment gains shown in the table below) for the calendar year 2006 increased to $92,033,000 ($12.93 per share) from $77,973,000 ($10.95 per share) in the previous year. Consolidated net income decreased, from $294,579,000 ($41.37 per share) in 2005, to $92,033,000 ($12.93 per share) in the current year. Wesco has four major subsidiaries: (1) Wesco-Financial Insurance Company (""Wes-FIC''), headquartered in Omaha and engaged principally in the reinsurance business, (2) The Kansas Bankers Surety Company (""Kansas Bankers''), owned by Wes-FIC and specializing in insurance products tailored to midwestern banks, (3) CORT Business Services Corporation (""CORT''), headquartered in Fairfax, Vir- ginia and engaged principally in the furniture rental business, and (4) Precision Steel Warehouse, Inc. (""Precision Steel''), headquartered in Chicago and engaged in the steel warehousing and specialty metal products businesses. Consolidated net income for the two years just ended breaks down as follows (in thousands except for per-share amounts)(1) : Year Ended December 31, 2006 December 31, 2005 Per Per Wesco Wesco Amount Share(2) Amount Share(2) Operating earnings: Wesco-Financial and Kansas Bankers insurance businesses Ì Underwriting ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $ 5,164 $ .73 $ 11,798 $ 1.

Reflections on the Importance of History- Milestones, Men, and a Moral Society Remarks by John C. Bogle, Chairman, The National Constitution Center And Founder, The Vanguard Group ∞ ∞ ∞ Celebrating 300 years of Presbyterian History Pine Street Presbyterian Church, Philadelphia, PA November 16, 2006 I’m deeply honored by the invitation to address you this afternoon and to salute the Presbyterian Church as we celebrate her 300 th birthday, right where she was born in this City of Brotherly Love. Over these past three centuries, Presbyterianism has moved far beyond the inspiration of its seven founders, with their leader, Francis Makemie, among those six larger- than-life statues that guard the Presbyterian Historical Society, just a few blocks from here. 1 Perhaps they are watching right now to see whether today’s leaders of the church can measure up to their doubtless lofty standards, and whether these leaders continue to protect the ideas and ideals that these giants of yore brought to their relatively new Christian denomination. In the context of this historical milestone, this afternoon I’d like to stimulate your own ideas about history—“the narrative of human affairs and actions”—by focusing on three of its aspects: milestones, men, and a moral society. But please don’t miss the backstory. No talk like this could possibly be prepared without the archivists and historians who honor our heritage by preserving its documents.

Building a Fiduciary Society Remarks by John C. Bogle Founder and former Chairman, The Vanguard Group IA Compliance Summit Washington, DC March 13, 2009 Not so long ago, Rahm Emanuel, President Obama’s chief of staff, expressed one of the eternal verities of our society: “Never allow a crisis to go to waste. (Crises) are opportunities to do big things.” That principle applies in a particularly profound way to the financial sector of our economic society. The crisis in our stock market and in our economy has presented us with the opportunity to do a really big thing—to reform our financial system. Over the past half-century, that system has changed radically, and for the worse. Our old ownership society, in which stocks were owned largely by individuals is long gone and will not return. Its successor, the agency society, now prevails, institutional money managers holding and trading the lion’s share of U.S. stocks and operating in their own financial interests. The present crisis is, in important measure, a reflection of that change, and it gives us the opportunity to build, out of the ashes of our failed agency society, a new fiduciary society in which the interests of the investors who put their capital to work come first. The Financial Crisis There’s no doubt that we have a financial crisis on our hands. In my long career in finance, going way back to 1951, I’ve witnessed ten bear markets (defined as stock market _______________ John C.

How Calvin Coolidge Could Guide Us Now Remarks by John C. Bogle Founder and Former Chief, The Vanguard Group Before the 50th Anniversary Symposium of the Calvin Coolidge Memorial Foundation John F. Kennedy Presidential Library and Museum Boston, Massachusetts October 7, 2010 I’m deeply honored to offer these closing remarks at this 50th Anniversary Symposium honoring Calvin Coolidge. Earlier today, you heard from experts on his life and times, discussing his strategic vision, his political philosophy, his values, his political instincts, and even more. It would be presumptuous of me to tread again the ground trod by these experts, so let me take this opportunity to discuss some of what I see as Coolidge’s wisdom, and how he might guide us were he living in this perilous era for our nation—an era nonetheless fraught with opportunity—in which we find ourselves as we gather this evening. I’ve never thought of myself as a businessman, nor as an entrepreneur, but rather as one who’s done his best to serve investors, and to force others who lead our giant investment institutions to do the same. In my modest sphere, I emulate—that is, to be clear, to strive to equal—the traits of character which we all associate with “Silent Cal” (although no one has ever called me “Silent Jack.” To the contrary!)

Economic Markets and Public Purpose (With Some Reflections by Adam Smith) A Lecture by John C. Bogle Founder and Former Chairman, The Vanguard Group Before The Reinvestment Fund’s 24th Annual Celebration Philadelphia, PA June 11, 2009 It seems almost fated that I’d come to address you during these days of crisis in our economy and travail in our financial markets, for we have much in common. Both the Reinvestment Fund and The Vanguard Group—the firm that I created almost 35 years ago—are financial service organizations that were created to march to a different drummer, organizations that have done their best to set a new standard—to “rediscover a public purpose,” using a phrase from the title of the recent monograph authored by your Jeremy Nowak and Ellen Seidman—in our investment sector, putting service to the community (in your case) and service to investors (in our case) before service to self. The sad fact is that it is in the field of finance where the seeds of our economic crisis and market travail were sown. The financial sector is easily enough seen as a monolith, driven by opportunism rather than service, by marketing rather than management, by self-interest rather than community good, by complexity rather than simplicity, by short-term speculation rather than long-term investment, and by salesmanship rather than stewardship. Vanguard is among the few—the very few—exceptions to this profile, so it is only appropriate that we meet together today, in common cause.

Building a Better Financial System Remarks by John C. Bogle Founder and former chief executive, Vanguard To “The Old Guard” at Princeton University Princeton, NJ November 7, 2007 It’s always a delight to return to the old stomping ground where I received such a great education and a fabulous start to my long career in finance. During this 55-year period, I’ve developed a strong point of view regarding the nature, the structure, and the efficiency (or, truth told, the inefficiency) of our financial system. In my fifth book, The Battle for the Soul of Capitalism, published by Yale University Press in the autumn of 20051 I’ve explored these issues in depth. 1. Basic Values The fact is that the basic values I hold about investing were formed during my four years studying at Princeton University as an undergraduate. Here, almost exactly 58 years ago, I happened upon the December 1949 issue of Fortune magazine and learned for the first time that something called “the mutual fund industry” existed. When I saw the industry described in the article as “tiny but contentious,” I knew immediately that I had found the topic for my senior thesis, then as now, a requirement for the Bachelor of Arts degree. Over the next 18 months, I spent countless hours researching and writing my thesis. Remarkably little public information was available about this field, then consisting of some 130 mutual funds with assets aggregating just $2½ billion.

Ethical Principles and Ethical Principals Remarks by John C. Bogle, Founder and former chief of Vanguard at The Johnson School at Cornell University Ithaca, New York November 11, 2010 I’m so pleased to return to Cornell and the Johnson School, and honored to have the opportunity to give the inaugural David BenDaniel Lecture Series in Business Ethics. I’ve reviewed the impressive reading list for the Business Ethics course, and was especially struck by the short essay by Professor Radcliffe and by the longer essay by Steven Pinker. Professor Radcliffe reminds us of the obligations that we in business and finance owe to our colleagues, our employees, our companies, our communities, and indeed to our nation. Dr. Pinker makes a strong case that “moral goodness is what gives each of us the sense that we are worthy human beings,” and identifies what he calls “the five spheres” of morality—avoidance of harming others, fairness, community (or group loyalty), authority, and purity. I loved his prophetic concluding quote from Chekov: “Man will become better when you show him what he is like.

The U.S. Financial Sector and the Relentless Rules of Humble Arithmetic Remarks by John C. Bogle Founder and former chief executive, Vanguard at New York University New York, NY November 14, 2007 A few years ago, when I was re-reading Other People’s Money, by Louis D. Brandeis, I came across a wonderful quotation. In his book, first published in 1914, Brandeis—who would later become one of the most influential jurists in the history of the U.S. Supreme Court—railed against the oligarchs who a century ago controlled financial America and corporate America as well. He described their interlocking and self-serving interests as, “trampling with impunity on laws human and divine, obsessed with the delusion that two plus two make five.” He predicted (accurately, as it turned out) that the widespread speculation of that era would collapse, “a victim of the relentless rules of humble arithmetic.” He then added this unattributed warning—I’m guessing it’s from Sophocles—“Remember, O Stranger, arithmetic is the first of the sciences, and the mother of safety.” These words hit me like the proverbial ton of bricks. Why? Because the relentless rules of the arithmetic of investing are so obvious, and recognizing the obvious has, I think, been a major contributor to my career. Indeed, it’s been said (by my detractors) that all I have going for me is “the uncanny ability to recognize the obvious.

The Coming Market Environment and Implications for Financial Innovation Remarks by John C. Bogle, Founder and former Chief Executive The Vanguard Group Before the Financial Planning Association (FPA) Retreat Weston, Florida June 2, 2008 I’m honored by your invitation to address this 2008 Financial Planning Association Retreat. Ever since Vanguard began, now almost 34 years ago, I’ve considered our firm as the natural ally of your firms, for a whole variety of reasons. While I’m not here today to plump for Vanguard, I believe that understanding what these reasons were will set a firm foundation for my remarks: 1. Common Goals. Our primary role is to provide diversified portfolios of securities—whether stocks or bonds, indexed or not—that deliver returns that are highly predictable relative to peer funds with comparable objectives and comparable portfolios. Surely that strategy constitutes the core of the strategies followed by most financial planners. 2. Combined Costs. We believe—passionately!—in providing our services at the lowest possible cost—low expense ratios, minuscule advisory fees (or none!), no sales loads, nominal portfolio turnover costs, and minimal drag from taxes—all with the goal of enabling your clients to garner the highest possible share of the returns that our funds deliver. Result: when we combine our costs with your fees, the total cost is nearly always far below the total costs of most funds . . .

Shi, an identical twin (his brother Chen Henglong is also a tycoon), studied at Changchun University of Science and Technology, earned a master's at the Shanghai Institute of Optics and Fine Mechanics, then obtained a doctorate in solar power technology at the University of New South Wales under Professor Martin Green, acquiring Australian citizenship along the way.

Remarks by John Bogle On Receiving The 2016 Bob Edgar Public Service Achievement Award Presented by Common Cause Pennsylvania Pyramid Club - Philadelphia June 7, 2016 Thank you, Ed Haldeman, man of principle, my accomplished friend and my regular breakfast companion, for that lovely introduction. And thank you, Common Cause of Pennsylvania, for the honor you bestow on me this evening with the Bob Edgar Public Service Achievement Award. It’s inspiring for me to read the words on the award, “John Bogle, who, by force of imagination, initiative and perseverance has made an outstanding contribution to the public interest in the areas of government performance and integrity.” I’ve been a huge admirer of Common Cause ever since the early 1970s, when I first learned about your noble mission of promoting open, honest, and accountable government. Surely during the next five months your voice will be needed more than ever. I’ve also been a long-time admirer of the late John W. Gardner, founder of Common Cause in 1970. His values, his integrity, and his gift for the wise aphorism place him in my Pantheon of Americans worth listening to and learning from. I was first inspired by John Gardner when, way back in 1968, I read his second book, No Easy Victories. ($4.95 at our local book store; weren’t those the days!)

Fiduciary Duty in an Age of Consumerism Remarks by John C. Bogle Before the “The Campaign for Investors” Sponsored by The Institute for the Fiduciary Standard The National Constitution Center, Philadelphia, PA May 24, 2016 On April 6, 2016, the U.S. Department of Labor (DOL) established a fiduciary duty principle— the requirement that investment advisers and brokers who give advice to clients holding retirement plans place the interests of investors first. One of the recent press reports on the rule headlined its story: FINALLY, JOHN BOGLE’S DREAM OF A FIDUCIARY STANDARD WILL COME TRUE. Yes, the new rule is complex, but previous comments from the fund industry have made it considerably more workable, with disclosures that are more practical and easier for advisers and brokers to follow. Nonetheless, the DOL fiduciary standard continues to face powerful adversaries. The U.S. Chamber of Commerce, as usual, places business interests ahead of consumer interests and, along with eight other groups, has filed a federal lawsuit seeking to block implementation of the new rule. But I strongly support the rule. I’ve arguably been campaigning for it ever since I wrote my senior thesis at Princeton University 65 years ago. There, I wrote at length about the use of mutual fund shares by fiduciaries and retirement plans, suggesting that such use “seems destined to increase in the future.

Ren has held the CEO title at Huawei continuously since 1988, and Wikipedia's infobox lists his Huawei vice-chairman tenure as running from the company's founding until November 2019, when Meng Wanzhou succeeded him in that vice-chair role.

Speaking at Stanford GSB's View From The Top series on 27 October 2006, Premji told students that failure is essential to innovation: you cannot generate a few good ideas without a lot of bad ones, and failures should be forgiven and forgotten quickly. The framing made risk-tolerance a structural requirement, not just a corporate slogan.

At the Summit Remarks by John C. Bogle, Founder, The Vanguard Group At the Tiburon Summit XX New York City, NY, April 13, 2011 I’m honored to be with you to receive the Tiburon Summit Award for my long service in the mutual fund industry. Of course I’m pleased to be here, but truth told—after being given fifteen extra years of life following my heart transplant in 1996—I’d be pleased to be anywhere this morning! In a certain sense, I’ll soon reach a certain summit of my own. On July 5, 2011, I’ll complete sixty years of active participation in the mutual fund industry. It was on July 5, all those years ago, when I walked into the offices of my first post-college employer—Philadelphia’s Wellington Management Company. I was nervous, green, and more than a little insecure, but ready to go to work with all the determination, ability, and enthusiasm I could command. I was on my way! Little could I imagine the exciting, bumpy, and often unpaved road that lay ahead when, after reading my Princeton thesis on the mutual fund industry, Wellington founder Walter L. Morgan hired me. “Mr. Bogle,” he generously wrote to our staff, “knows more about this business than we do.” (It was nice to read, but it couldn’t have been true.) In 1951, the firm was a (relatively) big fish in a (very) small industry. We ran but a single fund—the dominant business model of that era—the $120 million Wellington Fund, in an industry whose assets under management had only recently crossed the $3 billion mark.

HELPING OTHERS Remarks by John C. Bogle, Founder, The Vanguard Group On Receiving the “Others” Award from the Salvation Army Philadelphia, PA May 11, 2011 I am deeply honored to receive the “Others” Award of the Salvation Army, and pleased to have the opportunity to offer some brief reflections about the need, for each one of us here today, to reserve a fair portion of our busy lives for “giving back”—in the spirit of the award—for helping others in the community in which we raise our families, pursue our careers, and live our lives. In the hope of giving some deeper context to my remarks, I’ve taken the liberty of providing complimentary copies of my 2009 book—ENOUGH. True Measures of Money, Business, and Life— at each table. Now in its second printing, I was honored to receive a Foreword from President William Jefferson Clinton, a Prologue from best-selling author and business guru Tom Peters, and an endorsement from Yale Endowment Fund Manager David Swensen. Ironically, David found in the book the very message that I’d like to amplify today: “a challenge for each of us to aspire to become better members of our families, our professions, and our communities.” The Story of Enough. If I simply give you the titles of its ten short chapters, you’ll easily understand what Enough. is all about. Tom Peters described them as “the Ten Commandments:” ______________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management

∑ Third, because even before I joined the mutual fund industry—an opportunity greatly facilitated by the fact that I wrote my Princeton University senior thesis on it in 1949- 51—I was in fact a member of the media, a “stringer” for the long-gone Philadelphia Evening Bulletin, covering local news—auto accidents, police and fire activity, even an occasional murder—during the summer of 1949. I digress now to tell you of the most memorable moment of that apprenticeship, an event that made an impression on me that, arguably, shaped my whole career. On the theory that it is easier for us human beings to learn from the mistakes of others rather than from our own potentially costly mistakes, let me take a moment to tell you the story. Since The Evening Bulletin published a Sunday morning edition, we reporters worked every Saturday night.my

66 Investment income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 58,528 8.22 39,068 5.49 CORT furniture rental business ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 26,884 3.78 20,676 2.90 Precision Steel businesses ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ 1,211 .17 1,198 .17 All other ""normal'' net operating earnings(3) ÏÏÏÏÏÏÏÏÏÏÏ 246 .03 5,233 .73 92,033 12.93 77,973 10.95 Realized investment gains (4) ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ Ì Ì 216,606 30.42 Wesco consolidated net income ÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏÏ $92,033 $12.93 $294,579 $41.37 (1) All Ñgures are net of income taxes. (2) Per-share data are based on 7,119,807 shares outstanding. Wesco has no dilutive capital stock equivalents. (3) Represents income from ownership of the Wesco headquarters oÇce building, primarily leased to outside tenants, and interest and dividend income from cash equivalents and marketable securities owned outside the insurance subsidiaries, less interest and other corporate expenses. (4) Includes $216,112,000 ($30.35 per share) from the tax-free exchange of Wesco's common shares in The Gillette Company for common shares in The Procter & Gamble Company in connection with the merger of Gillette with Procter & Gamble. Although no cash was received, generally accepted accounting principles required that the gain be recorded. Because Wesco's balance sheet reÖects investments carried at market value, with unrealized gains, after applicable income tax eÅect, included in shareholders' equity, the transaction did not aÅect Wesco's shareholders' equity.

” But far more broadly, I wrote that, “the prime responsibility [of mutual funds] must always be to their shareholders.” And that’s precisely what our industry’s governing statute, the Investment Company Act of 1940, demands: Funds must be “organized, operated, [and] managed” in the interests of their shareholders, rather than in the interests of their directors, officers, investment advisers, or underwriters (distributors). __________________ The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

I loved those years, and while both Blair and Princeton are now co-educational, I hope that all-boy and all-girl schools will remain as options for our youth for as far ahead as we can see. ____________________ Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

During the years that followed, the company grew rapidly. In 1974, Vanguard became Wellington’s successor, and Wellington Fund, with assets now at $57 billion, remains one of our brightest stars. Combined with the assets of its now-170 siblings, that orphan of 1951 is part of a $1.65 trillion fund complex, the largest firm in a giant $12 trillion industry.management

Harvard’s corporate strategy guru Michael Porter advises people considering their careers to “pick a good industry,” and when I chose my *The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management. 1 I’m delighted to report that Battle for the Soul of Capitalism has been selected by Tiger Tomes as its “book-of-the-month” for the Princeton Alumni Education Program in April 2008. Please feel free to participate! http://alumni.princeton.edu/main/education_travel/home_study_programs/book_club/

” The authors listed a number of attributes that all professions share, including these three that are especially relevant to the work we all do: 1) a commitment to the interests of clients in 1 “The Professions in America Today: Crucial but Fragile,” Daedalus, Summer 2005, 13-18.

3. Client Focus. Our management company is owned and controlled by our own shareholders rather than by the national and international financial conglomerates that now largely control the fund industry. (41 of the 50 largest fund firms are now controlled by these giants.) Our unique structure is particularly relevant since the clients of financial planners and registered investment advisers—your clients—constitute a significant portion of our client base. When we serve them effectively, we serve you; when we serve you effectively, we serve them. Providing intelligent and productive financial planning advice to the “honest-to-God, down-to- earth human beings, each with their own hopes, fears, and financial goals” (a phrase I’ve used for decades) is, in my view, more demanding today than ever before. I make that observation only after careful consideration of how today’s financial environment differs from what has gone before. Today I’ll give you three poignant examples of that change:: 1. The folly of short-term speculation has come to dominate our financial marketplace; the wisdom of long-term investing has diminished commensurately. 2. Relative to historical norms, the outlook for future returns on stocks and bonds is, in a word, subdued. In such an environment, the temptation to go beyond traditional markets to garner extra returns is enormous. 3.

Murthy defined entrepreneurship as the courage to convert a powerful idea into wealth. He told YaleGlobal that the 1981 environment in India was deeply hostile to business, but that Infosys rode two parallel shifts: the falling cost of computing power unleashed software demand, and the globalisation paradigm made sourcing talent across borders acceptable.

Premji was introduced as the leader who transformed Wipro from a family-run vegetable oil business (Western India Vegetable Products Ltd) into one of the world's largest outsourcing companies over a roughly forty-year arc. The shorthand used in the West — from Crisco to computers — captured the sheer scale of the diversification in a single phrase.

” The curious irony, however, is that most people either seem to have difficulty recognizing what lies in plain sight, right before their eyes, or, perhaps even more pervasively, refuse to recognize the reality because it flies in the face of their deep-seated beliefs, their biases, and their own self-interest. Paraphrasing Upton Sinclair: “it’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.” But only by facing the obvious realities of investing will the intelligent investor succeed. ______________________ *The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

On Investing-- ∑ Too Much Cost, Not Enough Value ∑ Too Much Speculation, Not Enough Investment ∑ Too Much Complexity, Not Enough Simplicity On Business-- ∑ Too Much Counting, Not Enough Trust ∑ Too Much Business Conduct, Not Enough Professional Conduct Too Much Salesmanship, Not Enough Stewardship ∑ Too Much Management, Not Enough Leadership On Life-- ∑ Too Much Focus on Things, Not Enough Focus on Commitment ∑ Too Many Twenty-First-Century Values, Not Enough Eighteenth-Century Values ∑ Too Much “Success,” Not Enough Character My mission in writing the book was to provoke readers to think about these issues, and begin to move our society to a point where it has less of those attributes that we now have too much of, and more of those attributes of which (it seems to me) we have not nearly enough. Given our celebration today of the marvelous community service performed by The Salvation Army—most recently in the completion of the fabulous Kroc Community Center up in Nicetown—I thought that Chapter 10—“Too Much Success, Not Enough Character”—would be especially relevant. It begins with a wonderful story told by The Reverend Fred Craddock, a remarkable preacher from Georgia. He may have been imagining things—the way preachers are wont to do—but he says this story really happened. Dr. Craddock was visiting in the home of his niece. There was this old greyhound, one of those speedy dogs who race around a track chasing mechanical rabbits.

Lown has enriched and increased the lives of countless patients—thousands of human beings hungry for care, seeking solutions to their complex heart malfunctions, searching not only for reassurance, but for a chance to live full, productive, satisfying, contributing lives. I am privileged to number myself among those patients. In 1960, when I was barely thirty-one years old, I suffered my first heart attack. It puzzled cardiologists in Philadelphia and in Cleveland, where in 1967 one of the early pacemakers was implanted into my fragile heart. The operation was a success, but in fact the patient almost died. Worse, it didn’t relieve my symptoms, perhaps even made them worse. I was told that the then unknown disease was serious, that my life expectancy was limited, and that I should actually never work again.

broader and less parochial than mine to finance, for a long time we have shared a profound concern about the change in the character of the fields of our life’s work: from a professional culture focusing on the human beings whom we are duty bound to serve, to a business culture in which the proverbial “bottom line” has become the overriding goal of our enterprises. The trouble with that change must be obvious: in the words from my book Don’t Count on It!, in today’s bottom line society, we seek the wrong bottom line: money over achievement, form over substance, charisma over character, prestige over virtue, the ephemeral over the enduring. Dr. Lown’s concerns about the profession of medicine are almost interchangeable with my own concerns about the profession of trusteeship. Let me cite one of his paragraphs, in which I’ve simply changed his healthcare words into my mutual fund words—“patient” becomes “client,” “doctor” becomes “money manager,” and so on: Our profession’s fundamental ethics are under assault. Investment management is a calling—at its core a moral enterprise grounded in a covenant of trust between money managers and clients. The primary mission of the manager is to invest wisely, to promote the client’s financial well-being. Central to the relationship is the expectation that the manager will put the needs of the client first.

Fund management companies work under one of four different and distinct corporate structures. (1) Private ownership, usually dominated by the investment professionals who manage the funds. Until 1958, this form essentially constituted the entire fund industry. Then, our courts decided that private managers could go public. Today, only nine of the largest 50 fund management companies remain privately owned.

The first, as some of you may recall, was Bill Cosby, whom you honored a year ago. As we now pair up in a tribute to the diversity that America represents today—more effectively than ever before—I’m enormously proud to stand in his giant shadow. In that same Pathways issue, I also read the article about the legendary William T. Coleman, Jr., Esq., the civil rights pioneer who was the first black to serve on the board of the Harvard Law Review, to clerk for a Justice of the U. S. Supreme Court, and to serve in the cabinet of a President of the United States.but

Elisabeth Hasselbeck news (That’s twice!) Bailout bill Vice presidential debate Nothing at all about economics; the only political search was the vice presidential debate; and the FDIC failed bank list (I guess readers were worried about their savings) and the bailout of Wall Street were the only searches related to the financial markets. (Confession: I have absolutely no idea of who Elisabeth Hasselbeck and Heather Locklear are.) But I imagine that you friends of Blair Academy who have honored me with your presence this evening are here because you are indeed interested in the three topics of discussion on our agenda. Since the dramatic daily fluctuations of the stock market, however meaningless in the long-run—I have described them, after Shakespeare, as “a tale told by an idiot, full of sound and fury, signifying nothing”—tend to command our attention, I propose to begin with some much needed perspective on what investing is all about. I do so by quoting from my second book, Common Sense on Mutual Funds, New Imperatives for the Intelligent Investor, published almost a full decade ago. Investing is an act of faith. We entrust our capital to corporate stewards in the faith—at least with the hope—that their efforts will generate high rates of return on our investments. When we purchase corporate America’s stocks and bonds, we are professing our faith that the long-term success of the U.S. economy and the nation’s financial markets will continue in the future.

The Story of ENOUGH. Let me begin with a few comments about ENOUGH. I wrote my new book largely because I care deeply about the traditional values that are eroding not only in our financial system, but also in our businesses, in our communities, and even in our own lives. The story of ENOUGH. begins with a sort-of-poem by Kurt Vonnegut. It was entitled “Joe Heller,” and I chanced upon it in The New Yorker in April 2005. The poem was a tribute to the late author of Catch 22—one of the seminal books of the post-World-War-II era, and one of its most successful. I can summarize the short poem in just a few words: At a party given by a billionaire on Shelter Island, Kurt Vonnegut tells Heller that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responds, “Yes, but I have something he will never have . . . enough.” Enough. I was stunned by both the profound eloquence and the simple elegance of that word. And it couldn’t have been more accurate or more timely. For a critical element of our society, including many of the wealthiest and most powerful among us, there seems to be no limit on what enough entails. Think about it. We live in wonderful and sad times—wonderful in that the blessings of democratic capitalism have never been more broadly distributed around the globe, sad in that the excesses of that same democratic capitalism have rarely been more on display.

” As you all probably already know, it’s “enchiridion.” Don’t forget that word; you’ll hear it again later on. Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

After all, no matter how strong the ethical principles of the world of business may be, of what use are they without ethical principals to honor them, especially ethical leaders who have the Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management. 1 For the record, this motto of my family has always been taken to mean, press on, regardless of how tough the going, but regardless of how easy the going as well.

financial institutions which, in the infinite variety of their operations, consider only last, if at all, the interests of those who funds they command, suggest how far we have ignored the necessary implications of that principle. The loss and suffering inflicted on individuals, the harm done to a social order founded upon business and dependent upon its integrity, are incalculable. ______________ Note: The views expressed in this speech do not necessarily reflect the views of Vanguard’s present management.

I applaud The Reinvestment Fund (TRF), and the worthiness of your cause of community development. Through place-based revitalization focused on targeted financial investments, real estate development, and social service, you bring hope to those in the lower reaches of the nation’s economic mainstream. In doing so, according to the standards cited in another Nowak essay, you demand of yourselves: (1) efficiency; (2) minimum intrusiveness into the community; (3) a market-building horizon; and (4) the most direct route to the intended outcome. You also recognize that, since the capital that you put to work does not receive a conventional return on investment, you depend on public subsidy and private philanthropy, all in the name of community development. With the exception of that final point, there are remarkable similarities between TRF and Vanguard. We too have sought a better way to invest the hard-earned dollars of those human beings who have entrusted their savings to our care. I’ve challenged the financial system and done my best to improve it—to build a better world for investors. Vanguard was built on a firm foundation of service to our shareholder-owners rather than service to ourselves, in a unique mutual mutual fund structure in which our fund shareholders actually own the funds’ management company.

Even better, the job gave me some training in tactics (hiring good people); diplomacy (dealing with angry alumni); and even economics (balancing supply and demand). ______________________ *The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

Yes, it took determination (and luck, and timing, and the support of a few key directors of the Wellington Fund) to bring into being the first U.S. mutual mutual fund organization run, not in the interests of its managers but of its fund shareholders . . . But Vanguard (despite the name I chose) remains a leader with no followers. Even 38 years later, our firm’s structure has yet to be copied or even emulated, so low in excitement and acclaim that neither Brad Pitt nor Robert Redford have shown any interest in making a Bogle movie. (“Bogleball”? “Bogle-the Sundance Kid”?)

” This afternoon, I’ll talk about three subjects: (1) why we need not only ethical principles to guide us, but ethical principals to assure their observance; (2) the consequences to our society when traditional professional standards focused on service to the community are superseded by business standards focused on profit-seeking and ultimately, service to self; and (3) the story of Vanguard and the role played by our structure, our strategies, and our values, from which I’ll try to persuade you that “good ethics is good business.management

Milestones I begin, of course, by marveling at the remarkable achievement of this 300-year milestone by the Presbyterian Church (USA). Our religious institutions are almost alone in 1 I was especially struck by one name: David Caldwell (1725-1821). My twin brother, David Caldwell Bogle was named after our great grandfather David Caldwell Hipkins. Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

But our society, I think, is measuring the wrong bottom line: not only money over achievement, but form over substance; prestige over virtue; charisma over character; the ephemeral over the enduring; even mammon over God. Dollars have become the coin of the new realm, and unchecked market forces totally overwhelmed traditional standards of professional conduct, developed over centuries. ____________ The views expressed in this speech do not necessarily reflect the views of Vanguard’s present management.

After working as a bookkeeper in a Guangdong textile factory and studying accounting at trade school, Zhang moved to Shenzhen to manage the accounting and trading departments of a paper-trading company as Shenzhen was becoming a special economic zone and export hub.

Most notable among those changes are: first, the growing dominance of agents (giant banks and investment banks, and institutional money managers) as stock owners over principals (individual investors); and second, the ascendance of short-term speculation over long-term investment, focused on the illusion represented by the momentary precision of stock prices rather than the reality represented by intrinsic value—simply put, the discounted value of future cash flows. Both of these major changes in how we invest have played a critical role in creating a dysfunctional and expensive financial system, and in turn have ill-served our real economy.management

In 1954, MIT (now part of Massachusetts Financial Services, or MFS) lost its crown to Investors Diversified Services, (IDS) which became part of American Express, and then spun off as Ameriprise Funds, and just recently (through a merger), Columbia Funds. (No, I’m unable to rationalize how this kind of trafficking in mutual fund advisory fee contracts advances the interests of shareholders of the mutual funds involved.) IDS also wore the crown for a long time—24 years—through 1978, reaching a peak market share of 14 percent of industry assets. I’m confident that this audience knows who ultimately took that crown away from IDS.* Fidelity’s stunning ascent to industry leadership began in 1979, and it would hold that lead through 2005, a remarkable 26-year record of durability, with its market share peaking at a 13 percent share of industry assets. (You may be puzzled, as am I, why it took the financial press another four years to recognize Vanguard as Fidelity’s successor. Perhaps this oversight is explained by the fact that the firms were neck-and-neck in 2006- 07-08, with Vanguard sometimes ahead by as little as $3 billion, rounding error at these trillion-dollar levels.) In any event, Vanguard now firmly holds the undisputed crown of industry leadership. Our 13 percent market share is rapidly approaching the share level of the previous title-holders. The Vanguard-Fidelity rivalry, however, is rather complex. While our $1.468 trillion asset total exceeds Fidelity’s $1.

Nadar told Wharton that HCL's hardest early hurdle was not designing computers but obtaining government permission to make them — a classic licence-raj bottleneck he solved by entering a joint venture with the state of Uttar Pradesh, which had been granted approval and could sub-permission to the new company.

Some of you may have gotten there already; most of you will get there before too many more years have passed; some all at once, others imperceptibly, by degrees; and, as Wilson knew, “some men never come to themselves at all,” perhaps the sadness of never finding one’s place in the world, perhaps the tragedy of a life cut short. But given the remarkable skills you have acquired right here on this magnificent campus, the dedicated teachers and mentors who have given of 1 Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’ present management.

“Acres of Diamonds” So I can’t help but begin with some reflections on where my career began—right here in suburban Philadelphia. Just as Temple University Founder Russell Conwell had promised in his world-famous oration, I found my own “Acres of Diamonds” right here in my backyard. When our parents brought the “three Bogle boys” here in 1943, we were in tough straits. We all lived in a makeshift third-floor walk-up apartment in a house on Montgomery Avenue in Ardmore; and then to 2 ½-rooms over a garage on Rose Lane in Haverford, so small that when I came home from Princeton for holidays, I slept in one of the garages, dirt floor and all. One of my beautiful memories of that era: while home on Christmas vacation, I worked the graveyard shift at the Ardmore Post office. I still remember plodding down Montgomery Avenue from my garage room at 3:15 AM to begin my job. The snow was falling, the night cold and silent, not a car to be seen, the street lights soft, the challenges I faced at home and college put aside. As I walked, I distinctly remember counting my blessings. That moment remains one of my most enduring memories of those formative years. I was one lucky guy. During this era, my parents separated, but we got lucky, moving with our beloved mother to a real two-room apartment at Haverford Gables, right across Montgomery Avenue from the Cricket Club. (If you’re curious, it’s on the third floor, left, from here.)

Bogle is founder and former chief executive of the Vanguard mutual fund group. His career in the financial sector now spans almost 58 years. His seventh book, Enough. True Measures of Money, Business, and Life was published in November 2008. The opinions expressed in this article do not necessarily represent the views of Vanguard’s present management.

If an adviser were charging clients, say, 1 percent annually for its services (I know that many of you offer different methods of compensation for your services), offering Vanguard’s at-cost, truly mutual funds at (then) 25 basis points of cost would result in an all-in-cost of 1.25 percent annually for your clients. Our typical rival seeking to work with you, however, was charging an average of 1.30 percent for its mutual funds alone, higher than the joint costs of 1.25 percent using Vanguard funds. Together, we could provide good value for clients.

As your 2010 Memorial Foundation brochure describes these traits, President Coolidge was determined “to preserve the old moral and economic precepts” that led to America’s prosperity, focused on the fundamental virtues of high character, integrity, hard work, honesty, idealism, self-discipline, and, above all, determination and persistence.management

I also served for many years as the Finance Committee chairman and Audit Committee member at papermaker Mead Corporation (now MeadWestvaco); as chairman of the Audit Committee of television network provider Chris-Craft (now part of News Corporation); and as chairman of the Audit Committee at electronic stock market specialist Instinet. It was in that latter post that the firm adapted its accounting procedures to meet the tough and controversial standards of Section 404 of the Sarbanes- Oxley Act on internal controls.the

Alas, in the short- run, returns are driven by emotions. As the great Benjamin Graham put it: “In the short run, the ________ Note: The opinions expressed in these remarks do not necessarily represent the views of Vanguard’s present management.

In meeting after meeting, and in my speeches on common sense investing, I’ve often quoted from this volume of wisdom, which begins with this piece of advice: “Men intensely engaged in the action of the world probably shouldn’t write books . . . they haven’t the time to do the job as it ought to be done . . . drafting, reflecting . . . rewriting, and giving the whole manuscript a distinctive form and shape.” Clearly, John Gardner, author of eight books, didn’t take his own advice. Nor did I take his advice.the

Basic Values and My Princeton Thesis This distinction between speculation and investment is age-old. Indeed, I first expressed it in my 1951 Princeton senior thesis, “The Economic Role of the Investment Company.” Since then I’ve experienced at least four bear markets, each of which was followed by a bull market that ultimately more-than-erased those painful but often short-lived losses. This experience has only confirmed the basic values that I continue to hold about investing, formed during my study of Economics at Princeton more than a half-century ago. Writing my thesis about mutual funds was a happy accident. Late in 1949, I stumbled upon the December issue of Fortune magazine and learned for the first time that something called “the mutual fund industry” existed. When I saw the industry described as “tiny but contentious,” I knew immediately that I had found my thesis topic. Over the next 18 months, I spent countless hours researching the industry, trying to understand it, and then writing my thesis. Remarkably little public information was available about this field, then consisting of some 130 mutual funds with assets aggregating just $2½ billion. That lucky choice led to a job at fund pioneer Wellington Management Company (founded by Princeton’s Walter L. Morgan, ’20), a career in which I headed up the firm beginning in 1965; did an unwise (even stupid) merger in 1966 that got me fired in January 1974; and started Vanguard nine months later.

Complexity has, in far too many cases, replaced simplicity as the core of mutual fund management and financial planning, and financial innovation threatens to overwhelm the tried and true principles of sound investing. Each of these trends makes your responsibilities as a financial planner more challenging to honor. But simply being aware of how our investment world has changed ought to provide useful perspective, and enable you to better fulfill your vital responsibilities to your clients. So let’s consider these three issues. I. The Triumph of Speculation over Investment We’ll begin by talking about the difference between investment and speculation. Investing, to me, is all about the long-term ownership of businesses, focused on the gradual accretion in intrinsic value that is derived from the ability of our corporations to produce the goods and services that our consumers and savers demand, to compete effectively, to thrive on entrepreneurship, and to capitalize on change, adding value to our society.cumulative

It is in this last context, paradoxically, that some seventy years ago I first learned about Calvin Coolidge. I was in my early teens, and sailing aboard an old lobster boat on Long Island Sound with my uncle, Clifton Armstrong Hipkins, long-time commodore of Connecticut’s Riverside Yacht Club. On a small bronze plaque on the bridge of his boat, I read Coolidge’s words, so familiar to many of you: Nothing in the world can take the place of persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent. The slogan “Press On” has solved, and always will solve, the problems of the human race.1 On the transom of my uncle’s boat was its name: Press On Regardless. I’m not sure when or where or why “regardless” was added to the Coolidge quotation, but that phrase would become a sort a motto for our family. Whatever its derivation, the addition of “regardless” tells us of something that, deep down, we all know to be the reality of life. For “Press On Regardless” is a profound reminder that we must press on, not only through our trials and tribulations, but under all circumstances.

219 total by more than $200 billion, the assets of Vanguard’s long-term funds (stock and bond funds, excluding money market funds) of $1.3 trillion exceeds the $800 billion total of our long-time rival by fully $500 billion. This is not to say that Fidelity now plays second fiddle to Vanguard in all respects. Measured by profits, they are (I think) first in the industry and we are last. Fidelity Management and Research reported operating income last year of $2.5 billion, *There were two interlopers during this long sequence. Merrill Lynch and Dreyfus were the largest fund managers for a brief period during the late 1970s and early 1980s. In both cases, their leadership was attributable to their almost monoline dependence on money market funds, which represented 75 percent or more of their asset base.

With these profound, indeed, earth-shaking changes, our financial markets have become far more volatile and unpredictable than the underlying businesses that they ultimately represent, which collectively account for their aggregate market capitalization. Put another way, investors are more volatile than investments. Economic reality governs the returns earned by our businesses, but emotions and perceptions—the swings of hope, greed, and fear among the participants in our financial system—govern the returns earned in our markets. Emotional factors sometimes magnify, sometimes minimize, this central core of economic reality, and financial crises can arise at any time, but in the long-term it is reality that triumphs over illusion. Warren Buffett states the issue with his usual clarity. His firm, Berkshire Hathaway, is publicly held, and he regularly hammers home to his shareholders the message that he prefers its shares to trade at or around its intrinsic value—neither materially higher nor lower. He explains: “Intrinsic value is the discounted value of the cash that can be taken out of the business during its remaining life . . . When the stock temporarily over-performs or under-performs the business, a limited number of shareholders—either sellers or buyers—receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.

I. Principals and Principles The first of these three subjects focuses on the title I have chosen for my remarks this afternoon—“Ethical Principles and Ethical Principals.” That talk was inspired by, of all things, a typographical error. A mailing I received a few years ago announced that General Electric would receive an award for long-term excellence in corporate governance; GE President Jeffrey Immelt was quoted as focusing on the importance of “sound principals of corporate governance.” But while the quotation spelled principals with the concluding a-l-s, Mr. Immelt clearly meant principles, with the concluding l-e-s. But, at least in this instance, that is distinction without a difference. After all, no matter how strong the ethical principles of the world of business may be, of what use are they without ethical principals to honor them, especially ethical leaders who have the responsibility to assure that these ethical principles permeate and dominate the culture of our corporate world?1 I describe these classic ethical principles of our society in words very similar to those of Steven Pinker— integrity, honesty, and trustworthiness; fairness and justice; doing good and preventing harm; concern for the well-being of others and respect for their autonomy, and so on. But applying these societal principles to business principals is far easier said than done.

You could say, I suppose, that I’ve come a long way from there. In my career, from waiter and then part-time post office clerk to founder and for decades chief executive of what is now the largest ($2 trillion of assets) mutual fund complex in the world. It surprises even me! I was raised in a close but broken family, and both of my parents died the year after I graduated from college. But right here, 56 years ago, it was “Acres of Diamonds” all over again.children,

It merely resulted in a reclassiÑcation from unrealized gains to retained earnings, another component of shareholders' equity. This supplementary breakdown of earnings diÅers somewhat from that used in audited Ñnancial statements which follow standard accounting convention.foregoing

According to Nadar, only three computer companies founded in the 1970s still survived in 2006 — IBM, Apple and HCL — with HCL shipping its first computer in the same quarter as Apple, an achievement he repeatedly invoked to establish HCL's status as a global computing pioneer rather than a purely Indian services firm.

stock market is a voting machine. In the long-run, it is a weighing machine.” (This insight bears endless repeating!) I add my own phrase to Ben Graham’s: “The stock market is a giant distraction from the business of investing.” Of course it is! My profound concerns about the dominance of speculation over investment are expressed in my new book (to be published this August), The Clash of the Cultures, the story of how riskier short-term speculation has come to crowd out prudent long-term investment, and the negative consequences of this trend for investors, for our financial system, and for our society as a whole. Let me describe the vast areas on which The Clash of the Cultures has important ramifications and express some of my major concerns to you. 1. In our financial markets, annual trading in stocks—necessarily creating, by reason of the transaction costs involved, negative value for market participants—averaged some $33 trillion. But capital formation—that is, directing fresh investment capital to its highest, best and most profitable uses—new businesses, new technology, medical breakthroughs, modern plant and equipment for existing businesses—once considered the central role of finance, averaged some $250 billion. Put another way, speculation represented some 99.2 percent of the activities of our market system, with capital formation accounting for 0.8 percent. 2.

Such an outcome could never have been predicted. Indeed the odds against Vanguard’s very existence were stupendous. Time after time Lady Luck smiled on me. If she had not done so along the way . . . well, listen to the story: ∑ IF I had not gained admission to Princeton (thanks largely to my two years at Blair Academy, a great independent school), there would be no Vanguard today. ∑ IF I had not majored in Economics and decided to choose a topic for my senior thesis that ignored the classical economists and traditional macroeconomics, there would be no Vanguard today. ∑ IF I hadn’t opened FORTUNE magazine in December 1949, stumbled across page 116 which described the mutual fund industry as “tiny but contentious,” and decided that the industry would be the subject of my senior thesis, there would be no Vanguard today. ∑ IF Mr. Morgan had not made me head of Wellington in 1965—when I was excessively immature, opinionated, and self-confident—I would not have undertaken a really foolish—okay, stupid— 1966 merger with a “go-go” firm with a hot fund (now long gone) and paid too large a share of the firm’s voting power, there would be no Vanguard today.

His niece had taken the dog in to prevent it from being destroyed because its racing days were over. Dr. Craddock struck up a conversation with the greyhound: I said to the dog, “Are you still racing?” “No” he replied. “Well, what was the matter? Did you get too old to race?” “No, I still had some race in me.” “Well, what then? Did you not win?” “I won over a million dollars for my owner.”

Yes, I’ve tried to create a business with character and class, holding human values high. That’s a task I’ve yet to complete . . . But it’s not the only task before me, for I’ve yet to climb all Seven Summits, host the Oscars; nor (despite my Scots’ heritage) solve the mystery of Loch Ness; nor been a candidate to manage the Phillies (or even the Red Sox); and it’s too late for me to run for President. (Sorry ‘bout that!) Yes, I’m now writing my tenth book, many of which have been best-sellers . . . But only for a little while. After a single week on the New York Times best-seller list, ENOUGH. was replaced by—I guess it’s okay to say it aloud—Real Sex for Real Women. “Is this a great country or what!” Yes, I’ve been among the strongest advocates in my field for activism in corporate governance . . . But words aren’t the same as deeds, and I’ve yet to see any tangible results whatsoever. “The Silence of the Funds” remains deafening, but I’m not about to give up the mission. Yes, I’ve had a few portraits painted . . . But one sits in my office (it’s a long story), not in the Louvre nor even the Philadelphia Museum of Art. I confess too that there is a larger-than-life sculpture of me on the Vanguard campus . . . But its only function seems to be to allow fund industry leaders to describe me (cynically, of course) as “a saint with a statue.

tough standards established by the Congress were worthwhile. I supported them—as did our board of directors—without reservation.) My comments on auditor rotation are hardly the stuff of which headlines are made. While I do not believe that mandatory rotation would come close to resolving the plethora of issues surrounding auditor independence, such rotation would be a step in the right direction. “Independence” can be fairly defined as the requirement that “the audit be performed in a disinterested manner, free from influence by the client,” and that the auditor should “exercise appropriate professional skepticism and make objective auditing judgments.” But meeting that standard will call for much more than mere rotation. As to frequency of the mandatory rotation, I would think that a formal review of the existing auditor no later than at the 10-year mark of service would be reasonable, and that there should be a flat limit of 20 years for any audit firm’s service with a client. While my own audit firm experience was limited to companies whose auditing issues seemed not particularly complex, my conclusion is that concern about the costs of rotation are generally rather exaggerated, and the benefits are understated. Here, I take the liberty of expressing my strong reservation that the (theoretically wonderful) requirement that a “cost-benefit analysis,” a requirement of federal regulators since 1993, is the paragon of common sense.

In any event, speaking at an all-boys school gives me the opportunity to quote from one of my favorite poems, which is about becoming a man. My theme is taken from a single phrase of that poem: “If you can trust yourself . . .” If you can trust yourself. Now trusting what is in your own heart and soul is a truly big idea. But I didn’t think much about it until I was perhaps 15 years of age, and my father read me this poem that I have never forgotten. Written 100 years ago by the British poet Rudyard Kipling, it was entitled “IF . . . “ Many of you may already know it, but since it is a fairly short poem, I’d like to read it to you. IF . . . IF you can keep your head when all about you Are losing theirs and blaming it on you, If you can trust yourself when all men doubt you, But make allowance for their doubting too; If you can wait and not be tired by waiting, Or being lied about, don’t deal in lies, Or being hated, don’t give way to hating, And yet don’t look too good, nor talk too wise: If you can dream – and not make dreams your master; If you can think – and not make thoughts your aim; If you can meet with Triumph and Disaster And treat those two impostors just the same; If you can bear to hear the truth you’ve spoken Twisted by knaves to make a trap for fools, Or watch the things you gave your life to, broken, And stoop and build ‘em up with worn-out tools.

with great admiration. He shares my belief in the importance of education and the great value of community colleges that, in his words, “allow people to get new learning and do different things . . . a necessary development if the United States is going to continue its position of (world) leadership.” And of course, William Coleman is right. How did Coleman overcome the obvious obstacles created by the racial intolerance that was so prevalent in our society during his early life? He tells us; “There are always obstacles in life. That’s one of the challenges you have. It’s just a matter of being able to take advantage of opportunities.” And so it is, and that’s what CCP is trying to do for the 500,000-plus men and women who have come through its doors to study and to learn, to better overcome the obstacles they have faced in their lives. Last week I visited with four of those students—Carl, Heidi, Ervan and Sharon—and came away from the conversation impressed with the diversity of their backgrounds and the single-mindedness of their determination to overcome those obstacles, and to take advantage of the opportunities that are presented along the challenging pathway of life. “All Men Are Created Equal” My visit with these four exceptional students reminded me of the deep concerns that I’ve held for most of my adult life about our nation’s failure to adequately provide equality of opportunity, most recently articulated in my new book, Enough.

When I last spoke here in March 2000, I discussed my second book—Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor—which had been published six months earlier. The high hopes that I had for Common Sense have been more than realized. To my astonishment, this 475-page-book became a best-seller (about 160,000 copies to date, second only to my Bogle on Mutual Funds: New Perspectives for the Intelligent Investor, with some 220,000 copies purchased). What is more, Common Sense has proved to have what the booksellers call “legs,” steadfastly remaining near the top of the rankings on Amazon.com. When I checked last week, it ranked #3,213 among the four million volumes now listed there . . . not too shabby for a book now seven years old. In those earlier remarks, I reported that I’d just been invited to write a book for McGraw- Hill Publishing, to be the first in their series “Great Ideas in Finance.” It was published in 2001 under the title John Bogle on Investing: The First 50 Years, a collection of some of my favorite speeches, with sections on Investment Strategy (including “The Bagel and the Doughnut”), the Mutual Fund Industry (“The Silence of the Funds”), Economics and Idealism (“On the Right Side of History”), and Personal Perspectives (“The Hedgehog and the Fox,” “The Things by Which One Measures One’s Life”)—I love to provide offbeat titles! The book also included my Princeton senior thesis on the mutual fund industry, completed way back in 1951.

responsibility to assure that these ethical principles permeate and dominate the culture of our corporate world? We’re all familiar, I’m sure, with the classic ethical principles of our society—integrity, honesty, and trustworthiness; fairness and justice; doing good and preventing harm; concern for the well-being of others and respect for their autonomy, and so on. But applying these societal principles to business is far easier said than done. Honoring Ethical Principles in Business No one can be more aware than I am that in the dog-eat-dog competition that has always been inherent in our capitalist system, these ethical principles are often difficult to honor. Dealing with this fierce competition without compromising one’s character is no mean challenge! For example, while I’m sure that 100 percent of our business leaders describe integrity and honesty as the essential elements of leadership, it’s also clear that less than 100 percent of them deliver on those two essentials. Among our large publicly held corporations, having a clear set of standards and an ethical code is now a commonplace, yet we’ve seen too many examples where these standards have been ignored, often to meet ambitious—perhaps overly ambitious—goals for growth in corporate revenues and earnings. Our corporate directors pay lip service to the responsibility of stewardship.

We see the excesses most starkly in the continuing crisis in our overleveraged, overly-speculative banking and investment banking industries, creating a financial crisis that has been, in turn, the principal cause of the economic crisis we are facing, the worst since the Great Depression. Despite the economic and market meltdown, however, we witness the obscene (there is no other word for it) compensation paid to the chief executive officers of our nation’s publicly held corporations—including failed CEOs, often even as they are being pushed out the door— compensation that, given the capital these institutions urgently require merely to survive, is being paid by the federal government—or, more accurately, the taxpayers, or, even more poignantly, us.

enduring for that length of time. The Christian church, of course, is now beginning its third millennium, and the Muslim religion about the same. Judaism is even older, Confucianism goes back 5000 more years, and Hinduism even longer, perhaps 9000 years in all. While the Protestant denomination goes back a far shorter time—to 1514, when Martin Luther nailed his 95 theses to the door in Wittenberg and inspired the Reformation—that’s still some considerable durability. Only the university seems to rival the church in its staying power. Al Karaovine in Morocco goes back to 859 and Egypt’s Al-Azhar to 998, followed by Bologna in 1088, Paris in 1150 and Oxford and Cambridge in 1117 and 1209. In all, our world has 48 universities that predate Martin Luther. Here in the United States, our universities are even older than our nation. Harvard was founded in 1636, William and Mary in 1673, Yale in 1701, Princeton in 1746, and Pennsylvania in 1749. These universities themselves were founded by the Protestant religious leaders of the age, with The University of Pennsylvania the sole exception. (It claims its heritage as “non-sectarian,” apparently because its Anglican founders did not wish to offend Philadelphia’s Quaker community. Benjamin Franklin, billed as Penn’s founder, was a Deist.) By the longevity standards of our oldest churches and universities, our nations seem almost fly-by-night. Yes, Great Britain goes back to 1707 (or is it 1604?), and France to the 1600s.

And so I drive to return fund managers to their traditional commitment to serve as the honest stewards of their clients—in my case, the mutual fund shareholders whom our industry is duty bound to serve. (I should note here that both our keynote speaker Jeremy Grantham and our co- host James Joslin are both paradigms of these stewardship values, and I thank them for gracing this lovely evening with their participation.) Of course my mission to build a better financial world will not be fully realized during my lifetime. But that knowledge hardly slows me down, for I love the battle itself. I relate to Gutzon Borglum, the determined sculptor of Mount Rushmore, who said “Life is a kind of campaign.good

declines of 20 percent or more). The current bear market is the worst of the bunch—off by almost 55 percent, even worse than 1973-74 and 2000-2001, when the drops reached 50 percent. What’s more, this decline is the first that I can recall in which the distress in the financial economy has so profoundly impacted the real economy of goods and services, harming a large mass of our citizenry, even those who had no meaningful participation in the boom that led to the bust, but who are now paying the penalty for the market’s excesses. It is not Wall Street, but the ordinary citizens of the United States who will foot the bill for the gross financial excesses of the recent era. “The government,” as always, has no money of its own. So it is paying the financial sector with our money. We may pay for part of this bailout with higher taxes; but given our flawed political system, the cost is more likely to be extracted from future generations with dollars that buy less. Inflation is just another form of taxation, albeit one that is sharply regressive. What we are witnessing is the verification of “the financial instability hypothesis” put forth by the economist Hyman P. Minsky (1919-1996). In 1992, Minsky warned that, “capitalist economies exhibit . . . debt deflations that . . . spin out of control (as) the economic system’s reactions to the movement of the economy amplify the movement.” Sad to say, Minsky adds, “. . .

(2) Public ownership, with working control usually held by management company officials, but with public investors holding widely diffused amounts of the management company’s shares. Among those 50 major fund groups, ten firms (including T. Rowe Price and Franklin Templeton) operate under this public ownership structure. (3) Conglomerate ownership, under which giant diversified financial firms (including Goldman Sachs and JP Morgan) operate their own mutual fund management companies, often to diversify revenue sources and earn generally steady fee income. In other cases, conglomerates have acquired existing fund management companies (including Massachusetts Financial Services and Putnam), often at substantial acquisition costs. With 30 of the largest 50 fund managers owned by conglomerates, this ownership model has become the industry standard. (4) Mutual ownership, under which the shareholders of the funds actually own the management company, which operates on an at-cost basis. Only one mutual fund complex is truly mutual—Vanguard, the firm that I founded in 1974, then with assets under management of a mere $1.2 billion. While our structure has yet to be emulated or duplicated, Vanguard has become by far the largest firm in the industry, supervising $2 trillion in assets.

thesis topic I certainly did just that. With an annual growth rate of almost 16 percent since then, the fund industry just may have been the fastest growing business in America. Today, there are 9,000 funds, with total assets that approach $12 trillion! Read today, my thesis would probably impress you as no more than workmanlike, perhaps a bit callow, but above all, shamelessly idealistic. And you can read it, for six years ago it was published by McGraw-Hill as part of John Bogle on Investing: the First 50 Years. (If you wait a half-century, perhaps anything can be published!) On page after page of the thesis, my youthful idealism speaks out, calling again and again for the primacy of the interests of the mutual fund shareholder. At the very opening of my thesis, I get right to the point: Mutual funds must not “in any way subordinate the interests of their shareholders to other economic roles. Their prime responsibility must always be to their shareholders.” (Important advice that the industry seems to have ignored; witness the disgusting market-timing scandals uncovered by New York Attorney General Eliot Spitzer four years ago.) Shortly thereafter, “there is some indication that costs are too high,” and that “future industry growth can be maximized by concentration on a reduction of sales charges and management fees.” (My advice fell upon deaf ears there as well!)

1. A Parable The first of the two relentless rules of humble arithmetic I’ll mention is a simple one: Gross return in the financial markets, minus the costs of financial intermediation, equals the net return that we investors share. To understand that is how our financial system really works. Consider my version of this parable told by Warren Buffett, chairman of Berkshire Hathaway Inc., in the firm’s 2005 annual report. It clarifies the foolishness and counterproductivity of our vast and complex financial market system. Here goes: Once upon a time . . . a wealthy family named the Gotrocks, grown over the generations to include thousand of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game. But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than the other relatives. These Helpers convince the cousins to sell some of their shares in the companies to other family members, and to buy some shares of others from them in return.

In his argument, every market at every juncture has significant scale advantages that make incumbents look invincible, yet upstart technologies repeatedly disrupt them and rewrite the rules. He cited Skype, which became the first to offer voice-over-Internet phone services at broad scale, long after established telecom companies had begun talking about the technology — a reminder that incumbents often describe change before they execute it.

leader of a company in crisis and given the responsibility of saving it, I continued to publish papers and write essays, many of which became parts of my later books. Even when I got fired in early 1974 and barely survived a career crisis, I kept on writing. Later in that same year, out of the ashes of that crushing personal defeat, I created a tiny new company—and against all odds, succeeded in building it. (I had lots of help!) Throughout this trying time, my pen was my constant companion. Yes, as it is said, “the pen is mightier than the sword.” That new firm, which I named “Vanguard,” was founded with a truly mutual structure without precedent in the still misnamed mutual fund industry. Its growth would ultimately be driven by an investment strategy that was also without precedent . . . and, yes, that would be the index fund. That combination of a structure designed to serve the public—to serve fund shareholders rather than fund managers—and a strategy dominated by our creation of the world’s first index mutual fund in 1975 have changed the mutual fund industry as we knew it. Operated at rock-bottom cost, that index fund requires no money manager. It simply buys and holds the 500 stocks in the S&P Index, effectively guaranteeing that its investors will earn their fair share of the stock market’s return, neither more nor less, and whether that return is good (mostly) or bad (sometimes).

The 1971 Challenge In 1971, even more pointedly, speaking to the partners of Wellington Management Company— where I served as chief executive from 1965 through early 1974—I expressed my focus on fiduciary duty in much sharper terms. In a section of my remarks entitled, “The Challenge of Fiduciary Duty,” I said: “We live in a world that is increasingly intolerant, not only of conflicts of interest, but even the appearance of conflicts. It is hard to argue either that this trend is baneful or that it is likely to abate. For this is but one aspect of the “consumerism” whose impact pervades almost every aspect of our society, and certainly is not limited to the world of money management. It seems beyond question that consumerism, along with the entire thrust of the legislative, regulatory, and judicial overview of our profession will play a critical role in how we conduct our affairs in the years ahead.” And then—yes, 45 years ago—I pulled out all the stops. The next section of my talk was entitled, “A Man Cannot Serve Two Masters.” “Listen, for example, to Justice Harlan Fiske Stone, speaking in 1934: ‘I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of the mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that a man cannot serve two masters . . .

Today, industry assets exceed $12 trillion, and Vanguard’s assets alone exceed $1.3 trillion, one of the industry’s three largest firms. Think about it: no Princeton, no thesis. No thesis, no fund career. No fund career, no Vanguard. Of course, it pains me even to contemplate that eventuality. Read today, my thesis would probably impress you as no more than workmanlike, perhaps a bit callow, but above all, shamelessly idealistic. And you can read it, for seven years ago it was published by McGraw-Hill as part of John Bogle on Investing: the First 50 Years. (If you wait a half-century, perhaps anything can be published!) On page after page of the thesis, my youthful idealism speaks out, calling again and again for the primacy of the interests of the mutual fund shareholder. At the very opening of my thesis, I get right to the point: Mutual funds must not “in any way subordinate the interests of their shareholders to other economic roles.prime

He framed the opportunity as releasing the power of India's English-speaking technical talent to produce software for the global market. Even so, the first decade was marked by tremendous friction to business, and Infosys only truly accelerated after the 1991 reforms that came after India's foreign reserves had collapsed to about 1.2 billion dollars.

instructions. (There were no cell phones in those days.) I figured it would take more than a half- hour on two different trolleys to get there. (I had no car.) It was late; I was tired, and, truth told, I was a bit bored. A house fire, for heavens sake! So I skipped the trip and got a report from the firemen when they returned. I called in the story, but the wise rewrite man quickly figured out that I had not actually gone to the scene. “What color was the house?” he boomed. To which I responded, “I’m sorry. I was wrong. I’ll get over there right away.” And I did. The house turned out to be grey, with green trim. The moral of the story, which I urge upon you: “Whatever you do in your careers, do every job with commitment, with professionalism, and with excellence, and never, never take short-cuts.” If you get nothing more out of my remarks this evening on business, please remember that lesson, which has stuck with me ever since, and has represented the standard which I’ve tried my best to honor throughout my long career in the financial field. Complete information and punctilious accuracy are the responsibility of business in all of its communications to all of its constituents, including the media and the public. Let me begin by describing the philosophy that undergirded my actions in dealing with our various publics during my quarter-century as chief executive and then as senior chairman of Vanguard.

particular, and the welfare of society in general; 2) the developed capacity to render judgments with integrity under conditions of ethical uncertainty; and 3) the development of a professional community responsible for the oversight and monitoring of quality both in practice and for professional educators. The article concluded with these wonderful words: "the primary function of any profession [is] to serve responsibly, selflessly, and wisely … and to establish [an] inherently ethical relationship between the professional and the general society.” This evening, I will build on that theme in four specific areas: 1) my own life and career; 2) the history of the CFA Society of Philadelphia; 3) the development of the international CFA Institute; and finally, 4) my perspective on the failure of capitalism’s gatekeepers, specifically including the failures of too many security analysts, money managers, and corporate stockholders to do their part in maintaining the standards of our profession. I. My Life and Career in Finance Let me begin with a few words about my credentials to stand before you. While I may well be known as the founder of what is now a very large manager of other people’s money, and as the creator of the first index mutual fund, I’m not typically thought of as a security analyst nor portfolio manager. But I've actually been engaged in those fields throughout my career at Wellington, where I began in 1951. Then, we ran only a single mutual fund, Wellington Fund.

I’m not one to accept such advice. So I decided to search for the best cardiologist in America. The name that kept coming up was, of course, Dr. Lown. He took on my case, beginning a 20-year doctor-patient relationship that saved my life, and gave me a bridge over the troubled waters of a mysterious heart disease. As he would write to me years later, “that dire early prognosis left out of the calculus the indefinable human spirit that can powerfully tilt the balance toward life.” In the words from a song in Les Miserable, Bernard Lown not only “gave me hope when gone, he gave me strength to carry on.” Over the following two decades, I made a score of extended visits to Brigham Hospital where he frequently inspected me (if you will) on his legendary rounds. Believe me, it was not only the residents and fellows who accompanied him who were intimidated. So were his patients! But I was also inspired and utterly confident that I had his rapt attention and concern— yes, and love—every moment that he stood by my bedside. I should add that sadly one of my four daughters, Nancy, inherited my genetic malady. Dr Lown also helped her along the difficult road, and she shares my feelings about him, perhaps even more fervently. At Brigham I endured a then-record 50 stress tests, evaluating the effectiveness of the various experimental drug therapies with which he tried to alleviate my frequent bouts of ventricular tachycardia.

When we invest in a mutual fund, we are expressing our faith that the professional managers of the fund will be vigilant stewards of the assets we entrust to them. We are also recognizing the value of diversification by spreading our investments over a large number of stocks and bonds. A diversified portfolio minimizes the risk inherent in owning any individual security by shifting that risk to the level of the stock and bond markets. Kindled by bull markets and chilled by bear markets, Americans’ faith in investing has waxed and waned, but it has remained intact.a

As you may have already figured out, those words (except for the very first sentence) are not mine. Rather they are the words of Harlan Fiske Stone, excerpted from his 1934—yes, 1934—address at the University of Michigan Law School, reprinted in The Harvard Law Review later that year. But his words are equally relevant—perhaps even more relevant—on this very day. For they could hardly present a more appropriate analysis of the causes of the present-day collapse of our financial markets and the economic crisis now facing our nation and our world. You could easily react to Justice Stone’s words by falling back on the ancient aphorism, “the more things change, the more they remain the same,” and move on to a new subject. But I hope you’ll react differently, and share my reaction: In the aftermath of that Great Depression and the stock market crash that accompanied it, we failed to take advantage of the opportunity to demand that our giant businesses and financial organizations—the trustees of so much of our nation’s wealth—measure up to the stern and unyielding principles of fiduciary duty described by Justice Stone. So, 75 years later, for heaven’s sake, let’s not make the same mistake again. The Columbia Connection Given this history and this topic, it seems singularly fitting to present this lecture at Columbia University. For Harlan Fiske Stone (1872-1946) ranks among Columbia’s most distinguished sons.

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As it happened, there was another benefit that was even larger. Partly because so many of us freshman were waiters in Commons (yes, that’s the way the world worked at Princeton 60 years ago), I developed lifetime friendships with some of the greatest football players in Princeton’s history. A truly remarkable number of these athletes went out into the world and achieved career success that served our society well. Let me mention just a few of these splendid athletes from the great Class of 1951: George Chandler, business leader; Cliff Kurrus, mortgage banker; Hal Urschel, cardiovascular surgeon; Jack Davison, educator; Reddy Finney, headmaster at Gilman School for 24 years; Hollie Donan, insurance underwriter; Joe Zawadsky, orthopedic surgeon and Tiger team physician; and of course Jake McCandless, whose memory we honor this evening—practitioner of the art of coaching for nearly a quarter-century (including a decade at Princeton), followed by a successful two-decade career as a financial executive. There’s a good message here about Princeton athletics, teamwork, and coaching, but I’ll focus my remarks this evening on the role of a Princeton education and on the sense of competitiveness and ethics—yes, ethics—that education at this best old place of all has instilled in so many of her sons, and now daughters.

The result has been a marked change in our society. The traditional standard of conduct in which “there are some things that one simply does not do,” took a back seat to a new standard: “if everyone else is doing it, I can do it too.” I would describe this change as a shift from moral absolutism to moral relativism. The moral themes of virtue, loyalty, fidelity, faith, and honor have been debased. Business ethics has been a major casualty of that shift in our traditional societal values, and the idea of professional standards has been lost in the shuffle. We seemed to forget that the driving force of any profession includes not only the special knowledge, skills, and standards that it demands, but the duty to serve responsibly, selflessly, and wisely, and to establish an inherently ethical relationship between professionals and the society they serve. The old notion of trusting and being trusted—which once was not only the accepted standard of business conduct, but the key to success in the marketplace—came to be seen as a quaint anachronism, a relic of an era long gone.

themselves to you, and your inculcation into the Isaiah Williamson Free School philosophy of service to society, I have no doubt that the world you seek will be yours. Wilson recognized that coming to yourself is not determined by the passage of time, but by the passage of the spirit. Using Wilson’s ageless words: . . . It is in real truth that common life of mutual helpfulness, stimulation, and contest which gives leave and opportunity to the individual life makes coming to yourself possible, makes it full and complete . . . In discovering your own place and force, if you seek intelligently and with eyes that see, you find more than ease of spirit and scope for your mind. You find yourself, as if mists had cleared away about you and you know at last your neighborhood among men and tasks. 2 Likely it is that Isaiah Williamson came to himself well before he reached manhood, for he was a remarkable youth. According to his biographer, John Wanamaker (yes, the Philadelphia merchant prince), young Isaiah was “an apt, enthusiastic scholar, a boy who did a man’s work; never tired, never absent, never idle; a lad of manly ways, of merit, integrity and industry; a lad who threw himself into the whirl of work and life.” Wanamaker then goes even further, describing Williamson’s “fairness, good temper, Quaker thrift and industry, modesty, and absolute trustworthiness.

In the years since I founded Vanguard (1974) and relinquished my role as CEO (1996), our firm’s emphasis on the RIA business has waxed and waned . . . and then waxed again. The rise of the ETF has honed our focus on firms like yours, and our marketing efforts with you have intensified. We now have regional offices across the country available to serve you, representatives to meet person-to-person with you, sharing the goal of focusing above all on the interests of the clients we jointly serve. “Gentlemen, Cut Your Costs!” When I addressed you in 1999, I was also focused importantly on mutual fund costs. (No surprise there!) The title of my remarks was, “Gentlemen … To Save Our Business from Ruin, We Must Reduce Expenses.” That title was taken from a speech given by my great-grandfather Philander Banister Armstrong in a speech to his colleagues in the fire insurance industry in St. Louis, Missouri, way back in 1886. Grandpa Armstrong (as we called him) later turned his career focus to life insurance, and once again became a critic of his own industry. In his 1914 book, A License to Steal: Life Insurance, The Swindle of Swindles, he demanded that “life insurance, one of the necessities of modern civilization, should be furnished at cost . . . Old Line Life Insurance is a crime, and criminals belong in Sing Sing, where there is no license to steal.” Armstrong, obviously, spoke in strong language (he puts me to shame!)

Vanguard operates on an “at-cost” basis, and our structure and fiscal discipline have resulted in cumulative savings to our shareowners of nearly $100 billion so far, subtracting less value from society than any financial firm on the face of the globe. In short, our rise to dominance in the financial field has come simply because we are (1) structurally correct; (2) mathematically correct; and (3) strategically correct. It is hardly a stretch to say that, although your implementation of those principles is vastly different from ours, you share them in philosophy and spirit. Our core investment strategy is the index fund—a fund that, at its best, simply owns the entire stock market (or the entire bond market). Operated at rock-bottom cost, this strategy guarantees that our shareholders receive neither more nor less than their fair share of whatever long-term returns on investment that our stock and bond markets are generous enough to provide. The index fund, arguably, is an exercise in plain and simple engineering. Think about it. In the 2005 book, Power, Speed and Form. Engineers and the Making of the Twentieth Century,1 the best engineering is described as embodying “efficiency, economy, 1 David P. Billington and David P. Billington Jr., Oxford University Press, 2005.

He received his law degree here in 1898, and returned to serve as dean of Columbia Law School from 1910 to 1923. In 1924, President Calvin Coolidge named Stone as attorney general, and in 1925 appointed him as associate justice of the United States Supreme Court. In 1941, President Roosevelt appointed him as Chief Justice of the United States. When Stone died in 1946, after 21 years of service on the Court, he left a remarkable legacy of career accomplishment, judicial philosophy, and worldly wisdom.* It seems particularly fitting, then, to discuss Justice Stone’s philosophy and his remarkably prescient warning about the abject failure of our corporate and financial institutions that we have witnessed during the recent era, so remarkably similar to their failure some three generations earlier. It is even more fitting to discuss these issues at the annual KPMG Peat Marwick/Stanley R. Klion Forum for 2009, part of Columbia’s effort to encourage greater * A curious coincidence: Justice Stone appeared on the cover of TIME magazine on May 6, 1929, just two days before my own birth on May 8. In its profile story, TIME accurately speculated that one day Stone would become the chief justice, in part because (in those backward sentences that distinguished the early style of the magazine), “Well he has always tackled the public interest.”

In the new ownership structure of our corporations and institutional money managers, the “Double-Agency Society,” giant corporate manager/agents interface with our giant investment manager/agents in a symbiotic “Happy Conspiracy,” focusing on the momentary fluctuations of evanescent stock prices rather than the building of durable, long-term intrinsic corporate value. 3. In corporate governance, the failure of our institutional investors—who now control, not 8 percent of stocks as in 1950, but a controlling 70 percent—to step up to the plate and exercise the rights and responsibilities of corporate governance in the interests of the fund shareholders and plan beneficiaries whom they are duty-bound to serve. 4. In mutual funds, the cottage industry that I joined in 1951—a profession focused on stewardship—has become a giant business focused on salesmanship, and where old notions of fiduciary duty have been subverted both by short-term investment focus and by control of money managers by financial conglomerates (41 of the 50 largest fund complexes are now publicly-held or under conglomerate domination.) 5.being

Main Street bailing out Wall Street for its disgraceful conduct . . . it doesn’t seem fair, does it? Well, it isn’t! But the rampant greed that has overwhelmed our financial system and corporate world runs deeper than money. Not knowing what enough is subverts our society’s traditional values, as self-interest and greed replace community interest, professions behave as businesses, money vs. service to the community, and service to self takes priority over service to others. This confusion about what is enough leads us astray in our larger lives, as we too often bow down at the altar of the transitory and finally meaningless; and we fail to cherish what is beyond calculation, indeed eternal. Unchecked, our failures ultimately result in the diminution of our national character and values. So in a broader sense, we all bear some of the responsibility for what has gone wrong in America. That message about our society’s worship of wealth and the growing corruption of our ethics, I think, is what Joseph Heller captured when he spoke that powerful single word . . . enough. A Speech at Georgetown I was so inspired by Vonnegut’s poem that, in my commencement address at Georgetown University’s business school two years later, I used it to send a message. It was May of 2007, only a few short months before the great bubble that had enveloped our stock market, our financial system, our real estate holdings, and our economy would begin to burst.

He positioned Wipro's gradual evolution as a sequence of pivots rather than one grand one. The 1970s exit of IBM from India opened room for local computer manufacturing; Wipro began assembling its own machines, then moved into computer and IT services for global firms operating in India, and as computers commoditised, shifted toward servers and R&D labs for hire to Western tech and consumer firms.

Murthy recalled the early 1980s pains: it took Infosys a year to get a telephone line, and two years to secure a Delhi licence to import a fifty-thousand-dollar computer. The stack of obstacles convinced him that if Infosys wanted to grow, it had to fight the system through alternative routes — including building relationships with multinationals willing to bring in equipment themselves.

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$1 $10 $100 $1,000 $10,000 $100,000 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 Investment Return 9.5 % (earnings growth plus yield) Annual Growth Rate Investment Return Growth of $1 from 1900 1. accretion of dividend yields and earnings growth—resembles a gently upward-slopping line with, at least during the past 75 years, precious few significant aberrations. (Chart 1) Speculation is just the opposite. It represents the short-term—not long-term—holding of financial instruments—not business—focused (usually) on the belief that their prices—as distinct from their intrinsic values—will rise; indeed, the expectation that the prices of the stocks that are selected will rise more than other stocks, as the expectations of other investors come to match one’s own. The line that we draw representing the path of stock prices over the same period is significantly more jagged and spasmodic than the line showing investment returns. (Chart 2) In the short run, speculative returns are only tenuously linked with investment returns. But in the long-run, both returns must be—and will be—identical. Don’t take my word for it. Listen to Warren Buffett: “the most that owners in the aggregate can earn between now and Judgment Day is what their business in the aggregate earns.” Illustrating the point with Berkshire Hathaway, the publicly-owned

operating income excludes investment gains of $216.6 million, net of income taxes, realized in 2005. No investment gains or losses were realized in 2006. The discussion below will concentrate on insurance underwriting, not on the results from investments. Wes-FIC engages in the reinsurance business. For the past several years, its reinsurance activity has consisted of the participation in several risk pools managed by an insurance subsidiary of Berkshire Hathaway, our 80%-owning parent. The arrangement became eÅective in 2001 and most recently covered hull, liability and workers' compensation exposures relating to the aviation industry, as follows: for 2005, to the extent of 10% in the hull and liability pools and 5% of a workers' compensation pool; for 2006, 121 /2% of the hull and liability pools and 5% of the workers' compensation pool. For 2007, participation in the hull and liability pools has increased to 16.67%. The Berkshire subsidiary provides a portion of the upper-level reinsurance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a diÅerent interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. Wes-FIC's underwriting results have Öuctuated from year to year, but have been satisfactory. When stated as a percentage, the sum of insurance losses, loss adjustment expenses and underwriting expenses, divided by premiums, gives the combined ratio.

If you can make one heap of all your winnings And risk it on one turn of pitch-and-toss, And lose, and start again at your beginnings And never breathe a word about your loss; If you can force your heart and nerve and sinew To serve your turn long after they are gone, And so hold on when there is nothing in you Except the Will which says to them: ‘Hold on!’ If you can talk with crowds and keep your virtue, ‘Or walk with Kings – nor lose the common touch, If neither foes nor loving friends can hurt you, If all men count with you, but none too much; If you can fill the unforgiving minute With sixty seconds’ worth of distance run, Yours is the Earth and everything that’s in it, And – which is more – you’ll be a Man, my son!

True Measures of Money, Business, and Life. Here is the essence of my philosophy: All of us who have been favored by fate, enriched by education, and driven by determination can feel proud of our good fortune. But even as we thrive on the great benefits of our American civilization, we must remind ourselves that today these benefits are shared by far too small a portion of our citizenry, while, as our Declaration of Independence assures us, “all men are created equal,” inequality—in family, in education, and, yes, even in opportunity—begins at the very moment of our birth. But the Constitution of the United States of America demands something better. “We the People” are enjoined “to form a more perfect Union, to establish Justice for all; to insure domestic Tranquility . . . to promote the general Welfare, and to secure the Blessings of Liberty to ourselves and our Posterity.any

While the 40 fund management companies with public owners of one kind or another predominate the number of firms, their share of industry assets is smaller relatively smaller—about $6 trillion, less than half of the $12.5 trillion industry total. The 10 privately-held and mutual firms are disproportionally large, with these firms managing some $4.5 trillion. Under each of the first three forms of ownership, to varying degrees, management companies face a profound conflict of interest. They wish to earn the highest possible return on their ownership stake, by gathering ever-larger pools of assets and steadily increasing their management fee revenues and profits. But this objective comes at the direct expense of the returns that they deliver to the mutual fund shareowners whom they are duty-bound to serve. For the publicly-owned and conglomerate-owned firms, the conflict of interest is, ironically, even more severe than for the privately-held managers. Arguably, they have a fiduciary duty to maximize the returns of both their own shareholders and their fund shareholders. To understand the severity of the problem, just consider the Biblical warning, “no man can serve two masters.”

If one has the patience to wait 50 years, perhaps anything can find its way into the library. The First 50 Years was followed in 2002 by Character Counts, my fourth book, a collection of the speeches I had given to our Vanguard crew over the first three decades of our firm’s history, with some explanatory text added. My idea was to set down the truth about events as they actually happened, not only so that our history wouldn’t be rewritten by others, but so it wouldn’t be rewritten by me. I presented these speeches, warts and all, without editing, so they compose a sort of oral history, without the benefit of hindsight. The Battle for the Soul of Capitalism That brings me to my fifth book, The Battle for the Soul of Capitalism. As 2004 began, I had absolutely no plans—none, nada—for writing another book. But only until I received a letter from Michael O’Malley, senior editor of business and economics for the Yale University Press, who wrote: “I think that your next book will be your best. As your ideas begin to take shape, I was wondering if we might discuss Yale as the publisher of your work.”

But preserving, protecting, and defending the corporation’s resources with the interests of its owners as the highest priority seems the exception rather than the rule today. We know that the CEO is the senior employee of the corporation, responsible, through the board of directors, to the owners. Yet we live in a world with many imperial CEOs who seem to view themselves as solely responsible for the creation of “shareholder value” (more about that later) and, worse, and paid accordingly. Indeed, with the abject failure of the owners of our corporations to aggressively demand their rights of ownership and equally aggressively assume their responsibilities of ownership, why should we expect our corporate managers to honor the responsibilities they so clearly owe to their owners? We see corporations preach “the balanced scorecard” that calls for fair dealing with the corporation’s other constituencies—customers, employees, suppliers, the local community, government, and the public.companies

Neither Germany nor Italy became unified states until 1871. In fact, 48 of the 192 countries that are members of the United Nations are less than thirty years old. Young as we may be, our own country is something of an oldster among the world’s nations. I’m reminded of that country song from the movie “Nashville” that runs, “We must be doing something right to last 200 years.” Arguably, to last 300 years is even more impressive. So I hope that the Presbyterian Church can take a moment to reflect on her signal achievement. Even by the relatively modest standards of longevity achieved by the nations of the world, the lifespans of our commercial enterprises seem rather puny. General Electric is the only company in the Dow Jones Average to survive the past 100 years. Even the Dow Jones Average itself goes back only to 1894. What’s more, its early components—for example, Standard Rope and Twine, Pacific Mail Steamship, U.S. Leather, and American Cotton Oil—have long been consigned to the dustbin of history. Clearly, survival in the brutal competition that is central to our capitalistic system faces long odds. That is not necessarily bad.Schumpeter’s

government interventions aimed at containing the deterioration (are often) inept in historical crises.” It remains to be seen whether he was right or wrong on that point. Minsky concluded that over long periods of prosperity, the economy transits from financial structures that make for a stable system to structures that makes for an unstable system; i.e., that “stability leads to instability,” largely through what he described as hedging, speculation and Ponzi finance. With these words, all those years ago, Minsky proved a prophet of today’s crisis. Another of his insights was also prophetic: “Institutional complexity (for example, today’s collaterized debt obligations and credit default swaps) may result in several layers of intermediation between the ultimate owners of the communities’ wealth, and the (business and individual) units that operate and control the communities’ wealth.” This separation between ownership and control has now come to pass. In our old ownership society 92 percent of all stocks were owned by individuals and 8 percent by institutions. But in today’s agency society, only 24 percent of stocks are owned by individuals, with the remaining 76 percent held by institutions.the

After analyzing mutual fund performance, I conclude that “funds can make no claim to superiority over the market averages,” perhaps an early harbinger of my decision to create, nearly a quarter-century later, the world’s first index mutual fund. Still later in the thesis, “fund influence on corporate policy . . . should always be in the best interest of shareholders, not the special interests of the fund’s managers.” (Again, my advice fell by the wayside, and shareholders remain ill-served by the passive governance policies of most funds.) My conclusion powerfully reaffirmed the ideals that I hold to this day: “The principal function of investment companies is the management of their investment portfolios. Everything else is incidental.” The role of the mutual fund is to serve—“to serve the needs of both individual and institutional investors . . . to serve them in the most efficient, honest, and economical way possible.” This gratuitous advice from a callow college senior was also largely ignored by the fund industry.group—operated

The Helpers handle the transactions, and as brokers, they receive commissions for their services. The ownership is thus rearranged among the family members. To their surprise, however, the family wealth begins to grow at a slower pace. Why? Because some of the return is now consumed by the Helpers, and the family’s share of the generous pie that U.S. industry bakes each year—all those dividends paid, all those earnings reinvested in the business—100 percent at the outset, starts to decline, simply because some of the return is now consumed by the Helpers.they

Beginning in the mid-1990s, that combination of mutuality and index funds would produce the colossus that Vanguard has become, the largest mutual fund complex in the world, now managing more than $3 trillion of investor assets. Yes, Vanguard is just “a business,” and it is now a large one. But establishing values has always been more satisfying to me than operating a business. Again quoting John Gardner, “what could be more satisfying than to be engaged in work in which every capacity or talent one may have is needed . . . every value one cares about is furthered.” So why would I retire? I continue to enjoy my challenging and exciting career in the mutual fund industry, soon to enter its 66th year. My books—now ten, perhaps with another one in the offing—have been among my principal means of spreading the word about that still unique structure and that still controversial strategy. I continue to raise hell with a mutual fund industry that is ripe for disruption—call it a “lover’s quarrel.” Conventionally operated funds could serve investors with so much more integrity, harmony, efficiency, and economies than they do today; I’m happy to push them in that direction.

the development of the corporate structure so as to vest in small groups control over the resources of great members of small and uninformed investors, make imperative a fresh and active devotion to that principle. Yet, those who serve nominally as trustees, but relieved, by clever legal devices, from the obligation to protect those who interests they purport to represent . . . consider only last, if at all, the interests of those whose funds they command, suggest how far we have ignored the necessary implications of that principle.’ I then continued: “I endorse that view, and at the same time reveal an ancient prejudice of mine: All things considered, absent a demonstration that the enterprise has substantial capital requirements that cannot be otherwise fulfilled, it is undesirable for professional enterprises to have public stockholders. This constraint is as applicable to money managers as it is to doctors, or lawyers, or accountants, or architects.cases,

responsibility must always be to their shareholders.” Shortly thereafter, “there is some indication that costs are too high,” and that “future industry growth can be maximized by concentration on a reduction of sales charges and management fees.” (My advice, however, fell upon deaf ears.) After analyzing mutual fund performance, I concluded that “funds can make no claim to superiority over the market averages,” perhaps an early harbinger of my decision to create, nearly a quarter-century later, the world’s first index mutual fund. Still later in the thesis, I urged that “fund influence on corporate policy . . . should always be in the best interest of shareholders, not the special interests of the fund’s managers.” (Again, my advice fell by the wayside, and shareholders remain ill-served by the passive governance policies of most funds.) Finally, I predicted that rather than engaging in short-term speculation focused on forecasting the psychology of the stock market, funds would bring far greater focus on wise long- term investment. Defying Lord Keynes’s prediction that professional investors would join the ignorant crowd of stock traders, I predicted that fund managers would be “steady, sophisticated, enlightened, and analytic” institutional investors, focused on corporate performance and intrinsic value rather than momentary and evanescent share prices. (Once again, I was wrong.

We have essentially three constituencies: (1) our crewmembers (I detest the “you” vs. “me” idea suggested by the word “employees”), (2) our clients (I don’t much care for the word “customers,” either), and (3) the public, reached largely through the media. Since virtually everything I did was designed to be an open book (most corporate secrecy is just plain silly), the standards were the same for all. It may surprise you, but this philosophy begins with caring: The simple recognition that the millions of investors whom we serve, and the thousands of our crewmembers with whom we serve and are real, honest-to-God, down-to-earth human beings, with their own hopes, fears, and financial goals. To the best of my ability, I tried to think of them, not as large aggregates, but as individuals. Secondly, this philosophy depended on integrity—personal integrity to be sure, but also corporate integrity, right down to our basic mission, which I conceived of as service to others— our clients and crewmembers—before service to self. Any institution is a fragile construct, and so “it must be the object of intense human care and cultivation.it

Early in my career, I worked with our bond and stock analysts, helping them with basic data on corporate balance sheets, income statements, and other financial statistics, later serving on our Investment Committee. While I should have known better, I’m afraid I was largely responsible (though well-intentioned!) for our firm’s ill-fated change in focus from long-term investment to short-term speculation, beginning in 1966. My decision to merge Wellington Management Company with a much smaller Boston firm of hot managers of that “go-go” era was simply stupid. It had unfortunate consequences for our funds, including Wellington Fund, our crown jewel. To my everlasting regret, I came to believe that these new managers could outperform the market forever. (Yes, I did!) But it quickly became apparent that they could not meet that lofty standard. All too soon, I came to realize the obvious: there is no such a thing as a permanently superior long-term mutual fund manager: Good, rarely; superior, never.

These attacks were punctuated by perhaps a dozen fibrillations, and a half-dozen or so cardiac arrests. Some were resolved by CPR; some by the electrified paddles administered by the very cardioverter that Dr. Lown invented all those years earlier; and one when my squash opponent simply hammered on my chest. (It beats doing nothing!) I lived. I lived! But by early 1995, half of my heart had stopped pumping. It was time for a heart transplant, which I received in Philadelphia on February 21, 1996. I’ve now enjoyed 12 ½ extra years of life, years during which I’ve written six more books, books that have increasingly focused on challenging American society to return to a focus on our traditional values. In particular, it’s high time for our egregious financial system to change its ways, to serve its clients first and itself only second. It’s proven to be a lot to ask, but I hope my forthcoming book, entitled Enough., will make a difference in our “more” society. So here I am tonight, to report to you that the package of love, healing, care, intensity, focus, empathy and professional skill provided by Dr. Lown was without parallel in my long struggle with cardiomyopathy, and enabled me to press on with my life.even

barrage of unnerving changes: booms and bankruptcies, inflation and deflation, shocks in commodity prices, the revolution in information technology, and the globalization of financial markets. In recent years, our faith has been enhanced— perhaps excessively so—by the bull market in stocks that began in 1982 and has accelerated, without significant interruption, toward the 20th century’s end. As we approach the millennium, confidence in equities is at an all-time high. Might some unforeseeable economic shock trigger another depression so severe that it would destroy our faith in the promise of investing? Perhaps. Excessive confidence in smooth seas can blind us to the risk of storms. History is replete with episodes in which the enthusiasm of investors has driven equity prices to— and even beyond—the point at which they are swept into a whirlwind of speculation, leading to unexpected loses. There is little certainty in investing. As long-term investors, however, we cannot afford to let the apocalyptic possibilities frighten us away from the markets. For without risk, there is no return. As you might suspect, then, even these ten years later, I wouldn’t change a word that I then wrote.

fight.” However elusive the destination, the real thrill is the journey, and I’ve had a thrilling career. But however respected and acclaimed the movers and shakers who do their best to excel in their own fields may be, the core of our mission must focus not only on our society, but also on the individual human beings who constitute our society—the macro, to be sure, but let’s never forget the micro. I suppose this is where the word “humanitarian” enters the picture. For my part, I’ve tried to focus on the many human beings who have been clients of Vanguard—now some 15 million shareholders strong, the largest congregation of mutual fund shareholders in the world. For a quarter-century or more I have used these words to describe our mission: Those whom we serve must be treated as honest-to-God, down-to-earth human beings, each with their own individual hopes and fears and financial goals, to treat them as we would expect the honest stewards of our own assets to treat us. We must never let them down. (Hint: the Golden Rule actually works!) I close with this personal reflection: I sometimes fear that I—and many others who have enjoyed the opportunity to have a strong impact on their chosen fields—have focused too heavily on our careers, and not enough on our families. I say that knowing that my wife Eve, five of our six children, four of our twelve grandchildren, my brother Bill, and another five members of our extended family are here tonight.

It is, I think, these two factors—competitive zeal and moral values—that have been central to my career-long quest to make the things that I have touched during my long life better than I found them. Hence, the title I’ve chosen for my remarks this evening—“Aspiring to Build a Better Financial World.”1 I’ll talk first about the causes of today’s financial crisis, then set out an eminently sensible—if provocative—solution, and close with some reflections on how many, well, “Princeton coincidences” have punctuated my career, and on how the values and character of my Princeton education contributed to my mission. Causes of the Financial Crisis Why is it important to build a better world in finance? Because finance provides credit and fosters liquidity, it is the oil that lubricates the machinery of corporate capitalism, an essential element of a flourishing society. But our financial sector has failed us, and bears the overwhelming responsibility for the current economic crisis. The proximate causes of this crisis 1 I’m mindful of the fact that the theme of Princeton’s present capital campaign is “Aspire,” in the sense of “ambition to achieve a higher goal.” One citation in the Oxford English Dictionary defines aspire in especially beautiful terms: “an immense instinct in man’s nature (that) points upward, like a spire of flame.”

The proximate causes of the current financial and economic crisis are usually laid to easy credit; the cavalier attitude toward risk of our bankers and investment bankers; “securitization,” in which the traditional link between borrower and lender was severed; the extraordinary leverage built into the financial system by derivative securities of mind-boggling complexity; and the failure of our regulators to do their job. But the larger cause of the present crisis was our failure to recognize the sea-change in the nature of capitalism that was occurring right before our eyes. The “Agency Society” Displaces the “Ownership Society” That change in capitalism, simply put, was the growth of giant business corporations, controlled not by their own shareholders, but by the agents of the ultimate owners. What went wrong in corporate America, aided and abetted by investment America, was a pathological mutation in capitalism—from traditional owners’ capitalism, in which the rewards of investing went primarily to those who put up the capital and took the risks, to a new and virulent managers’ capitalism, where an excessive share of the rewards of capital investment went to corporate managers and financial intermediaries. Two major trends set the stage for this baneful change: First, the old “ownership society” shrank radically in size and importance. Only a half-century ago, 92 percent of all shares of our corporations were held by direct stockholders.percent

” Could there possibly be a better set of standards for a man who has come to himself than those eternal standards exemplified by your legendary founder? Work . . . Trade . . . Finance I have always been a huge admirer of the craftsman who works with his hands as well as his mind, the consummate professional who enhances our daily existence by his talents and his skills. You and your peers—those who came through these halls before you and those who shall follow you, those who study and learn their trades—add great value to our society. Indeed, you constitute the very backbone of our nation, and you should be rightfully proud of learning the trades you will soon practice. Those of us in finance are of a rather different status, for it is no longer any secret that our financial sector subtracts value from our society. 2 Throughout these quotations, I have taken the liberty of substituting “you” and “your” for Wilson’s “he” and “his.”

, never more so than in one of the concluding chapters of his book: “Why talk about correcting the present evils? The patient has a cancer. The virus is in the blood . . . He is not only sick unto death, but he is dangerous to the community. Call in the undertaker.” My Career Values in Today’s Fund Industry So I can properly say that Grandpa Armstrong’s apple’s apple’s apple didn’t fall very far from the tree. While virtually my entire career has focused on cutting costs for mutual fund investors and giving them a fair shake, compared to my great-grandfather, I am a moderate.(You

and elegance”2—the very kind of ingenious simplicity and effectiveness that characterize the index fund. It is the antithesis of the discredited “financial engineering,” the excessive costs, the product complexity, and the rampant speculation that created the global financial crisis that Wall Street has inflicted on Main Street. We created the first index mutual fund in 1975, and today it is the largest mutual fund in the world.3 This afternoon, I’d like to discuss the current state of our economy and financial markets, with the emphasis first on what went wrong, and second on what we might do to assure that our financial system takes on a greater sense of public purpose. I’ll do so by focusing on four quotations from Adam Smith, ranging from the obvious to the prophetic, to the idealistic. I’ll conclude with a few closing words about how all of this fits in with the message of my new book, Enough. True Measures of Money, Business, and Life. Adam Smith I – The Invisible Hand To say that the nation’s financial sector has ignored the principles of efficiency and economy—to say nothing of elegance—would be to put one’s head in the sand. The fact is that the bubble that led to the current financial and economic crisis; the easy credit; the cavalier attitude toward risk taken by our bankers and investment bankers; “securitization,” in which the traditional (and essential!)

It means we should press on not only through bad times, but through good times as well; press on through stormy seas and calm seas alike; press on when we experience failure of course, but also when we achieve success; and press on when we meet both triumph and disaster (even as we honor Kipling’s mandate to “treat those two imposters just the same”). Our Economy, Then and Now While I’m certain that the timeless virtues that Calvin Coolidge exemplified should remain our guiding stars today, I’m doubtful, alas, that his views of the role of our 1 This classic Coolidge quotation continues to find its way into my life, sometimes in surprising forms. For example, I recently learned that Ray Kroc, founder of McDonald’s, had the “press on” quotation posted on the wall of the office of the manager of every McDonald’s restaurant. However, it was not signed “Calvin Coolidge.” It was signed “Ray Kroc.”

while The Vanguard Group, manager of the Vanguard funds, earned precisely zero. (As the only mutual mutual fund organization, all of our profits are, in substance, returned to our shareholders.) History has not been kind to those earlier monarchs of the mutual fund kingdom. The MFS market share, which peaked at 15 percent all those years ago, has now fallen below 1 percent. The IDS/Columbia market share also peaked at 15 percent and is now less than 2 percent. And Fidelity’s market share has fallen from 13 percent in 1999 to 11 percent today. What explains these declines? As I look at this history, I date the decline of MFS from 1969, when it abandoned its original unique mutual structure (similar, but not identical to Vanguard’s) in favor of private ownership of its management company. The firm was sold to Sun Life of Canada in 1982; it joined the performance-chasing game; and it saw its composite expense ratio rise from 0.19 percent to 1.20 percent, more than a six-fold rise. IDS operated during the golden age of captive sales forces, capitalized on its huge (insurance-oriented) client base, but ultimately failed to develop a strategy for a world in which giant brokerage firms and no-load funds would dominate fund marketing. As for Fidelity, I see it as a firm heavily oriented toward the superior performance of their funds (especially Magellan) during and beyond the short-lived “Go-Go Era” of the late 1960s, achieved when the firm was managing some $3.

Nadar disputed the popular version that IBM was 'evicted' from India in 1977; he told Wharton that IBM actually withdrew over a government rule requiring source code to reside in India and a foreign-equity dilution requirement — clarifying that HCL did not benefit from a competitor's forced exit but rather lost the market-creation partner IBM had been.

The Wisdom of John Maynard Keynes Whatever one may think about “Keynesianism” in the field of economics—essentially calling for government expenditures to stimulate demand in economies performing below their capacity—the great British economist John Maynard Keynes was little short of brilliant in the field of investment. Keynes recognized this critical distinction between economics and emotions way back in 1925. Observing the predilection of investors to implicitly assume that the future will resemble the past, Keynes warned: “It is dangerous to apply to the future inductive arguments based on past experience unless we can distinguish the broad reasons for what it (the past) was.” A decade later, in 1935, in his amazing The General Theory of Employment, Interest, and Money, Keynes focused on the two broad reasons that explain the returns on stocks. The first was what he called enterprise—“forecasting the prospective yield of an asset over its entire life.” The second was speculation—“forecasting the psychology of the market.factors

Honoring Ethical Principles in Business No one can be more aware than I am that in the dog-eat-dog competition that has always been inherent in our capitalist system, these ethical principles are often difficult to honor. Dealing with this fierce competition without compromising one’s character is no mean challenge! For example, while it seems that 100 percent of our business leaders—those principals of our corporations—describe integrity and honesty as the essential elements of leadership, it’s also clear that less than 100 percent of them deliver on those two essentials. Among our large publicly held corporations, having a clear set of standards and an ethical code is now a commonplace, yet we’ve seen too many examples where these standards have been ignored, often to meet ambitious—perhaps overly ambitious—goals for growth in corporate revenues and earnings. 1 This difference leaped out at me just two nights ago, when I stumbled upon a television rerun of the movie about the collapse of Enron—“The Smartest Guys in the Room.” Enron’s principles were solid: “Communication; Respect; Excellence; and Integrity—open, honest, and sincere.” But every one of those principles was violated by the Enron principals, and the company failed. At least some of the principals went to jail for their misdeeds.

four children-in-law, twelve grandchildren, soon to have, our, well, fourth grandchild-in-law, 28 in all. Malthus knew what he was talking about! Why on earth am I telling you about this saga tonight? For two reasons, I think. First, as a reminder that in this life of ours, anything can happen. (“Never give up. Never. Never. Never. Never. Never!” is a long-time family motto.) Second, because the values that have shaped my career in finance are a product of my nature (of course), but also of my nurture—my upbringing and what some would consider a long, hard, struggle for self-reliance and financial security, learning that we must work for what we get, trying to make something of myself. These challenges I’ve faced and overcame are what have taken this soul from a humble background to where I am today—a person of no more than decent intelligence, eagerness to accept responsibility, an ability to get along with individuals from all walks of life, and a passion to make a difference, not only in my own life, but for the human beings in our society at large. Let me be honest, I’ve not gotten here by myself alone. I’ve been the beneficiary of a relentless determination, and so much good luck and so many incredible—often fortuitous— breaks that would be impossible for most of you here tonight even to imagine them. I didn’t do whatever I’ve been able to do without the love and support of lots of other human beings.

∑ IF my new partners had not fired me from my job at Wellington Management Company in January 1974, leaving me with the opportunity to create a new firm with a new mutual structure—designed, as I suggested in that ancient thesis, to be managed in the “most economical, efficient, and honest way possible”—there would be no Vanguard today. ∑ IF the independent directors of the Wellington Funds had not believed in the unprecedented new structure I proposed for the firm, and if senior independent director Charles D. Root, Jr. had not believed in me, there would be no Vanguard today. ∑ IF an aging book salesman had not stopped in my office to sell me some antique prints of the military battles of the Napoleonic wars (the Duke of Wellington, of course, was the hero), and if he had not shown me some prints from the naval battles of the same era, I would never have learned that HMS Vanguard was Lord Nelson’s flagship at the historic Battle of the Nile, and there would be no “Vanguard” today. ∑ IF I hadn’t read Paul Samuelson’s 1974 article “Challenge to Judgment” in the first issue of the Journal of Portfolio Management—jogging my memory of my conclusion in my thesis—mutual funds “can make no claim to superiority over the market averages”—it’s almost inconceivable that we would have started, in 1975, the world’s first index mutual fund.

“Well, what was it? Bad treatment?” “Oh, no,” the dog said. “They treated us royally when we were racing.” “Did you get crippled?” “No” “Then why?” I pressed. “Why?” The dog answered, “I quit.” “You quit?” “Yes,” he said. “I quit.” “Why did you quit?” “I just quit because after all that running and running and running, I found out that the rabbit I was chasing wasn’t even real.” America’s Heritage A true story? Well, perhaps not. But I expect that most of us who ply our trades in business, commerce, and finance know just how that old greyhound felt. How often have we sped around and around the track, doing our busy jobs and chasing the false rabbit of personal success, measured by wealth, fame and power? Then one day, if we’re lucky, we discover the real rabbit—a life well-lived, finding for ourselves a meaningful place in life, one which includes substantial service to our communities, especially those that desperately need help, populated by human beings with barely a fighting chance to enjoy “the inalienable rights to life, liberty, and the pursuit of happiness” that our Declaration of Independence promises. Yes, our Declaration assures us that “all men are created equal.” But far too often that equality ends at the moment birth takes place. For too large a segment of our society, we find lots of inequality, including extreme disparities in wealth, in family cohesion, in education, and ultimately in opportunity as a whole.

” Yes, I think I’ve played a major role in bringing into the public discourse the importance of long- term investing, of rational expectations for returns in the financial markets, and of the crying need for a fiduciary standard . . . But there’s so much I haven’t done: Walk on water, leap tall buildings at a single bound, publish poetry in Russian, make the cover of TIME, or Fortune, or FORBES, or Bloomberg Business Week. Despite my infinite failings, however, I’m simply unable to conceal my pride on this great day of celebration. I’m reminded again of Benjamin Franklin, whose character was central to his dedication to the public interest, so easily observable in his entrepreneurship, in the joy he took from his creations, and in his ingenuity, his energy, and his persistence. That trait of character also found its expression in Franklin’s ongoing struggle, not unlike my own, to balance pride with humility—a balance that, in this age of bright lights, celebrity, and money, our society seems to have largely ignored. As Franklin wrote in his autobiography: In reality, there is, perhaps, no one of our natural passions so hard to subdue as pride.still

In my experience, cost is usually within the realm of calculation; benefits too often are not. The costs of auditor rotation are wide-ranging and malleable (depending on the interests of those doing the arithmetic). What’s to be said about the benefits? Surely our common sense and our instincts do not mislead us when we conclude that the benefits of auditor independence are far-reaching and create substantial (if immeasurable) value for our financial system and our society. To reach the ideal world of audit independence, the obvious solution is to have the audit firm retained by the providers of the firm’s capital, rather than by its managers. (Don’t laugh. I’m told that when the canny Scots sent all that capital to America in the mid-18th-century to help build our nation’s vast cross country railroad system, they sent their own auditors along.) Today, however, nearly all of our publicly-held corporations have thousands of owners or even hundreds of thousands: One might have thought that as control of our corporations moved from a large group of relatively small individual owners to a small group of relatively large institutional investors, that control might be exercised. Institutional owners—mutual funds, public and private pension funds, endowment funds, trust companies, etc.—now hold 72 percent of all shares of U.S. corporations, up from 8 percent in 1950. The largest 25 of these investor/agents hold 56 percent of all shares—complete control … if they want it.)federal

Within eight years, the merger fell apart. But it was the new partners who fired me as the CEO of Wellington Management in January 1974. Within months, I came back as CEO of the Wellington Funds, and started Vanguard as a mutual company that would be responsible for the funds’ operations and the ongoing appraisal of their managers (including, of course, the firm that had just fired me). I quickly took on the task of restoring Wellington Fund to its traditional balanced focus. With the board’s consent, I directed Wellington Management to return Wellington Fund to its original investment values—less focus on growth and more focus on income. Indeed, I presented to Wellington a sample stock portfolio designed to produce a 70 percent increase in the fund’s annual income income dividend over the subsequent five years, and set that goal as our objective. The fund’s portfolio manager was not amused, but he complied, the dividend soared, the objective was met, and the strategy worked. Restoring Wellington Fund to its founding investment values saved it, and today it is once again the industry’s largest balanced fund ($75 billion). Some of you may think of me as the “anti-analyst” because I came to focus on the simple math of investing, the tautology that led to Vanguard’s formation of the world’s first index mutual fund in 1975. Simply put, gross return in the stock market, less the costs of active investing, equals the net returns earned by investors as a group.

No Easy Answers I want to be clear that while such a direct conflict does not face a manager operating under the mutual (fund-shareholder-owned) structure, even today’s sole mutual manager (that’s us), inevitably faces issues of self-interest—for example, in executive compensation, in edifice-building, and in providing complete transparency. Such a mutual structure may be “a more perfect union” of the interests of both managers and shareholders, but it is not perfect, inevitably dependent on the character, the values, and the principles of the executives who control the organization at any moment in time. These agency issues were well-recognized by Harvard Business School professor Michael C. Jensen, whose seminal 1976 paper described agency relationships and how and to whom the costs and rewards of corporate ownership are allocated. Since the relationship between the stockholders and the managers of a corporation fits precisely the definition of a pure agency relationship, it should come as no surprise to discover that the issues associated with the separation of ownership and control in the modern diffused-ownership corporation are intimately associated with the general problem of agency. The challenge of inducing an “agent” to behave as if he were maximizing the welfare of the “principal” is quite general. Quoting Dr.

There I used “Enough” as my theme, and began it with Vonnegut’s poem. Here’s what I then said to those newly-minted MBAs: “If you enter the financial 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.only

age, of any race, and of any heritage who wishes to improve his or her lot in life. Education and career training are the keys to unlocking, and then opening, those doors. Abraham Lincoln and Theodore Roosevelt These ideals are hardly mine alone. In fact, a century and a half ago, they were beautifully expressed by one of our greatest presidents, and restated a century ago by another. First hear Abraham Lincoln: “ I hold that while man exists it is his duty to improve not only his own condition, but to assist in ameliorating mankind . . . Labor is prior to, and independent of capital. Since capital is only the fruit of labor, labor is the superior of capital, and deserves much the higher consideration.” Yet, Lincoln added, “Let not him who is houseless pull down the house of another, but let him work diligently and build one for himself, thus by example assuring that his own shall be safe.” Almost 100 years ago, Theodore Roosevelt quoted Lincoln’s words in his remarkable 1910 speech on “The New Nationalism,” noting that “if Lincoln’s remarks were original with me, I should be even more strongly denounced as a Communist agitator than I shall be anyhow.

Well, I was hooked immediately. Not only because I was egotistical enough to be impressed with the idea of a university press imprint, and from a top university publisher at that. But even more, after four books focused largely on mutual fund investing and personal idealism (sort of strange bedfellows, when you think about it . . . which I didn’t, and I don’t), I wanted to “spread my wings” and plunge into some of the deep societal forces that, I feared, were undermining the foundations of our great nation. An amusing sidelight. There are very few people in the world of commerce and finance who write books. (And many of those whose books are published didn’t even write them. Business is a ghost writer’s paradise!) Michael Lewis, of course, is a real standout. And right next to him I’d put Peter Bernstein (Against the Gods, The Power of Gold) and James Grant (Money of the Mind), both enormously gifted writers and friends of mine. Soon after I signed up with Yale, both had produced new books that were to make my “wing spreading” seem sort of, well, pathetic. Bernstein wrote The Wedding of the Waters, a history of the Erie Canal, and Grant wrote Party of One, a biography of John Adams. Talk about bringing my inflated ego down to earth! When I received the Yale letter, I had already been speaking out on the shortcomings of our business leaders, our financial community, and our mutual fund industry.

My books and essays constitute a major force in my goal of driving that change, of earning the trust of investors, and of explaining Vanguard’s mission to give them a fair shake. Truth told, I find it hard to separate my writings from my efforts to build Vanguard. Among other things, these books describe why I strived to shape a new kind of institution, and then how I went out and did it. John Gardner writes that in his long experience he had uncovered “pervasive examples of vigorous leaders sharing a vision of how they might shape their future.” What it takes to do that, he continued, “depends on leaders who are clear as to what those purposes are . . . and then to persuade individuals to lend themselves to a worthy common purpose.” I’ve done my best. Common purpose. Common Cause. We stand together as we strive for a better America.

as in ours, it is hard to see what unique contribution public investors being to the enterprise. They do not, as a rule, add capital; they do not add expertise; they do not contribute to the well-being of our clients. Indeed, it is possible to envision circumstances in which the pressure for earnings and earnings growth engendered by public ownership is antithetical to the responsible operation of a professional organization. Although the field of money management has elements of both, differences between a business and a profession must, finally, be reconciled in favor of the client. . . . If it is a burden to our fund and counsel clients to be served by a public enterprise [which Wellington Management Company then was], should this burden exist in perpetuity? And if we believe that it is in the interest of our fund and counsel clients that our firm should be owned by its active executives and not by the public, shouldn’t we work to solve this problem in a way that is equitable to all? What a great objective to be accomplished by 1976!” Mutualization? I then turned to the options available for a publicly-held fund manager which sought to free itself of those burdens: “I wish there were a simple way to accomplish what I am talking about, let alone to describe it. But, let me say that a variety of options may open up as the legal atmosphere clears. For example, there may be ‘mutualization’ whereby the funds acquire the management company.

heard it here!) Consider these quotations from my Princeton senior thesis, which I completed in 1951. “[Mutual funds] should be operated in the most efficient, honest, and economical way possible . . . Future growth can be maximized by reducing sales charges and management fees . . . Funds can make no claim to superiority over the market averages . . . The principal function of investment companies is the management of [their] investment portfolios. Everything else is incidental . . . The principal role of the mutual fund should be to serve its shareholders.” More than 61 years later, those idealistic words continue to serve as my mantra, as they did when I established Vanguard, and did my best to establish our founding corporate structure, our investment strategies, and our human values. My Long Career Ever since I began my career in the fund industry, those values set forth in my thesis have continued to be at the forefront of my continuing mission to serve the fund shareholders who have entrusted their hard-earned dollars to our care. The validation of those values by the data themselves, by analysts, by Academia, and by the investing public has grown at a rapid pace, even accelerating over the past decade.

As my dedication of my new book, The Clash of the Cultures: Investment vs. Speculation acknowledges, citing John Donne’s eternal wisdom, “No man is an island, entire of itself.” Education Makes the Difference A wonderful education was essential in shaping my values, sharpening my mind, honing my intellectual curiosity, and developing my career. My beloved mother was determined that her three boys would receive first-class schooling.in

overwhelmed by the “new model” of the exchange traded fund (ETF), which now hold assets that are larger than the TIFs themselves. So often used for speculative purposes, ETFs now experience an annual share turnover averaging about 500 percent per year, to the tune of $18 trillion in trading volume in 2011 alone. The original SPDR (S&P 500) ETF is, day after day, the most widely-traded stock in the world. 6. In our failing national retirement system—ranging from Social Security to defined benefit plans (DB) to loosely controlled defined contribution (DC) plans—most offer little likelihood of fulfilling their investors’ hopes for retirement. In each of these realms, speculation—on future returns, on fund choices, or on other decisions—calls the tune. II. The Wisdom of Lord Keynes Way back in 1925, John Maynard Keynes provided a wonderful insight on the role of speculation in shaping stock returns. Observing the predilection of investors to implicitly assume that the future will resemble the past, Keynes warned: “It is dangerous to apply to the future inductive arguments based on past experience unless we can distinguish the broad reasons for what it [the past] was.” A decade later, in 1936, in his classic The General Theory of Employment, Interest, and Money, Keynes focused on the two broad reasons that explain the returns on stocks. The first was what he called enterprise—“forecasting the prospective yield of an asset over its entire life.

To these 16 human beings, I want to say that I’m conscious of the fact that the hours of our day are limited, and that my family may have paid a price—I hope not too large a one—for my determined focus on my mission and the tasks at hand.my

government should act to arouse these sleeping giants as to the rights and responsibilities of stock ownership. Until then, I like the section of Sarbanes-Oxley that puts the audit committee—rather than management—in charge of hiring the auditor and overseeing the engagement. That extraordinary latent power is limited by the fact that it is the management that appoints the Audit Committee, and that even the most qualified of audit committee members rarely has the knowledge to analyze the issues— especially the issues behind the issues—in depth. Perhaps the Audit Committee should retain its own consultant to assure that the significant issues surrounding the corporation’s financial statement receive a full airing. (Management will not easily warm to this idea.) One of the pressures of the current era is the focus on building “corporate value,” so often defined as a focus on the inevitably evanescent short-term stock price. But we all understand that it is the long- term intrinsic value of the corporation we should be focused on. Yes, over the long haul the two must be the same. (Ask Warren Buffett.1) But corporate financial statements and reporting often seem fixated on the stock price. It must be obvious that much of the financial engineering that goes on today is only for the here-and-now, and is inevitably zeroed-out over time. But corporate managers are focused on the price of the stock and “earnings guidance” that must be met, lest Wall Street’s rancor be incurred.

alive, and will every now and then peep out and show itself; you will see it perhaps often in this history; for even if I could conceive that I had completely overcome it, I should probably be proud of my humility. In candor, these words serve to remind me that my own pride must be all too evident in the brief history of my career that I’ve recited here, a career focused on the stewardship of the wealth of our nation’s citizens. Too often, I’m sure, my pride has indeed peeped out and shown itself, reminding me that my own humility could doubtless use a little more development. I must work on that tomorrow . . . Thank you again. ______________ Note: My focus on what I haven’t done was inspired by Jason Gay’s Wall Street Journal column on what Denver Broncos quarterback Tim Tebow hasn’t done. December 1, 2011.

Yet together, we who have been so favored have much to do to help those far less favored, to spread “the blessings of liberty throughout the land.” As our Founding Fathers demanded, we must do our best to “promote the general welfare . . . for ourselves and our posterity.” Despite the recent financial crash and our still-stumbling economy, with unemployment at shocking levels (and showing few signs of improvement), America’s material wealth—our productivity, our technology, and our innovation—remain the envy of the world.of

Well, those eight “ifs” are surely a lot! And if, at any one of those junctures (and, truth told, more than a few others), the coin had landed on “tails” rather than “heads,” the industry would, I think, look rather different then it does today. But please be clear: I’m not saying that this industry needs Vanguard. Rather, I believe that every industry needs a Vanguard—a firm that says, “I see what you’re doing, but I have a different design that will serve consumers better, with better products and services, and at lower prices.” Whatever the case, Vanguard has become the world’s largest manager of mutual funds, with a market share of industry assets recently reaching 16 percent, yes, again, a summit that, by a wide margin, no fund firm seems to have reached before. 1 And we continue to grow apace, accounting for some 40 percent of industry cash flow during the past five years. (I doubt that such a dominant share is sustainable.) In 1976, indexing was heresy. “Indexing is un-American!” said a famous poster of that time, and our index fund was known as “Bogle’s Folly,” with a market share of just 0.1 percent of equity fund assets. Today indexing is dogma, the widely accepted core standard for evaluating investment performance, and having a 25% share of equity fund assets. What’s more, index mutual funds have accounted for $688 billion of the $672 billion total cash flow into all equity mutual funds over the past five years.

Our corporate directors pay lip service to the responsibility of stewardship. But preserving, protecting, and defending the corporation’s resources with the interests of its owners as the highest priority seems the exception rather than the rule today. We know that the CEO is the senior employee of the corporation, responsible, through the board of directors, to the owners. Yet we live in a world with many imperial CEOs who seem to view themselves as solely responsible for the creation of “shareholder value” (more about that later) and, worse, are paid accordingly. Indeed, with the abject failure of the stockholders of our corporations to aggressively demand their rights of ownership and equally aggressively assume their responsibilities of ownership, why should we expect our corporate managers to honor the responsibilities they so clearly owe to their owners? We see corporations preach “the balanced scorecard” that calls for fair dealing with the corporation’s other constituencies—customers, employees, suppliers, the local community, government, and the public. But the record suggests, for one example, that too many companies demand loyalty from their employees even as they fail to reciprocate by demonstrating loyalty to their employees. And how about the integrity of the firm’s financial statements, let alone the true independence of the independent auditor who attests to their conformity with generally accepted accounting principles (GAAP)?

explain “The State of Long-Term Expectation” for an investment, the title of Chapter 12 of The General Theory. From his vantage point in London, Keynes observed that, “in one of the greatest investment markets in the world, namely, New York, the influence of speculation is enormous . . . It is rare for an American to ‘invest for income,’ and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that he is attaching his hopes to a favorable change in the conventional basis of valuation, i.e., that he is a speculator.” Today, 75 years after Keynes wrote those words, the same situation prevails, only far more strongly. Lord Keynes’s conviction that speculation would dominate enterprise in the financial markets was based on his belief that individuals, who were then the dominant force in the markets, were largely ignorant of business operations and lacking financial savvy, prone to betting on how other investors might value their stocks in the short term. (A “beauty contest,” Keynes posited; not a contest to pick the most beautiful woman, but to pick the woman whom other voters choose as the most beautiful.) This second-derivative gambling mentality leads to excessive, even absurd, short-term market fluctuations based on investors’ responses to events of an ephemeral and insignificant character.

2 billion of equity assets, but not repeated when those equity assets approached $1 trillion. (Not that managing even a small asset base makes superior returns easy to achieve!) Costs Matter Vanguard faces lots of challenges, but they do not include those problems that I have just touched on—conglomerate ownership; failed marketing strategy; a model built on delivering high performance (with commensurately high risks.) As a truly mutual mutual fund firm, we are independent; focused on the interests of our fund shareholders, and with an incredible—and sustainable—cost advantage.expense

federal government in today’s national affairs can offer much guidance that will help us through the financial mess in which our nation finds itself, so unlike the role of government in the era of remarkable prosperity over which President Coolidge presided. Under Coolidge, our economy flourished, growing by 22 percent (in real terms) from 1923 to 1929. There was, literally, zero inflation; federal government expenditures held flat (really!); the U.S. debt was slashed; the top marginal income tax rate was cut from 43% to 24%; unemployment fell to 3.2 percent. In short, in the president’s words, our citizens “reached a state of contentment seldom before seen.” Given that level of growth and prosperity, it is hardly surprising that Coolidge believed that government should try to get out of the way and leave it to the private sector—to rely on our citizens—to keep the momentum going. “I want the people of America to be able to work less for the government and more for themselves,” Coolidge said. “I want them to have the rewards of their own industry. This is the chief meaning of freedom.” But in this recent winter of our discontent, it is only to state the obvious that America’s growth has been hobbled and our prosperity limited. Our national product is no higher than it was three years ago, and unemployment, at 9.5 percent, is running at the highest levels of the past quarter century.

link between borrower and lender was severed; the complicity of our rating agencies with the issuers of all those collateralized debt obligation; the extraordinary leverage built into the financial system by derivative securities of mind-boggling complexity; the failure of our regulators to do their job, and the susceptibility of our elected representatives to the temptations of political contributions. But the larger cause of the present crisis was our failure to recognize the sea-change in the nature of capitalism that was occurring right before our eyes. The crisis in capitalism also comes, in part, from our conviction that the Invisible Hand— described by Adam Smith more than 230 years ago in his seminal work, The Wealth of Nations— would benignly serve our society. Hear Smith’s words: 2 In fact, in my 1951 thesis at Princeton University, I urged that mutual funds be operated “in the most efficient, economical, and honest way possible.” If honesty is understood to represent a certain kind of elegance, the ideas are identical. 3 Assets of our Index 500 Funds total $125 billion; assets of their near-counterpart, our Total Stock Market Index Fund, total $95 billion, $220 billion in all.

How can that be? Of course credit is central to our economy. Liquidity—enabling one person to acquire the stream of future income generated in a business, by using his capital to purchase shares from another person who wishes to withdraw his capital and relinquish his claim—is vital. And the efficient pricing of shares traded in our financial markets is essential to their functioning. But the principal function of the financial sector is to act as the middleman in a trade between a buyer and a seller, a trade that pits one investor against another, a trade that inevitably constitutes a zero-sum game (one side wins, the other side loses). But once the costs of the middlemen—the brokers, the bankers, the money managers, all those croupiers of finance— are extracted, speculation in stocks, becomes a loser’s game, a subtractor from social value. An old English saying puts it well:3 Some men wrest a living from nature and with their hands; this is called work. Some men wrest a living from those who wrest a living from nature and with their hands; this is called trade. Some men wrest a living from those who wrest a living from those who wrest a living from nature and with their hands; this is called finance. So, yes, I confess to you who will actually do the world’s work, making your living “from the earth and with your hands,” that your commencement speaker has earned his own living, not in that kind of real work, but in finance.

of all shares. Ownership of U.S. stocks by institutions, on the other hand, has soared more than seven times over—from 8 percent of shares all those years ago to more than 70 percent today. But in our new “agency society,” with financial intermediaries as a group now holding clear voting control of corporate America, our agents have failed to behave as owners. Indeed, in far too many cases, they have placed their own interests ahead of the interest of their principals, largely those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. It’s not that we were not warned about the consequences of our failure to honor the fiduciary principle that “no man can serve two masters,” and that fiduciary duty imposes a high standard of morality upon those entrusted with managing the property of others. Indeed, it was way back in 1934—75 years ago—in the aftermath of the Great Crash in the stock market that Supreme Court Justice Harlan Fiske Stone warned: The separation of ownership from management, the development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to [the] principle [that “no man can serve two masters] if the modern world of business is to perform its proper function.

are usually laid to easy credit; the cavalier attitude toward risk of our bankers and investment bankers; “securitization,” in which the traditional link between borrower and lender was severed; the extraordinary leverage built into the financial system by derivative securities of mind- boggling complexity; and the failure of our regulators to do their job. The Securities & Exchange Commission was almost apathetic in its failure to recognize what was happening in the capital markets. The Commodity Futures Trading Commission allowed the trading and valuation of derivatives to proceed opaquely, without demanding transparency and the sunlight of full disclosure. And let’s not forget Congress, which in the name of “free-market capitalism” rolled back many vital regulations and gutted the Glass-Steagall Act, which, since the early 1930s, had separated traditional banking from investment banking. Market participants—now dominated by speculators, not investors—also joined the parade of miscreants, and our professional security analysts failed to do their job of appraising company balance sheets, largely ignoring the huge credit risks assumed by the new breed of bankers and investment bankers. And let’s not forget our credit rating agencies, which happily bestowed AAA ratings on securitized loans in return for enormous fees that were paid in return by the issuers themselves. (It’s called “conflict of interest.”) Yes, there’s plenty of blame to pass around.

awareness of the ethical dilemmas faced by today’s business leaders. Included among these leaders are the chiefs who manage our publicly-held corporations—today valued in the stock market at some $10 trillion—and the professional managers of “other people’s money” who oversee equity investments valued at some $7 trillion of that total, owning 70 percent of all shares and therefore holding absolute voting control over those corporations. Like their counterparts in business, those powerful managers have not only an ethical responsibility, but a fiduciary duty, to those whose capital has been entrusted to their care. Fiduciary Duty The concept of fiduciary duty has a long history, going back more or less eight centuries under English common law. Fiduciary duty is essentially a legal relationship of confidence or trust between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, who justifiably reposes confidence, good faith, and reliance in his trustee. The fiduciary acts at all times for the sole benefit and interests of another, with loyalty to those interests. A fiduciary must not put personal interests before that duty, and, importantly, must not be placed in a situation where his fiduciary duty to clients conflicts with a fiduciary duty to any other entity. Way back in 1928, New York’s Chief Justice Benjamin N.

For investing is all about buying businesses—real operating companies, making real goods and providing real services for real consumers who use the goods and services in their daily lives; real companies that are operated by real managers and staffed by real workers, with real strategies; earning real net income and plowing some of it back into real capital goods and distributing what remains to the owners in the form of, yes, real dividends. Let’s call this the real capitalism. In the long run, it is the returns earned by businesses that create value for investors. For example, over the past 100-years, the return on stocks has averaged 9 ½ percent per year—4 ½ percent from dividend yields and 5 percent from earnings growth. Speculation can—and does!—raise or lower this total investment return during interim periods. For example, the price that investors paid for each dollar of earnings on stocks in 1980 soared from $8 (a p/e ratio of 8 times) and to $32 (32 times earnings) in early 2000—adding, on average, an amazing total of some 7 percentage points per year to investment return in the greatest bull market of all time.

imagine that a man who first experienced congestive heart failure six decades ago would, God willing, soon begin the ninth decade of his life? Were my case unique, my story would hardly be worth the telling. But Nancy and I are microcosms representing all those individual patients to whom Dr. Lown has given—one at a time—an extra lease on life. I have no doubt that his art of healing each of these human beings is every bit as important as the macrocosm of his mission—yes, his battle—fought to save the world from nuclear madness, driven by his remarkable ability, as a concerned citizen of the world, to summon those spirits. And make them come! To pay tribute to the great humanitarian and cardiologist whom we honor this evening, I close with a daring leap from Shakespeare to the Beatles, paraphrasing the words of my favorite Beatles’ song. If you’ll think “Bern-ard” rather than “Hey, Jude,” you’ll get the picture. I’ve talked Kai-Yun Lu, clarinetist with the Atlantic Symphony Orchestra (which graces us with their beautiful music at tonight’s celebration), into giving me some musical support. Here we go: Bern-ard, you’ve made it good You took a sad song and made it better You remembered to let the world get under your skin Then you began . . . to make it better. Better, better, better, better, better, oh Na, na na na na na Na na na na, Ber-nard. Now, please, all join me in the chorus. . . Then you began. . . to make it better.

must be cared for, and the burden must be shared by all who work for it, all who own it, all who are served by it, and all who govern it.”1 Without integrity, simply put, none of those publics will care. Nor should they. Third (perhaps obviously), this philosophy requires full disclosure, straightforward disclosure, and candid disclosure with all parties concerned, including investors, crewmembers, regulators, and legislators, and above all, the press. By disclosure, I not only mean the kind of formal disclosure one associates with publicly-owned businesses, such as regular reporting of accurate financial information. I also mean full disclosure of all significant events affecting our organization and its many publics, and prompt disclosure of these events, not only when the news is good, but—especially—when it’s bad. A useful rule-of-thumb: “When in doubt, disclose.” Notice, please, that my business philosophy says nothing about growth. Indeed I have a rather ambivalent attitude toward growth, and have often observed that “nothing fails like success.” After all, history is littered with poignant examples of empires (think Rome), business enterprises (think of our nation’s auto and steel companies), and individuals (in this heated election season, I won’t go there) who at the moment of their greatest triumph were planting the seeds of their own destruction.

Fund portfolio turnover, about 16 percent during my first two decades in this field, soared to 100 percent during the recent era.) My conclusion powerfully reaffirmed the ideals that I hold to this day: “The principal function of investment companies is the management of their investment portfolios. Everything else is incidental.” The role of the mutual fund is to serve—“to serve the needs of both individual and institutional investors . . . to serve them in the most efficient, honest, and economical way possible.” This gratuitous advice about efficiency, honesty, and economical operation from a callow college senior was also largely ignored by the fund industry. But the creation of Vanguard in 1974 as a truly mutual mutual fund group—operated on an “at cost” basis for the benefit of its owners rather than its managers—was my attempt to walk the walk that I had talked the talk about nearly a quarter-century earlier. Today, I assure you that my youthful idealism remains intact. Indeed, it is shamelessly reflected not only in Vanguard but in my book The Battle for the Soul of Capitalism, published by Yale University Press in 2005, and also in The Little Book of Common Sense Investing, published by Wiley in 2007.about

realize from their stock-swapping back and forth, further diminishing the family’s total wealth. The smart cousins quickly realize that their plan has actually diminished the rate of growth in the family’s wealth. They recognize that their foray into stock-picking has been a failure and conclude that they need professional assistance, the better to pick the right stocks for themselves. So they hire stock-picking experts—more Helpers!—to gain an advantage. These money managers charge a fee for their services. So when the family appraises its wealth a year later, it finds that its share of the pie has diminished even further. To make matters still worse, the new managers feel compelled to earn their keep by trading the family’s stocks at frantic levels of activity, not only increasing the brokerage commissions paid to the first set of Helpers, but running up the tax bill as well. Now the family’s earlier 100 percent share of the dividend and earnings pie is further diminished. “Well, we failed to pick good stocks for ourselves, and when that didn’t work, we also failed to pick managers who could do so,” the smart cousins say. “What shall we do?” Undeterred by their two previous failures, they decide to hire still more Helpers. They retain the best investment consultants and financial planners they can find to advise them on how to select the right managers, who will then surely pick the right stocks. The consultants, of course, tell them they can do exactly that.

on an “at cost” basis for the benefit of its owners rather than its managers—was my attempt to walk the walk that I had talked the talk about nearly a quarter-century earlier. Today, I assure you that my youthful idealism remains intact. Indeed, it is shamelessly reflected not only in Vanguard but in my Battle book, an expression of my concern about our American society today, my conviction that our system of capital formation is essential to our economic growth and world leadership, and my acknowledgement that much has gone wrong in our financial system. 2. A Parable So what’s gone wrong? Let’s begin with a parable that describes how the system really works. It’s my version of a story told by Warren Buffett, chairman of Berkshire Hathaway Inc., in the firm’s 2005 annual report, and it clarifies the foolishness and counterproductivity of our vast and complex financial market system. Here goes: Once upon a time . . . a wealthy family named the Gotrocks, grown over the generations to include thousand of brothers, sisters, aunts, uncles, and cousins, owned 100 percent of every stock in the United States. Each year, they reaped the rewards of investing: all the earnings growth that those thousands of corporations generated and all the dividends that they distributed. Each family member grew wealthier at the same pace, and all was harmonious. Their investment had compounded over the decades, creating enormous wealth, because the Gotrocks family was playing a winner’s game.

locus of control of corporate America from owners to managers, a change I’ve described as “a pathological mutation in capitalism.” The Consequence of Agency Capitalism How has this separation contributed to the recent crisis? First, because our newly- empowered financial agents—largely the giant institutional money managers that advise mutual funds and retirement plans—have far too often placed their own financial interests ahead of the interests of fund owners and retirement plan beneficiaries; that is, ahead the interests of their own principals. And second, because these agents have departed from traditional investment principles—focused on the wisdom of long-term investing—and have embraced a new focus that engages in the folly of short-term speculation. How great a departure does this change in investment principles represent? An enormous change, however rarely noted. Today, turnover of stocks in the United States, which ran in a range of 20 to 30 percent during my first twenty years in the financial sector, came to an estimated 300 percent in 2008—more than ten times as large. In the mutual fund industry the change has also been extreme, albeit at lower levels. Turnover among actively-managed equity funds has risen from 16 percent in those early years to an average of 95 percent in 2008. Such turnover—whether 300 percent or 95 percent—is not investment, focused on long-term cash flows and intrinsic values. It is speculation, focused on short-term bets on stock prices.

creative destruction—new ideas driving out old businesses—actually works to the benefit of society as a whole, for entrepreneurship is the engine of progress and economic advancement. Why is it that the public non-profit institutions that focus on faith, enlightenment, and moral values—and certainly on service to others before service to self—have had so much greater staying power than their private corporation counterparts? Could it be that society ultimately places a lesser value on institutions that focus more heavily on profits than on building better products and providing better services to customers? Or that while they cannot survive without creating value for others, these private institutions are expressly designed to serve their owner/stockholders? (Be clear, please, that I’m not arguing that, at its best, capitalism is bad; rather, that it is too often short-sighted.) While I’ll let you muse about these existential questions, I will say (if you’ll forgive this personal note) that I founded Vanguard on a principle quite the opposite from every other investment management firm in the mutual fund field—a truly mutual structure designed to serve the fund shareholders—our clients—rather than the management company owners. With Wellington Fund—founded by Walter L. Morgan in 1928, the oldest member of The Vanguard Group—we’ll be joining that 100-year club just a few decades from now. (I’m actually already planning the celebration.)

demand loyalty from their employees even as they fail to honor in return the loyalty to their employees that would seem a quid pro quo of that demand. And how about the integrity of the firm’s financial statements, let alone the true independence of the independent auditor who attests to their conformity with generally accepted accounting principles (GAAP)? With the looseness that prevails among the myriad detailed standards developed to implement those accounting principles, small wonder that the engineering wonder of our age is financial engineering. I am not necessarily arguing that our business principals are less ethical then their predecessors. But I am arguing that our business principles have been diluted. It seems to me there are far fewer absolute standards in the conduct of business—things that one just doesn’t do—and much more reliance on relative standards. “Everyone else is doing it, so I can do it, too.” (Think about executive compensation, stock options, and the multiple facets of financial engineering.) What Went Wrong in Corporate America and Investment America? So why did all these things go wrong?

Many years ago, I read this poem to my own two sons—including John’s father—and, lest they forget its message, had copies of it framed for them. When the time comes, I’m hoping that my son, in turn, will read it to his son, your classmate. And if any of you would like to read it, well, just Google it. Better yet, stay with Google long enough to hear Kipling himself reading it, captured for eternity on film, happily, before his death in 1926. If you’re into tennis, go to YouTube and hear the poem recited by Roger Federer and Rafael Nadal, with some of their great action shots showing behind them. (Yes, even at my ancient age, I Google, and I visit YouTube. You can even find me there!) Of course a lot happens in 100 years, and the world has changed dramatically since IF . . . was written. But the ideas expressed by Kipling are eternal. So what I’ll try to do this morning is relate just a few of those phrases from IF . . . to my own life and career, and to their relevance to dealing with the global financial and economic crisis that we citizens face today, the worst since the Great Depression of the early 1930s. Reflections on my Career As much as I appreciate the generous introduction by your headmaster, I feel the obligation to bring my own life and career down to earth.

The combined ratios of Wes-FIC have been much better than average for insurers. Wes-FIC's combined ratios were 94.0% for 2006 and 75.9% for 2005. We try to create some underwriting gain as results are averaged out over many years. We expect this to become increasingly diÇcult. Kansas Bankers was purchased by Wes-FIC in 1996 for approximately $80 million in cash. Its tangible net worth now exceeds its acquisition price, and it has been a very satisfactory acquisition, reÖecting the sound management of President Don Towle and his team. Kansas Bankers was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its oÇces are in Topeka, Kansas. Over the years its service has continued to adapt to the changing needs of the banking industry. Today its customer base, consisting mostly of small- and medium-sized community banks, is spread throughout 30 mainly midwestern states. In addition to bank deposit guaranty bonds which insure deposits in excess of FDIC coverage, KBS oÅers directors and oÇcers indemnity policies, bank employment practices policies, bank insurance agents professional errors and omissions indemnity policies and Internet banking catastrophe theft insurance. When Wesco purchased KBS, it had been ceding almost half of its premium volume to reinsurers. Now it reinsures only about 14%. EÅective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS's sole reinsurers. Previously, an unaÇliated reinsurer was also involved.

investment company he has run for more than 40 years, Buffett says, “When the stock temporarily over- performs or under-performs the business, a limited number of shareholders—either sellers or buyers— receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.” Put another way, as Benjamin Graham, legendary author of The Intelligent Investor and Warren Buffett’s great mentor, pointed out, “in the short run the stock market is a voting machine . . . (but) in the long run it is a weighing machine.” But we must take Buffett’s obvious truism—and Mr. Graham’s—one step further. For while “the gains made by shareholders must of necessity match the business gains of the company,” the aggregate gains or losses by the sellers and buyers—even though they are trading back and forth with one another in what is pretty much a closed circle—do not balance out evenly. Investors capture Berkshire’s return; speculators do not. Why? As these traders trade with one another, they incur transaction costs—largely brokerage fees, bid-ask spreads, and excess taxes, and also, in today’s agency society (we have come a long way from an old ownership society) most of us pay, directly or indirectly, our mutual fund and pension fund agents additional fees for doing our trading for us.

He credited then-Finance Minister Manmohan Singh's 1991 reforms with three transformative moves: removing licensing (so Infosys no longer had to lobby Delhi to import equipment), permitting easier foreign travel and imports, and allowing 100 percent foreign equity. That last change brought IBM and Coca-Cola back, intensifying competition for talent rather than for a barely-existent domestic market.

By the time of his Stanford talk, Wipro was the world's largest independent R&D services provider — a positioning that put it a step beyond pure coding into contracted research for Western high-tech and consumer-product companies, leveraging Indian engineering talent at a lower cost than their in-house labs.

HCL launched with roughly INR 20 lakh (about US$180,000 then) — a quarter from the UP government and the rest from founders' savings generated through a separate calculator-marketing company — a capital structure Nadar credits with teaching him the practical meaning of cash flow, profit and reserves.

Short-term fluctuations in the earnings of the stocks of business firms, he argued (correctly), would lead to unreasoning waves of optimistic and pessimistic sentiment. Keynes’ “Battle of Wits” Keynes conceded that competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, should correct the vagaries caused by ignorant individuals. Yet he predicted that the energies and skills of the professional investor would come to be largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. He therefore described the market as “. . . a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.”

It was certain that if we acted always with caring, with integrity, and with candor, Vanguard would grow, and indexing would lead the way. While I concede that “growth is the only evidence of life,” my attitude was to let our growth just happen, not by forcing it, for example through expensive sales promotions, aggressive marketing schemes, nor the offering of faddish new funds that would attract the evanescent and therefore useless assets of short-term speculators. Rather we sought to attract the durable and therefore priceless assets of long-term investors by earning their trust. I was confident that an enterprise whose mantra is not salesmanship but stewardship would grow organically, a natural result of our philosophy. And so it did. We began in September 1974 with $1.4 Billion of investor assets, today our asset base exceeds $1.2 Trillion. Business or Profession? 1 Dean Howard M. Johnson, chairman of the Massachusetts Institute of Technology.

my freshman and sophomore years. Somehow—despite being able to pay only $100 in tuition for each of us—she persuaded Blair Academy to take her boys under its wing. Blair provided us with scholarships and jobs. I was a waiter—for almost a decade, my perennial job, winter, spring, summer and fall—and, as a senior, captain of the waiting crew. Before that life-changing opportunity, the odds were miniscule that I would ever make something of myself. Without Blair Academy—a truly great school, with marvelous masters who, bless them, demanded that I excel and wouldn’t take no for an answer. It took all of the determination at my command to measure up to their high standards. It was a remarkable blessing, for Blair led me directly to Princeton, where a remarkably direct link to my career lay in waiting. Princeton, too, provided me with jobs and scholarships, and I was able to be self- sustaining (as if there were any alternative!) My early years were bereft of distinction, and in my sophomore year I almost lost my scholarship, which would have prematurely put an end to my college career. The prognosis for a bright future seemed grim, but my plodding determination (not, I assure you, my brains!) bailed me out, my grades improved, and continued to improve, and I went on to get a first-class liberal education. When I graduated, it was with High Honors in Economics. The Princeton Thesis How did that ever happen? Simple!

ratios average 0.23 percent. The average mutual fund charges 1.19 percent—more than five times as much! Does it matter? Think about it: over the past decade, our funds, largely passive rather than active, have earned net returns that outperformed 82 percent of their peers in the various fund objective categories in which we compete. I do not believe that any large fund manager has matched that figure. But our gross returns—before the deduction of our lower expense ratios and our competitors’ far higher ratios—exceeded those of just 51 percent of our peers—a hair above average. Yes, costs matter. I don’t think I’m hyperbolizing when I use the phrase sustainable cost advantage. I simply can’t see how any of our peers could possibly reduce their expense ratios in the aggregate to anything like 0.23 percent, where we are today—let alone the even lower expense ratios we’re likely to establish in the coming years. As the industry leader, we have huge economies of scale; we’ve worked hard to achieve excellence in shareholder services; we employ state-of-the-art technology; we have a solid leadership team, and our 12,000 able crewmembers include thousands of veterans who revel in passing along the human values and the investment strategies that have carried us to our present industry position. How to Compete? Could others compete with us on costs? I don’t see how. Among our large management company peers, the average expense ratio is about 1 percent. To reduce that ratio to 0.

The Men of History 2 Emerson believed that “an institution is the lengthened shadow of one man,” reaffirming Carlyle’s conclusion that “history is but the biography of great men.” Of course, there’s some considerable hokum in the idea that historical events are driven by larger-than-life heroes, but there’s also some considerable truth in it. Whatever the case, this is a fine moment to salute three of those giants of the early Presbyterian church. First, Francis Makemie, who grew up with the Presbyterianism of the Scots, followers of John Calvin who were led by John Knox. Dr. Makemie, with his left hand raised in magisterial splendor in the sculpture outside your Historical Society, is seemingly driving home 2 I mean no offense to women, but in the era of which I speak, virtually all of our church and government leaders were men.

No responsible commentator has failed to acknowledge that focusing on the wisdom of long-term investing and the debilitating impact of the heavy costs of money management have become the central tenets of intelligent investing, as well as providing measurably superior returns to investors. But while the powerful tide rolling toward index investing and careful cost management is powerful, it is too slow for the likes of me. To accelerate these trends now demanded by the consumers of investment services, we need to demand the same of the producers of those services.of

any nation. Rather, it is our character—our values, our determination, our persistence, our resilience, our moral standards, and our virtue that has made this nation great. That character is the great reality of this nation, and what gives us hope. Character and Values It’s easy to talk about the importance of character and values in this general sense. So now let me focus on a particular case where they are so easily visible. I refer, as you might suspect, to The Salvation Army, this remarkable charity, yes, but an equally remarkable investment. One of our greatest business philosophers and writers, the late Peter Drucker, clearly recognized that this organization is not only about charity and good works, but about investments that help it fulfill some of the nation’s greatest needs. He told former Salvation Army National Commander Robert Watson that “I consider you to be venture capitalists.” Whatever the case, it is also the Salvation Army’s character and values that are the foundation of its impressive range of achievements, including those we celebrate today. In his wonderful book, The Most Effective Organization in the U.S. (that’s a quote from Dr.

Simply put—and this is the main thesis of my latest book, The Battle for the Soul of Capitalism—what went wrong in corporate America, aided and abetted by investment America, was a pathological mutation in capitalism—from traditional owners’ capitalism, where the rewards of investing went primarily to those who put up the capital and took the risks—to a new and virulent managers’ capitalism, where an excessive share of the rewards of capital investment went to corporate managers and financial intermediaries. There were two major reasons for this baneful change: First, the “ownership society”—in which the shares of our corporations were held almost entirely by direct stockholders—gradually lost its heft and its effectiveness. It is not going to return. In its stead, a new “agency society” has developed, with financial intermediaries controlling the overwhelming majority of shares. (Since 1950, institutional ownership has risen from 8 percent of U.S. stocks to 68 percent; individual ownership has dropped from 92 to 32 percent.) But those agents haven’t behaved as owners. They failed to honor the interest of their principals, largely those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. If the owners of corporate America don’t give a damn about corporate governance, I ask you, who on earth should?

These three interlinked subjects would become the three main sections of my book: corporate America, investment America, and mutual fund America. Each subject was in turn organized into three sections—what went wrong, why it went wrong, and how to fix it. Organizing the new book was the easy part. But I also wanted to provide three special perspectives. The first, of course, was borne of my own first-hand experience as a participant in and close observer of business and finance for more than a half century; second, to draw on the wisdom of the best and brightest investment thinkers of our age; and third, to emphasize the lessons we might learn from history, and the reinforcement we might find in the traditional values of American society.

Murthy listed four future challenges for Infosys: moving up the value chain by lifting per-capita productivity; achieving scalability (he cited bringing 300 US-bound employees to India for nine months of training); building multicultural team capability; and growing talent pipelines fast enough to meet client demand without diluting quality.

what has gone wrong in our nation’s corporate, financial, and mutual fund sectors, while The Little Book offers common sense advice on how to invest intelligently for the long term. (Hint: It recommends index funds as the core investment in individual & institutional portfolios.) Investment and Speculation Now, before I turn to the recent turbulence in the markets that I’m sure is on many of your minds this evening, I want to focus on the fundamental distinction between investment and speculation that I first touched on in that ancient thesis. Echoing the inspired wisdom of Lord Keynes, I defined investment as “forecasting the prospective yield on an asset” over its entire life. (Keynes used the term enterprise to describe this practice; today finance teachers describe it as discounted future cash flow.) Speculation, on the other hand, is “the activity of forecasting the psychology of the market.” When I speak of investment return, I speak of the current dividend yield on stocks plus their subsequent rate of earnings growth, together representing the real return on corporate capital. When I speak of speculative return, I speak of the impact of the change in the number of dollars that investors are willing to pay for each dollar of corporate earnings. Simply add the two together and, viola!

So the winning strategy was obvious: own the entire stock market (without any security analysts!) and cut costs to the bare bones. That’s it! It really is that simple! I was also mindful that the new firm needed not only solid arithmetic, but also high principles. As it happens, in my Princeton University senior thesis, way back in 1951, I had cited these principles: that mutual funds should be managed “in the most efficient, honest, and economical way possible;” that “funds can make no claim to superiority over the market [indexes];” that funds must concentrate “on a reduction of sales charges and management fees;” and that the funds’ “prime responsibility must always be to their shareholders.” When the new firm was founded in 1974, those tenets became Vanguard’s mantra. As they say, “the rest is history.”

“Just pay us a fee for our services,” the new Helpers assure the cousins, “and all will be well.” Alas, the family’s share of the pie tumbles once again. Alarmed at last, the family sits down together and takes stock of the events that have transpired since some of them began to try to outsmart the others. “How is it,” they ask, “that our original 100 percent share of the pie—made up each year of all those dividends and earnings—has dwindled to just 60 percent?” Their wisest member, a sage old uncle, softly responds: “All that money you’ve paid to those Helpers and all those unnecessary extra taxes you’re paying come directly out of our family’s total earnings and dividends. Go back to square one and do so immediately. Get rid of all your brokers. Get rid of all your money managers. Get rid of all your consultants.family

”1 The second was speculation—“forecasting the psychology of the market.” Together, it is these two factors that explain “The State of Long-Term Expectation” for stocks, the title of Chapter 12 of The General Theory. From his vantage point in London, Keynes observed that “in one of the greatest investment markets in the world, namely, New York, the influence of speculation is enormous . . . It is rare for an American to ‘invest for income,’ and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that he is attaching his hopes to a favorable change in the conventional basis of valuation, i.e., that he is a speculator.” Today, 75 years after Keynes wrote those words, the same counterproductive situation prevails, only far more powerfully.1936)

Cardozo put it well: Many forms of conduct permissible in a workaday world for those acting at arm’s length are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the marketplace . . . As to this there has developed a tradition that is unbending and inveterate . . . Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior . . . Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It has been said, I think accurately, that fiduciary duty is the highest duty known to the law. It is less ironic than it is tragic that the concept of fiduciary duty seems far less imbedded in our society today than it was when Stone and Cardozo expressed their profound convictions.the

Yes, 102 percent of cash inflow, as actively-managed equity funds suffered a cash outflow of $16 billion during that period. Yet we remain—and I have reason to believe that I remain—a sort of outlier in an industry that has yet to accept (or even seriously copy) the Vanguard model. As Walter Bagehot, founding editor of the London Economist pointed out a century and a half ago, there’s both pain and pleasure in that. On the one hand, “one of the greatest pains in human nature is the pain of a new idea.” On the other, “a great pleasure in life is doing what people think you cannot do.” I’m not at all sure there aren’t more deserving recipients of the Tiburon CEO Summit Award than yours truly. I haven’t served as Vanguard’s CEO for many years, though perhaps I qualify in my role today as CEO, as it were, of Vanguard’s Bogle Financial Markets Research Center. But the fact is that, without knowing them until a few days ago, I’ve spent 60 years in my quest to meet the standards that Tiburon’s Managing Principal Chip Roame told me represent the criteria for this award. 1 Data based on assets in long-term mutual futures, and excluding money market funds.

Jensen, “It exists in all organizations at every level of management in firms, in universities, in [yes] mutual companies, in cooperatives, in governmental authorities and bureaus, (and) in unions.” It is impossible to deny the logic of the Jensen thesis that posits that managers rarely maximize the interests of the shareholders they are duty-bound to serve, and instead mainly look out for themselves. More important, its truth has been confirmed, over and over again, by actual experience in the functioning of our giant corporations and investment institutions. In my personal experience over a 61-plus year career I’ve run the gamut of these structures: First, nine years at a privately-held firm; second, fourteen years at the publicly-held firm it became after a public offering of its shares in 1960; and, after being fired from the firm in 1974, 38 years with Vanguard, the mutual company I founded later that year. I understand well the pros and cons of these four structures, for I have had considerable experience in each. That 1974 change radically altered the way I ran the new business (which I did until 1996) with an unprecedented mutual structure.from

But I’m embarrassed about the field in which I ply my trade. All too many of its leaders bear a heavy responsibility for running our economy into the ground, even as they made personal fortunes by playing fast and loose with the system and taking absurd risks, not (of course!) with their own money but with other people’s money; even successfully lobbying for the rollback of regulations that had well-served investors for decades. Taking on the System But I’ve marched to a different drummer. I’ve challenged the financial system and done my best to improve it—to build a better world for investors. Vanguard, the company that I founded almost 35 years ago, was built on a firm foundation of service to our investors rather than service to ourselves, in a unique mutual mutual fund structure in which our fund shareholders actually own the funds’ management company. Vanguard operates on an “at-cost” 3 I’ve not been able to identify the source of the quotation.

Premji distinguished creativity from innovation in his Stanford talk: creativity is about making new things, while innovation is about doing new things. The distinction mattered to him because it placed execution, not invention, at the centre of business value — a stance that explains Wipro's services-first DNA.

Yet those who serve nominally as trustees, but [are] relieved, by clever legal devices, from the obligation to protect those whose interests they purport to represent; corporate officers and directors who award to themselves huge bonuses from corporate funds without the assent or even the knowledge of their stockholders; [and] financial institutions which, in the infinite variety of their operations, consider only last, if at all, the interests of those who funds they command, suggest how far we have ignored the necessary implications of that principle. The loss and suffering inflicted on individuals, the harm done to a social order founded upon business and dependent upon its integrity, are incalculable. Justice Stone’s words, excerpted from his 1934 essay in The Harvard Law Review, are equally relevant—perhaps even more relevant—at this moment in history. They could hardly present a more appropriate analysis of the causes of the present-day collapse of our financial markets and the resultant economic crisis now facing our nation and our world.

But after a while, a few fast-talking Helpers arrive on the scene, and they persuade some “smart” Gotrocks cousins that they can earn a larger share than the other relatives. These Helpers convince the cousins to sell some of their shares in the companies to other family members, and to buy some shares of others from them in return. The Helpers handle the transactions, and as brokers, they receive commissions for their services. The ownership is thus rearranged among the family members. To their surprise, however, the family wealth begins to grow at a slower pace. Why? Because some of the return is now consumed by the Helpers, and the family’s share of the generous pie that U.S. industry bakes each year—all those dividends paid, all those earnings reinvested in the business—100 percent at the outset, starts to decline, simply because some of the return is now consumed by the Helpers.

I have written much on the subject of accounting, and take the liberty of attaching excerpts from my books Don’t Count On It! (Wiley, 2011) and The Battle for the Soul of Capitalism (Yale University Press, 2005), as well as my Seymour Jones Distinguished Lecture at NYU where I served as Henry Kaufman Visiting Professor in 2002. Among the subjects I take on are: ∑ Operating and pro forma earnings ∑ The role of public accountants as gatekeepers ∑ Earnings management ∑ Pension accounting and return assumptions ∑ Financial reporting improvements ∑ Fundamental accounting principles ∑ Option accounting 1 In his 1996 letter to shareholders, Warren Buffett said “when the price of Berkshire-Hathaway stock temporarily over-performs or under-performs the business, a limited number of shareholders—either sellers or buyers—receive out-sized benefits at the expense of those they trade with. [But] over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company.”

stewardship, I freely concede the profound limitations of my own human being-ness. Perhaps these few lines from Eve’s favorite anthem will convey some of the ambiguity of my life and even the lives of many of you here tonight. It closes, not with an answer, but with two questions about balancing work and life. In the evening of my life I shall look to the sunset. At a moment in my life when the night is due. And the question I shall ask, only I can answer. “Was I brave and strong and true? Did I fill the world with love my whole life through?” I believe that I’ve answered that first question in the affirmative. I promise to keep working on the answer to the second. Thank you, Dr. Lown and the Lown Foundation for the great honor you bestow on me this evening, and thanks to all of you who have joined me and my family and share in this splendid event with us. Good evening.

Thus, long-term investing in America is a winner’s game that depends on the ability of business to earn a return on their capital; short-term speculation is a loser’s game that depends on outguessing other investors with enough skill (or luck) to overcome those substantial croupier costs, which I estimate at a staggering $500 billion per year. (Mutual fund costs, even ignoring their substantial portfolio turnover costs, will exceed $100 billion this year alone.) So if stock market participants were rational wealth-maximizers—simply preferring to play a winner’s game rather than a loser’s game—investment ought to be steadily gaining over speculation. Right? Wrong! Consider that during most of my first 15 years in this industry (through about 1966), it was not that way. Fund turnover averaged about 16 percent per year—let’s call that “investing,” a six- year average holding period—and never varied significantly from that norm. (Chart 3) But turnover moved steadily upward, and in the past decade, has averaged nearly 100 percent per year—let’s call that “speculation,” a one-year average holding period—exactly the opposite of my expectations when I joined this industry all those years ago.

In the uniform and uninterrupted effort to better (man’s) condition, the principle from which (both) public and private opulence is originally derived, is powerful enough to maintain progress. Each individual neither intends to promote the public interest, nor knows how much he is promoting it . . . (but) by directing his industry in such a manner as to its produce may be of the greatest value, he is led by an invisible hand to promote an end which was no part of his intention. Yet somehow the invisible hand of self-interest has gone awry. Trusting and being trusted were essential elements explaining why the invisible hand worked for society, but today we seem to rely far less on these essentials. Despite the vital role of self-interest in providing the plenty of modern society, we need something more. We need to restore trust and we need to raise our society’s expectations of the proper conduct of our citizens, and especially of our leaders. During the past two centuries, as capitalism came into its own, we took the virtues of trust and trusting, and of trustworthy leadership for granted. The free market system demanded them. Hear, for example, Federal Reserve Chairman Alan Greenspan, speaking in 2004: “ . . . One can hardly overstate the importance of reputation in a market economy . . . Rules cannot substitute for character of those with whom we do business . . .

But in the very long run, speculative returns account for nothing—zero. Speculation simply reflects the optimism or pessimism—the hopes and fears—of the mass of investors, reflected in the “expectations market” rather than garnered through the stern arithmetic of the “real market” of investment returns—authentic earnings growth and dividend yields. In this sense, as I wrote in my 2007 book The Little Book of Common Sense Investing, “the stock market is a giant distraction to the business of investing.” Of course it is! But the market is more than a mere distraction. It is an expensive distraction. For it must be obvious that all investors as a group exactly capture the market’s return. If stocks return 8 percent, we earn a gross return of 8 percent. But only before the costs of our investment system are deducted, say about 2 percent per year. After these costs, our net return drops to 6 percent. “Gross return minus cost equals net return.” What else is new? So, those who invest in business—buying and holding a diversified list of stocks that may encompass the entire U.S. stock market (yes, I’m speaking of the index fund)—capture virtually the entire return of the market. Those who speculate on stock prices, on the other hand, lose to the market by the amount of “croupier costs” they incur. (My choice of this gambling term is deliberate; speculating on whether the momentary price of a stock will rise or fall is, simply put, gambling.)

To attract talent into an attic-office in 1976, Nadar offered monthly salaries of INR 2,000 — more than Citibank India then paid — explicitly because each hire added five percent to overhead and the company could not afford to mis-hire; he sourced five IIM-Calcutta graduates and judged them unusually intensely given the marginal cost of each headcount addition.

As the woes of our financial system resonate through our economy, it seems crystal clear that our current recession represents a “Minsky Meltdown” of significant proportions. While I believe that our economy is not facing the kind of depression that our nation endured in the early 1930s, we simply don’t know whether our plummeting stock market: (a) has yet to adequately anticipate the depth of the economic downturn; (b) has already anticipated most of it; or (c) has anticipated something much worse than what is likely to transpire. “Phantom Wealth” I’m inclined to believe that the answer is somewhere between (b) and (c). Why? Because the market value of U.S. stocks has tumbled from $17.2 trillion at the October 2007 high to $7.9 trillion at the recent low.that

The increased volume of business retained comes, of course, with increased irregularity in the income stream. KBS's combined ratios were 73.8% for 2006 and 58.8% for 2005. We continue to expect volatile but favorable long-term eÅects from increased insurance retained. CORT Business Services Corporation (""CORT'') In February 2000, Wesco purchased CORT Business Services Corporation (""CORT'') for $386 million in cash.

I’m a pretty ordinary human being, blessed with a decent intelligence, extraordinary good luck, teachers and mentors who saw some potential in me and demanded that I live up to it, and (with apologies for bragging) a powerful determination to get ahead in the world. Part of that luck, of course was being “Born in the USA.” (Yes, I’m a fan both of the Boss and of the United States of America.) Part—this may surprise you—was being born into a family whose wealth had vanished during the Great Depression. For when one is required at a young age to work for what he gets, you learn to take responsibility, to follow orders, and to work with people from all walks of life—“to talk with crowds” in Kipling’s words, “nor lose the common touch,” a truly priceless blessing as we move from school to college to career. When I attended Blair and then Princeton, I was given full scholarships that covered my tuition, and earned the money for my room and board by working at demanding, time-consuming jobs.an

Median family income is now actually lower than it was a decade ago, despite the enormous increase in incomes earned by the top 1/100th of 1 percent of the population. Our nation’s wealthiest 15,000 families report an average annual income of $27 million, in contrast to the $31,000 average income of the lower 90 percent of our families, 135,000,000 in all, including nearly 9 million living below the poverty line of about $18,000 per year. Today’s “state of contentment,” then, likely applies to only a small fraction of our population. Coolidge, I’m confident, would have worried about this growing disparity. Help for the disadvantaged was an important part of his political philosophy. “Government is not, must not be, a cold impersonal machine,” he said, “but a more human agency, satisfying the heart, full of mercy, assisting the good, resisting the wrong, delivering the weak from any impositions of the powerful.”

With the looseness that prevails among the myriad detailed standards developed to implement those accounting principles, small wonder that the engineering wonder of our age is financial engineering. I am not necessarily arguing that our business principals are less ethical then their predecessors. But I am arguing that our business principles have been diluted. It seems to me there are far fewer absolute standards in the conduct of business—There are some things that one just doesn’t do—and much greater acceptance of relative standards—Everyone else is doing it, so I can do it, too. (Think about executive compensation, stock options, and the multiple facets of financial engineering.) As moral relativism comes to supersede moral absolutism, our society is moving in the wrong direction.

” Roosevelt put it this way, “The essence of the struggle between the men who possess more than they have earned and the men who have earned more than they possess is to equalize opportunity, destroy privilege, and give to the life and citizenship of every individual the highest possible value both to himself and to the commonwealth. “Practical equality of opportunity for all citizens, when we achieve it,” he continued, “will have two great results. First, every man will have a fair chance to make of himself all that in him lies; to reach the highest point to which his capacities, unassisted by special privilege of his own and unhampered by the special privilege of others, can carry him, and to get for himself and his family substantially what he has earned. Second, equality of opportunity means that the commonwealth will get from every citizen the highest service of which he is capable.” It seems to me that these words sum up precisely what the Community College of Philadelphia is all about. “But,” Roosevelt continued, “No man should receive a dollar unless that dollar has been fairly earned. Every dollar received should represent a dollar’s worth of service rendered—not gambling in stocks, but service rendered. (Italics added.)graduated

” As far as I can recall, this was my first use of the term mutualization. Only three years later, as it turned out, the set of challenges that I had described in 1971 was resolved in September 1974 by the mutualization of the operations of Wellington Fund and her sister funds. The incorporation of The Vanguard Group of Investment Companies represented a totally new and hitherto untried mutual fund structure. Vanguard was the first—and is still the only—mutual fund complex that is truly mutual.“at-

eerily prophetic, but surprisingly timely. For the financial sector was indeed about to be blown up by its own dynamite. An Act of Faith The failure of our financial system is reflected in its betrayal of the fundamental principles under which we invest, a betrayal of our faith. Paradoxically, just a decade ago, I wrote in the very first sentence of my 1999 book, Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor, that, “investing is an act of faith.” I then amplified that short, simple declarative sentence in three areas: 1) faith that our corporate managers “will generate high rates of return on our investments”; 2) faith that the “success of the U.S. economy and the nation’s financial markets will continue”; and 3) faith that our professional money managers “will be vigilant stewards of the assets we entrust to them.” As we now know, our faith, far too often, has been betrayed. Too many of our corporate managers—most recently those in the banking and investment banking industries, but earlier at Enron, WorldCom and the like—have forfeited our trust by operating in their own financial interests and not in the interests of their shareholders/owners. Our economy is in the midst of the deepest recession since the Great Depression. Our stock markets have plunged to levels not seen since 1996, forfeiting nearly a dozen years of gains.

A Pathological Mutation in Capitalism But the larger cause of the present crisis was our failure to recognize the sea-change in the nature of capitalism that was occurring right before our eyes. That change, simply put, was the growth of giant business corporations, controlled not by their own shareholders, but by the agents of the ultimate owners. What went wrong in corporate America, aided and abetted by investment America, was a pathological mutation in capitalism—from traditional owners’ capitalism, in which the rewards of investing went primarily to those who put up the capital and took the risks, to a new and virulent managers’ capitalism, where an excessive share of the rewards of capital investment went to corporate managers and financial intermediaries. There were two major reasons for this baneful change: First, the old “ownership society” shrank radically in size and importance. Only a half-century ago, 92 percent of all shares of our corporations were held by direct stockholders.of

article in FORTUNE magazine that described the then-tiny mutual fund industry. That piece of luck changed my life, for I immediately decided that mutual funds would be the subject of my senior thesis, which set the stage for my now-near-58-year career in the fund industry. Put simply, my 125-page thesis evaluated the fund industry and found it wanting. Idealistic to a fault, I demanded that mutual funds be operated solely in the interests of their shareholders, in “the most honest, efficient, and economical way possible.” I also warned that mutual funds “could make no claim to superiority over the market averages” (i.e., that stock fund managers as a group could not beat the stock market). The thesis led me right into the fund industry. After I graduated in 1951, Walter Morgan, my greatest mentor, liked the thesis enough to offer me a job at his budding Wellington Management Company. By 1965, at the tender (and in fact, for me, rather immature) age of 35, I was running the firm. But I impetuously entered into an unwise merger, and in 1974 my new partners joined together and fired me from what I had considered “my” company. It was not a pleasant experience. But, yes, I learned something about how to “meet with Disaster,” and quickly realized that I should treat my own disaster, using Kipling’s word, as an “imposter,” just one more obstacle that it was up to me to overcome.

Nadar told Wharton that HCL wrote Genesis, the first relational database, ahead of Oracle — written from scratch, not derived from IBM's DB-2 or CICS — because the team believed hierarchical databases could not meet emerging client-server architectures; the product was technically ahead of its time and ultimately failed commercially in India.

5 percent would be transformative, changing almost everything they do, including slashing—even eliminating—the profits they either earn for themselves, or share with public shareholders, or—most likely, given the predominant fund industry structure today—earn for the U.S. and international financial conglomerates and banks that own them lock, stock, and barrel. And even if our peers did succeed in cutting expenses by half, the costs their fund shareholders pay would remain more than 100 percent above Vanguard’s.

will again reap 100 percent of however large a pie that corporate America bakes for us, year after year.” They followed the old uncle’s wise advice, returning to their original passive but productive strategy, holding all the stocks of corporate America, and standing pat . . . and the Gotrocks Family Lived Happily Ever After. Adding a fourth law to Sir Isaac Newton’s three laws of motion, the inimitable Warren Buffett puts the moral of his story this way: “For investors as a whole, returns decrease as motion increases.” Accurate as that cryptic statement is, I would add that the parable reflects the profound conflict of interest between those who work in the investment business and those who invest in stocks and bonds. The way to wealth for those in the business is to persuade their clients, “Don’t just stand there. Do something.” But the way to wealth for their investor/ clients in the aggregate is to follow the opposite maxim: “Don’t do something. Just stand there.” For that is the only way to avoid playing the loser’s game of trying to beat the market. The higher the level of our own activity by investors, the greater the costs of financial intermediation and taxes, the smaller the net returns that our business owners as a group receive. The lower the costs that investors as a group incur, the higher rewards that they reap.

What Went Wrong in Corporate America and Investment America? So why did all these things go wrong? Simply put—and this is the main thesis of my 2005 book, The Battle for the Soul of Capitalism—what went wrong in corporate America, aided and abetted by investment America, was a pathological mutation in capitalism—from traditional owners’ capitalism, where the rewards of investing went primarily to those who put up the capital and took the risks—to a new and virulent managers’ capitalism, where a grossly excessive share of the rewards of capital investment went to corporate managers and financial intermediaries. As I see it, there were two major reasons for this baneful change: First, the “ownership society”—in which the shares of our corporations were held almost entirely by direct stockholders—gradually lost its heft and its effectiveness. It is not going to return. In its stead, a new “agency society” has developed, with financial intermediaries controlling the overwhelming majority of shares. (Since 1950, institutional ownership has risen from 8 percent of U.S. stocks to 70 percent; individual ownership has dropped from 92 to 30 percent.) But those agents haven’t behaved as owners. They have put their own interests ahead of the interest of their principals, largely those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. The whole notion of stewardship seemed to get lost in the shuffle.

the central truths of a powerful new branch of Christianity. ”The Great Awakening” of revitalized Christian piety was at hand, and he deserves to be recognized. Next, I’ll mention Jonathan Edwards, he of the “New Lights” of Presbyterianism whose sermon “Sinners in the Hands of an Angry God” was among the best known of the strident sermons of the day (which, by the way, were published and widely circulated throughout the colonies). Filled with hellfire and brimstone, and working from Deuteronomy 32:25 (“their foot shall slide in due time”), he warned of the many ways that God could “take wicked men out of the world and send them to hell . . . at any moment.” Those were pretty stern days! I mention Jonathan Edwards not only because of his powerful role in the early evangelical era of the Presbyterian church, but because in 1758 he became the third president of Princeton University, wisely (dare I say!) switching from Congregational Yale to Presbyterian Princeton. Alas, he died but a month after taking office in the brand-new Nassau Hall. (Previously, Princeton, founded by Presbyterians as a seminary to train clergymen, had been known as “the Log College.”) A decade later, the giant John Witherspoon came from Scotland to become Princeton’s sixth president. He was to serve for 26 years, longer than his five predecessors combined. His statue still graces the Princeton campus and Witherspoon Hall, completed in 1877, stands to this day.

(Leave aside that some of those gains reflected, well, irrational exuberance, and represented, well, “phantom returns” destined to vanish.) And our professional money managers, rather than acting as long term investors— serving as vigilant stewards of our assets and acting as prudent trustees for the mutual fund investors and the pension fund beneficiaries they were duty bound to serve—have instead largely become short-term speculators, behaving as stock traders and placing their own interests ahead of the interests of their clients. Fathers of the Crisis There is plenty of responsibility to spread around for what went wrong. So while it is often said that “victory has a thousand fathers, but defeat is an orphan,” the defeat suffered by investors in our devastating financial crisis seems to have, figuratively speaking, a thousand fathers.stock

having Wall Street security analysts with only a superficial knowledge of the business telling me how to run it; and, above all, freedom from of the pressures on marketing, with company growth remaining secondary to serving shareholders “with management operating in the most efficient, honest, and economical way possible.” (A quote directly from my 1951 Princeton senior thesis on the mutual fund industry and its proper role in our economy.) Simply put, the mutual structure provided the freedom to focus, not on the ephemeral and volatile price of a corporation’s stock, but on building the enduring intrinsic value that a corporation must provide to its clients over the long term, and offering excellent products and services at the lowest possible prices. Strategy Follows Structure Importantly, the mutual “at-cost” structure largely dictated the strategies that we would follow. Here’s how mutual mutual fund management companies differ from others, in seven key areas: 1. Profit Strategy ∑ Mutual firm—Maximize return on capital for fund shareholders. ∑ Manager Ownership—Serving two masters: conflicting mandates to maximize returns—management company stockholders vs. mutual fund shareholders. 2. Pricing Strategy ∑ Mutual—The lower the cost, the higher the return to shareholders. ∑ Manager—Whatever the traffic will bear. 3. Service Strategy ∑ Mutual—Service excellence, offered at cost. ∑ Manager—Service excellence, but costs must be increased in order to achieve it. 4.

The second reason is that our new investor agents not only forget the interests of their principals, but also seemed to forget their own investment principles. (There’s that distinction again.) The predominant focus of institutional investment strategy turned from the wisdom of long-term investing to the folly of short-term speculation. During the recent era, we entered the age of expectations investing, where growth in corporate earnings—especially earnings guidance and its achievement—became the watchword of investors. Corporate managers and corporate stockholders—now no longer true owners, but renters—came to accept that whatever earnings were reported were, well, “true.” In effect, as a corporate Humpty Dumpty might have told institutional investor Alice in Wonderland: “When I report my earnings it means just what I choose it to mean, neither more nor less . . . the question is who is to be the master—that’s all.” And Alice said, “aye, aye, sir.” Management became the master of the numbers, and our public accountants too often went along. In what I’ve called “the happy conspiracy” between corporate managers, directors, accountants, investment bankers, and institutional owners and renters of stocks, all kinds of bizarre financial engineering took place. The reported numbers met the demands of the expectations market, but often had little to do with the realities of the business market.

income tax on big fortunes, and a graduated inheritance tax on big fortunes . . . increasing rapidly in amount with the size of the estate.” Given Theodore Roosevelt’s commitment to progressive taxation, I find myself both amused and disappointed that when President-elect Barack Obama endorsed policies rooted in, yes, the Republican party of Lincoln and Roosevelt, he was described darkly as a “socialist” whose goal was to “spread the wealth,” echoing Roosevelt’s expectation of being called a Communist all those years ago. The Present Financial Crisis The present financial crisis, of course was precipitated importantly by gambling in stocks—to say nothing of the modern-day gambling in bonds and so-called derivatives. This gambling with other people’s money created enormous wealth for the few of Wall Street as, in essence, our nation’s “masters of the universe” served their own parochial interests during the market bubble. But, as we now know, when the bubble burst (as it always does) Wall Street inflicted an incredible disservice to the real people of Main Street, the backbone of our nation. All those years ago, Roosevelt clearly anticipated this outcome: “The absence of effective national restraint upon unfair money-getting has tended to create a small class of enormously wealthy and economically powerful men, whose chief object is to hold and increase their power . . .

To make matters worse, while the family had always paid taxes on their dividends, some of the members are now also paying taxes on the capital gains they realize from their stock-swapping back and forth, further diminishing the family’s total wealth. The smart cousins quickly realize that their plan has actually diminished the rate of growth in the family’s wealth. They recognize that their foray into stock-picking has been a failure and conclude that they need professional assistance, the better to pick the right stocks for themselves. So they hire stock-picking experts—more Helpers!—to gain an advantage. These money managers charge a fee for their services. So when the family appraises its wealth a year later, it finds that its share of the pie has diminished even further. To make matters still worse, the new managers feel compelled to earn their keep by trading the family’s stocks at frantic levels of activity, not only increasing the brokerage commissions paid to the first set of Helpers, but running up the tax bill as well. Now the family’s earlier 100 percent share of the dividend and earnings pie is further diminished. “Well, we failed to pick good stocks for ourselves, and when that didn’t work, we also failed to pick managers who could do so,” the smart cousins say. “What shall we do?” Undeterred by their two previous failures, they decide to hire still more Helpers.

Idealism Writ Large The Battle is one idealistic book! Just consider its first words, with the dedication to my twelve grandchildren and the other fine young citizens of their generation: “My generation has left America with much to be set right; you have the opportunity of a lifetime to fix what has been broken. Hold high your idealism and your values. Remember always that even one person can make a difference. And do your part ‘to begin the world anew.’” One turn of the page takes you to five epigraphs (count ‘em, five!), the first of which comes from St. Paul: “if the sound of the trumpet shall be uncertain, who shall prepare himself to the battle?” And in my acknowledgments, I get right to the point in the very first paragraph: “Capitalism has been moving in the wrong direction.” The introduction that follows doesn’t let up. I start off with a remarkably light revision of the classic first paragraph of Gibbon’s The Decline and Fall of the Roman Empire, adapted to the present era. Compare the two first sentences. Gibbon: “In the second century of the Christian Era, the Empire of Rome comprehended the fairest part of the earth and the most civilized portion of mankind.” Battle: “As the twentieth century of the Christian era ended, the United States of America comprehended the most powerful position on earth and the wealthiest portion of mankind.

If my ideas make you wonder whether I’m really a businessman, well, you’re very perceptive. For when one’s trade is providing investment management services to those millions of human beings whom I mentioned earlier, don’t think business, think trusteeship, think stewardship. Remove salesmanship and marketing from your agenda. Focus your career as engaging in a profession, far more than merely engaging in a business. It’s worked well for us. Of course I understand that every business has elements of a profession, and every profession has elements of a business. As I have often observed, unless its revenues exceed its expenses, “no organization—even the most noble of faith-based institutions—will long exist.” I also understand that the proper balance between business and profession varies widely, depending on the character of each company and industry. And I know full well—better than most—that maintaining that balance is a delicate challenge. In any event, I’m deeply troubled that the balance between business and profession is shifting, and for the worse. Our society is gradually moving away from the stern traditional values of yore to the flexible values of our modern age. Today’s “bottom line” society reflects the gradual mutation of our professional associations into business enterprises, in important measure because of the growing importance of making money.

all shares. In its stead, a new “agency society” emerged, with financial intermediaries now controlling the overwhelming majority of corporate shares. Ownership of U.S. stocks by institutions has soared from 8 percent of all shares 50 years ago to 75 percent today. But those agents haven’t behaved as owners. They failed to honor the interest of their principals, largely those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. The second reason is that our new investor agents not only forgot the interests of their principals, but also seemed to forget their own investment principles. The predominant focus of institutional investment strategy turned from the wisdom of long-term investing, based on the enduring creation of intrinsic corporate values, to the folly of short-term speculation, focused on the ephemeral prices of corporate stocks. Management became the master of its own numbers, and our public accountants too often went along. In what I’ve called “the happy conspiracy” between corporate managers, directors, accountants, investment bankers, and institutional owners and renters of stocks, all kinds of bizarre financial engineering took place. Loose accounting standards made it possible to create, often out of thin air, what passes for earnings, even under GAAP standards.

In my 1951 Princeton senior thesis on the mutual fund industry, I cited Keynes’ conclusions. And I had the temerity to disagree with the great man. Rather than professional investors succumbing to the speculative psychology of ignorant market participants, I argued, these experienced pros would focus on enterprise. In what I predicted—accurately—would become a far larger mutual fund industry, our portfolio managers would “supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic [italics added], a demand that is based essentially on the [intrinsic] performance of the corporation rather than the public appraisal reflected in the price of its shares.” Alas, the sophisticated and analytic focus on enterprise that I had predicted from the industry’s expert professional investors has utterly failed to materialize. In fact, the emphasis on speculation by mutual funds has actually increased many fold. Call the score, Keynes 1, Bogle 0. Interestingly, Keynes was well aware of the fallibility of forecasting stock returns, noting that “it would be foolish in forming our expectations to attach great weight to matters which are very uncertain.” He added that “by very uncertain I do not mean the same thing as ‘improbable.’” While Keynes made no attempt to quantify the relationship between enterprise and speculation in shaping stock market returns, however, it occurred to me, decades later, to do exactly that.

record financial wealth was in fact “phantom wealth”—borne not of the cumulative earnings and dividends generated by American business, but of extraordinarily high—indeed, speculative— valuations that were accorded by the marketplace to those fundamental investment returns.1 Whatever the case, sooner or later, valuations will reflect reasonable expectations for dividend yields and earnings growth, and the wealth created by business will determine the future level of stock prices. Put another way, let’s not forget Benjamin Graham’s observation that while in the short run the market is a voting machine, in the long run it is a weighing machine. Put yet another way, “the fundamental things apply as time goes by.” Now a caveat: Corporations generate earnings for the owners of their stocks, pay dividends, and reinvest what’s left in the business. In the aggregate, over the past century, the nominal returns generated by our businesses have grown at an annual rate of about 9 ½ percent per year, including about 4 ½ percent from dividend yields and 5 percent from earnings growth. But these are the gross returns generated by the corporations that dominate our system of competitive capitalism. Investors who hold stocks, either directly or through the collective investment programs provided by mutual funds and defined benefit pension plans, receive their returns only after the cost of acquiring them and then trading them back and forth among one another.

II. The Philadelphia Society My long involvement with your CFA Society of Philadelphia, originally known as the Philadelphia Society of Security Analysts, has been only tangential in my career. But when I first entered the mutual fund industry, I observed that most of our area’s analysts were employed by bank trust departments and insurance companies. At the top of the list was Girard Trust, led by a remarkably distinguished group of investment professionals, ranging from Francis Nicholson to F.W. Elliott Farr to Frank Block—all top-grade, integrity-laden pros. Sadly, Girard is now long gone, taken over by Mellon Bank in 1983, which itself was absorbed by Citizens Bank in 2001. In fact, few of those old trust companies exist today—no Girard, no First Pennsylvania, no Provident Bank, no Fidelity Trust Company. They were succeeded by analysts at the few large-sized investment managers that remain here, including Wellington Management, Vanguard and just a few others. With $2.2 trillion of assets under management, and over 100 members of the CFA Society of Philadelphia, Vanguard has become the elephant in the room. Originally, our local money managers all worked in the city, but then started to move west of the city limits. Wellington moved to Valley Forge in 1974 when Vanguard began, and other firms followed. But we all remained part of the Greater Philadelphia region.

we have the total returns generated in the stock market Here’s the point: Over the very long run, it is the economics of investment—enterprise— that has determined the total return on stocks. The momentary emotions that surround investing—speculation—so important over the short run, have ultimately proven to be virtually meaningless. Example: The 9.6 percent average annual return on U.S. stocks during the past century, has been composed of 9.5 percentage points of investment return (an average dividend yield of 4.5 percent plus average annual earnings growth of 5 percent), and only one tenth of one percent of speculative return, borne of an inevitably period-dependent increase in the price- earnings ratio. Despite the transient booms and busts of stock market history, for investors who have stayed the course, buying and holding a portfolio across all of American business, has been an extraordinarily successful strategy. What’s more, the investment return on stocks has proven to be remarkably susceptible to reasonable expectations. The dividend yield on the date of investment—a crucial but underrated factor in shaping stock returns—is a known factor.while

Perhaps we shouldn’t be surprised that not only our business managers but our money managers act first in their own behalf. Indeed, as Vice Chancellor Leo E. Strine, Jr., of the Delaware Court of Chancery has observed, “It would be passing strange if . . . professional money managers would, as a class, be less likely to exploit their agency than the managers of the corporations that make products and deliver services.” In the fund industry—by far the largest of all financial intermediaries—that failure to serve the interests of fund shareholders has wide ramifications. Ironically, the failure has occurred despite the clear language of the Investment Company Act of 1940, which demands that, mutual funds “should be organized, managed and operated in the interests of their shareholders”* . . . “rather than in the interests of (their) advisers.”† The Triumph of Speculation over Investment As control over Corporate America moved from owners to agents, our institutional money managers seemed to forget their duty to act solely in the interest of their own principals, those whose savings were entrusted to mutual funds and whose retirement security was entrusted to pension plans. These new investor/agents not only forgot the interests of their principals, but also seemed to forget their own investment principles.

Defending offshore outsourcing against Western political criticism, Premji argued it was inevitable not so much because of cost arbitrage as talent arbitrage: Western cultures were not pushing enough students into engineering, and those who entered often did not choose computer science. India, by contrast, had the engineering supply to plug that gap structurally.

Defending the cheap-labour critique of Indian IT, Murthy reframed the value proposition as better value for money rather than cheap labour — for every dollar, Infosys delivered more. He also pointed to India's structural advantages: a billion-strong population, 3.5 to 4 million graduates a year, 450,000 engineers, and roughly 300,000 master's-level IT and applications graduates annually.

Drucker), Commander Watson noted that “people are driven by an intrinsic need to connect with a purpose larger than themselves,” and even quotes the authors of two best-selling business books: First hear Jim Collins, author of Built To Last: “The best executives aspire to create something bigger and more lasting than themselves—an on-going institution rooted in a set of timeless core values that exists for a purpose beyond just making money.” And now hear Tom Peters (whom we met at the start of my remarks today), author of “Search for Excellence” (with Bob Waterman): “We wonder whether it is possible to be an excellent company without clarity on values and without having the right sort of values.” Like many of you here today, I’ve read Commander Watson’s book with compelling interest. By providential coincidence, his book is organized around chapters reflecting the same sorts of values that I expressed in Enough., indeed the same sorts of values that I invested in Vanguard when I founded the firm back in 1974.Purpose

So we must have a lot more investors than speculators in our markets, right? Wrong! During the recent era—right up to this very day—the wisdom of long term investing has been overwhelmed by the folly of short-term speculation.—an orgy of speculation the likes of which has never been seen before. It’s true! During the then-record speculation of 1929, for example, annual turnover of stocks reached a record level of 145 percent. When I came into this business all those years ago (the ancient 1950s), turnover had returned to a more normal level of about 30 percent annually. But by last year, turnover had soared to 280 percent, and this year it is on track to exceed 325 percent—great news for the financial sector, the brokers, the investment bankers, and the money managers; but terrible news for investors.

cost,” basis; and to operate with complete independence from their investment adviser. How would that work in practice? After an examination that lasted from 1977 until 1981, here’s how the SEC expected it to work, as described in its decision on the Vanguard plan: The Vanguard plan is consistent with the provisions, policies, and purposes of the Act. It actually furthers the Act’s objectives by ensuring that the Funds’ directors, with more specific information at their disposal concerning the cost and performance of the Funds, are better able to evaluate the quality of those services. The plan will foster improved disclosure to shareholders, enabling them to make a more informed judgment as to the Funds’ operations. In addition, the plan clearly enhances the Funds’ independence, permitting them to change investment advisers more readily as conditions may dictate. The plan also benefits each fund within a reasonable range of fairness. Specifically, the Vanguard plan . . . enables the Funds to realize substantial savings from advisory fee reductions; promotes savings from economies of scale; provides the Funds with direct and conflict-free control over distribution functions; (and) promotes a healthy and viable mutual fund complex within which each fund can better prosper. The approval of Vanguard’s structure by the five commissioners of the SEC was unanimous.

Lord Keynes’s confidence that speculation would crowd out enterprise came at a time when individual investors dominated stock ownership. Since “the crowd” was largely ignorant of business operations and valuations, Keynes argued, excessive—even absurd—short-term market fluctuations would occur, reflecting events of an ephemeral and insignificant character. Short-term fluctuations in the earnings of existing investments, he correctly argued, would lead to unreasoning waves of optimistic and pessimistic sentiment. Competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, Keynes added, should correct the vagaries caused by ignorant individuals. But he expected such competition to do the reverse. The energies and skill of the professional investor would come to be largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. Keynes described the market as “a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.” My first encounter with that priceless wisdom took place in the course of my research for my 1951 Princeton senior thesis on the mutual fund industry.

I hope and anticipate that trust and integrity again will be amply rewarded in the marketplace as they were in previous generations. There is no better antidote for the business and financial transgressions of recent years.” But if then-Chairman Greenspan believed in 2004 that the Invisible Hand of self-interest would do its job, by 2009 he’d concluded quite the opposite. His intellectual analysis, he conceded, was based on a false premise. In his testimony before Congress last October, Greenspan acknowledged that the crisis had been prompted by “a once-in-a-century credit tsunami,” which had arisen from the collapse of a “whole intellectual edifice . . . Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity—myself especially—are in a state of shocked disbelief,” he said. This failure of self-interest to provide self-regulation was, he said, “a flaw in the model that I perceived as the critical functioning structure that defines how the world works.”

How would Coolidge deal with this obvious tension between fiscal probity and a compassionate state? Today we describe this tension in hyperbolic terms—“left wing” vs. “right wing,” a caricature bereft of subtlety. More accurately, America’s political parties are philosophically divided between a so-called liberal tradition favoring the use of the national government to foster equality and social justice, and a so-called conservative tradition favoring limited national government in the name of protecting liberty, freedom, and personal responsibility. But even that difference paints too extreme a picture. In this vastly different American economy of the present day, which way would Coolidge lean? We will never know. But it might help us to understand Coolidge’s philosophy through the two great Americans who stand tallest in his pantheon, Alexander Hamilton and Theodore Roosevelt. Alexander Hamilton Alexander Hamilton didn’t care much for these sharp distinctions. Here’s how New York Times columnist David Brooks expresses Hamilton’s philosophy: “Through much of American history there has always been a third tradition, now dormant, which believed in limited but energetic government in the name of social mobility and national union. This third tradition was founded by Alexander Hamilton, embraced by Henry Clay, taken up by Abraham Lincoln and brought into the 20th century by Theodore Roosevelt. . . .

basis, and our structure and fiscal discipline have resulted in cumulative savings to our shareowners of nearly $100 billion so far, subtracting less value from society than any financial firm on the face of the globe. In short, our rise to dominance in the financial field has come simply because we are (a) structurally correct; (b) mathematically correct; and (c) strategically correct. Our core investment strategy is the index fund—a fund that, at its best, simply owns the entire stock market (or the entire bond market). Operated at rock-bottom cost, this strategy guarantees that our shareholders receive no more and no less than their fair share of whatever long-term returns on investment that our stock and bond markets are generous enough to provide—or, on occasion, mean-spirited enough to take away. The index fund, arguably, is an exercise in the very kind of plain and simple engineering that your own careers will demand. Think about it. In the 2005 book, Power, Speed and Form. Engineers and the Making of the Twentieth Century,4 the best engineering is described as embodying “efficiency, economy, and elegance”5—the very kind of ingenious simplicity and effectiveness that characterize the index fund. It is the antithesis of the discredited “financial engineering,” the excessive costs, the product complexity, and the rampant speculation that created the global financial crisis that Wall Street has inflicted on Main Street.

fiduciary duty. In my tenth and newest book, The Clash of the Cultures: Investment vs. Speculation, I spell out what I’m looking for: A Federal Standard of Fiduciary Duty 1. Promote long-term focus. 2. Effective shareholder presence is in the national interest. 3. Exercise rights and responsibilities of corporate ownership. 4. Ability to nominate directors. 5. Eliminate conflicts of interest. 1. A requirement that all fiduciaries must act solely in the long-term interests of their beneficiaries. 2. An affirmation by government that an effective shareholder presence in all public companies is in the national interest. 3. A demand that all institutional money managers should be accountable for the compulsory exercise of their votes, in the sole interest of their shareholders. 4. A recognition of the right of shareholders to nominate directors and make proxy proposals, subject to appropriate limits. 5. A demand that any ownership structure of money managers that entails conflicts of interest be eliminated. And of course, reasonable costs are central to meeting the fiduciary standard. For fiduciary duty, in a sense, comes down to a simple mathematical calculation: How are the rewards of investing divided between the providers of financial services and their clients who put up their capital. Why? Because for investors as a group, gross returns in the financial markets, minus the costs of financial service providers, equals the net returns that are actually delivered to investors.

markets. As I have often put it: We have moved from a society in which “there are some things that one simply does not do,” to one in which “if everyone else is doing it, I can do it too.” I’ve described this change as a shift from moral absolutism to moral relativism. Business ethics, it seems to me, has been a major casualty of that shift in our traditional societal values. You will hardly be surprised to learn that I do not regard that change as progress. At least a few others share this view. In her 2006 book Trust and Honesty, Boston University Law School professor Tamar Frankel provides worthy insights on the diminishing role of fiduciary duty in our society. She is concerned—a concern that I suspect that many of you here tonight would share—that American culture has been moving toward dishonesty, deception, and abuse of trust, all of which have come to the fore in the present crisis. What we need, she argues, is “an effective way to increase trust (by) establishing trustworthy institutions and reliable systems,” even as she despairs the pressures brought out by the stock market and real estate bubbles that led to “deteriorating public morals . . . and burst into abuse of trust.” In Professor Frankel’s view, “we reduced the power of morality in law . . . emasculated the regulation of trusted persons (that is, fiduciaries) . . . abused the laws that govern fiduciaries’ honesty . . . and opened the door to enormous losses to the public and the economic system.

1) Focusing on Consumers. Serving our fund clients has been the dominant theme of my long career. While I have been criticized for choosing the title “On Human Beings” for the final chapter of both editions (1999 and 2009) of my Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor, I can’t help but wonder what those critics think is the purpose of our careers. Perhaps we have forgotten that our duty is to serve “those honest-to- God, down-to-earth human beings” who have entrusted their savings to us, “each one with their own hopes and fears and financial goals,” phrases that I have used more than once! 2) Challenging Conventional Wisdom. Whether it is Vanguard’s unique mutual structure, our focus on rock-bottom costs, our index-oriented investment strategies, or our mission—to guarantee investors their fair share of whatever returns our financial markets provide—or our conviction that short-term speculation is a loser’s game and long-term investment is a winner’s game, we’ve challenged the conventional wisdom time and time again. If the cause is worthwhile—as ours is—fighting the good battle is, for me, what life is all about. 3) “Giving Back.” We all have the obligation to “give back” to our industry, to our investors, to our communities. My way to give back has been driven by speaking—at gatherings of investors, at industry forums, at academic institutions, at college commencements—and by writing books. Don’t Count On It!

Because I found a subject for my senior thesis that totally engaged me. It was a subject on which no thesis had ever before been written, just what I’d been looking for. And it involved an industry that was “tiny but contentious” (just like I was!) I learned of it for the first time when, in the reading room of Firestone library, I happened to open the December 1949 issue of FORTUNE magazine. (Like my snowy walk to the Ardmore Post Office, I remember that moment as if it were yesterday.) There, on page 116 began an article on the infant mutual fund industry, entitled “Big Money in Boston.fund

118% 19% 48% 111% 74% 16 % 41% 79% 0% 20% 40% 60% 80% 100% 120% 140% 1946 1949 1952 1955 1958 1961 1964 1967 1 970 1973 1976 1979 19 82 1985 1988 1991 1994 1997 2000 2003 2006 Equity Fund Portfolio Turnover 3. But it is not mutual fund managers alone who are engaging in this inevitably counterproductive trading behavior for investors as a group. They are reflecting a trend toward speculation that has been growing since the mid-1960s. Total turnover of U.S. publicly-traded equities was also less than 20 percent through the mid-1960s. Even by the mid-1990s, it rarely exceeded 50 percent. But in 2007, stock turnover exceeded 215 percent per year. (Chart 4) That number soars to 280 percent if we include the breath-taking level of trading in exchange traded funds (ETFs). Clearly, the nature and character of our equity markets have changed. We are in a new era, one that is importantly defined by this orgy of speculation, by far the highest in history. When our market participants are largely investors, focused on the economics of business, the underlying power of our corporations to earn a solid return on the capital invested by their owners is what drives the stock market, and volatility is low.

CORT is a very long-established company that is the country's leader in rentals of furniture that lessees have no intention of buying. In the trade, people call CORT's activity ""rent-to-rent'' to distinguish it from ""lease-to-purchase'' businesses that are, in essence, installment sellers of furniture. However, just as Enterprise, as a rent-to-rent auto lessor in short-term arrangements, must be skilled in selling used cars, CORT must be and is skilled in selling used furniture. CORT's revenues totaled $400 million for calendar 2006, versus $384 million for calendar 2005. Of these amounts, furniture rental revenues were $324 million and $304 million, furniture sales revenues were $70 million and $72 million, and apartment locator fees of its relocation division were $6 million and $8 million. CORT operated at an after-tax proÑt of $26.9 million for 2006, up satisfactorily from its $20.7 million of after-tax proÑt for 2005 (versus $5.0 million for 2004). These results reÖect the favorable eÅects of several ""tuck-in'' acquisitions made between the years 2001 and 2004. When we purchased CORT early in 2000, its furniture rental business was rapidly growing, reÖecting the strong U.S. economy, phenomenal business expansion and explosive growth of IPOs and the high-tech sector. Beginning late in 2000, however, new business coming into CORT began to decline.

With the burst of the dot-com bubble, the events of September 11, and a protracted slowdown in new business formation, CORT's operations were hammered, reÖecting generally bad results in the ""rent-to-rent'' segment of the furniture rental business. Obviously, when we purchased CORT we were poor predictors of near-term industry-wide prospects of the ""rent-to-rent'' sector of the furniture business. CORT started up a new service during 2001. Originally a subsidiary named Relocation Central, and now its CORTline division, it was conceived mainly to supplement CORT's furniture rental business by providing apartment locator and ancillary services to relocating individuals. Long CORT's star CEO, Paul Arnold is in process of expanding CORTline's operations and redirecting its marketing, with the expectation that it will become a Ñnancial success. CORTline, originally conceived to assist relocating individuals, has recently expanded its services and capabilities and has begun to market itself toward the needs of businesses and governmental agencies who require a skilled and able partner to provide the full gamut of seamless relocation services for the temporary relocation of employees. With several websites, principally, www.cortline.com, www.relocationcentral.com and www.apartmentsearch.

” We also came to ignore the critical distinction between fiduciary law itself and a fiduciary relationship subject to contract law. What’s more, she writes, “the movement from professions to businesses was accompanied by changes in the way the law was interpreted.” We forgot the fundamental principle expressed by Matthew and Luke, and repeated by Justice Stone: “No man can serve two masters.” My principal objection to moral relativism is that it obfuscates and mitigates the obligations that we owe to society, and shifts the focus to the benefits accruing to the individual. Self-interest, unchecked, is a powerful force, but a force that, if it is to protect the interests of the community of all of our citizens, must ultimately be checked by society. The recent crisis—which has been called “a crisis of ethic proportions”—makes it clear how serious that damage can become.

Looking beyond IT, Murthy argued India needed to expand software exports but also focus on low-tech manufacturing to absorb the semi-literate workforce, rather than assuming the IT sector alone could lift the country. He positioned IT as one necessary lever in a broader industrialisation story, not the whole story.

∑ Lead by Listening ∑ Spread the Responsibility, Share the Profits ∑ Act with Audacity ∑ Make Joy Count A Word About Vanguard I have the temerity to mention Vanguard only because my invitation to receive this treasured “OTHERS” award compared the Salvation Army’s quest with my own humble quest to build a unique mutual (shareholder-owned) enterprise that would give investors a fair shake by “sharing the profits” with our stockholders. We also aimed to serve the average investor, a lesser version of the quest of Salvation Army founder William Booth—he of “Blood and Fire” fame—to serve hurting humanity. Similarly, both our quest and yours came in the face of considerable opposition. Of course it’s not possible to create a commercial enterprise that precisely matches The Salvation Army model. But Vanguard’s principles are virtually identical, and have been a vital factor in explaining what we have been able to achieve for those millions and millions of “honest-to-God, down-to-earth, human beings, with their own hopes, fears, and financial aspirations,” who have entrusted us with some $1.6 trillion of their savings in their quest to achieve financial independence.. Yes, we “Put People in our Purpose,” with a promise to provide investors with their fair share of whatever long-term investment returns the financial markets are kind enough to reward us with (and, alas, their fair share of whatever short-term dips the markets are mean enough to inflict upon us along the way).

I cited Keynes’s conclusions, and then had the temerity to disagree with the great man. Rather than professional investors succumbing to the speculative psychology of ignorant market participants, I argued, these pros would focus on enterprise. In what I predicted—accurately, as it turned out—would become a far larger mutual fund industry, our portfolio managers would “supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic [italics added], a demand that is based essentially on the [intrinsic] performance of the corporation rather than the public appraisal reflected in the price of its shares.” Alas, the sophisticated and analytic focus on enterprise that I had predicted from the industry’s expert professional managers has failed abjectly to materialize. Rather, the emphasis on speculation by mutual funds has increased many fold. He was right. I was wrong. Ah, callow youth! Call the score, Keynes 1, Bogle 0. Keynes was well aware of the fallibility of forecasting stock returns, noting that “it would be foolish in forming our expectations to attach great weight to matters which are very uncertain.” He added that “by very uncertain I do not mean the same thing as ‘improbable.to

industry oversaw only $2 ½ billion of assets under management. Today, industry assets are $12 trillion, with Vanguard’s $2 trillion now representing an amazing 16 percent of that total—one dollar of every six invested have been placed in our mutual funds. The thesis, I think, was a workmanlike—if hardly flawless—effort by a young man barely out of his teenage years.1 After analyzing the fund industry’s past, I offered my ideas of how to make it a better industry for investors in the future. Here are some verbatim quotations from the thesis. Listen carefully, please. [Mutual funds] should be operated in the most efficient, honest, and economical way possible . . . Future growth can be maximized by reducing sales charges and management fees . . . Funds can make no claim to superiority over the market averages . . . The principal function of investment companies is the management of [their] investment portfolios. Everything else is incidental . . . The principal role of the mutual fund should be to serve its shareholders. If you see today’s Vanguard described by those words of course you’re right. But if you see only the mouthings of a callow and idealistic college senior; you’re also right. But whatever the case, it was those naïve but noble goals expressed in my thesis—efficiency, honesty, economy, low costs, index funds, serving shareholders first, in all, a fair shake for investors—that set the stage for my entire career in finance.

is my ninth book, following Enough., The Battle for the Soul of Capitalism, Character Counts, and others. I’m not about to stop “giving back,” even in these later years of my life. I close with this proverb recounted by Mario Cuomo—a member of my pantheon of American heroes—in last Sunday’s New York Times Magazine: An Arab traveler comes across a sparrow in the desert, laying on his back, with his claws outstretched to the sky. The traveler asks what the bird is doing, and the bird replies that he has heard the sky is about to fall and he wants to be ready to hold it up. “You foolish creature,” says the Arab, laughing. To which the bird replies, with resignation, “one does what one can.” And so I continue to do what I can, to work toward building a better financial world in which institutional money managers honor their fiduciary duty to the clients they serve, focusing on investment rather than speculation, on prudence and due diligence, and at last honor both their rights and responsibilities for good corporate governance; a brave new world in which fund investors get a fair shake. Our financial sky, truth told, is not in very good shape, and I’m doing my best to hold it up. If you tell me it’s going to fall anyway, well, I’ll just try a little harder.

If the owners of corporate America don’t give a damn about corporate governance, I ask you, who on earth should? The second reason is that our new investor agents not only seemed to forget the interests of their principals, but also seemed to forget their own investment principles. (There’s a somewhat different distinction between a-l-s and l-e-s.) In recent decades, the predominant focus of institutional investment strategy turned from the wisdom of long-term investing to the folly of short-term speculation. We entered the age of expectations investing, where growth in corporate earnings—especially earnings guidance and its achievement—became the watchword of investors. Corporate managers and corporate stockholders—now no longer true owners of stocks, but renters of stocks—came to accept that whatever earnings were reported were, well, “true.” In effect, as a corporate Humpty Dumpty might have told institutional investor Alice in Wonderland: “When I report my earnings it means just what I choose it to mean, neither more nor less . . . the question is who is to be the master—that’s all.” And Alice said, “aye, aye, sir.”

But when our markets are driven, as they are today, largely by speculators, by expectations, and by hope, greed, and fear, the inevitably counterproductive swings in the emotions of market participants—from the ebullience of optimism to the blackness of pessimism—the resultant turbulence that we are now witnessing was almost inevitable.

So I used the heavily-disguised opportunity created by my being fired to found a new firm built on those idealistic principles that I expressed in my thesis. (As it is said, “if you’re given a lemon, make lemonade.” No, that’s not Kipling.) I named the firm Vanguard, and ran it for the next 22 years. Our policies were based on honest disclosure, efficient management, and— above all—on economical operations. (Remember those words—“honest, efficient, and economical”—from my thesis?) We chose a unique and untested, truly mutual structure in which we eliminated conflicts of interest by having the fund shareholders own our management company; and we held our costs to the bare-bones minimum, by far the lowest in the field, saving them tens of billions of dollars over the years. And if our managed-fund peers couldn’t beat the market, well, we would—and did—create a “market fund” that would beat our managed-fund peers. Of course it did just that, and that first index mutual fund that we created is now essentially the largest fund on the face of the globe.our

But we grudge no man a fortune which represents his own power and sagacity, when exercised with entire regard to the welfare of his fellows . . .” So what was a lifelong Republican who shares these same concerns to do when he voted in our presidential election last month? I decided to cast my vote for Barack Obama, in part because I share those values with him, and with his Republican predecessors Abraham Lincoln and Theodore Roosevelt. Neither party has claim on them, for these values are societal in nature. Further, it seems to me that these values take the theme of the Community College of Philadelphia—The Path to Possibilities—to its logical fruition. Barack Obama’s inspiring election, will I think, help lead America away from her recent path in which our traditional values have been gradually eroded—and not only in the gross excesses of our financial sector which are now being borne by our citizenry—but also in our wasteful, short-term-oriented “me first” society.Character

Reflecting on growth, Nadar noted it took HCL 13 years to reach INR 100 crore in computer revenues (1989) and roughly another 10 years to reach INR 1,000 crore, before accelerating to INR 15,000 crore by 2006 — a J-curve he attributes to the post-liberalisation environment and HCL's accumulated engineering credibility.

Putting Numbers on Keynes’s Distinction By the late 1980s, based my own first-hand experience and my research on the financial markets, I concluded that the two essential sources of equity returns were: (1) economics, and (2) emotions. What Keynes had described as enterprise I called “economics.” What Keynes termed “speculation,” I found well-defined by “emotions.” The former I defined as investment return— the initial dividend yield on stocks plus the subsequent annual rate of earnings growth. The latter I defined as speculative return—the change in the price investors are willing to pay for each dollar of earnings. (Essentially, the return that is generated by changes in the valuation or discount rate that investors place on future corporate earnings.) Simply adding speculative return to investment return produces the total return generated by the stock market. For example, if stocks begin a decade with a dividend yield of 4 ½ percent and experience subsequent earnings growth of 4 ½ percent, the investment return would be 9 percent.a

Loose accounting standards made it possible to create, often out of thin air, what passes for earnings, even under GAAP standards. My favorites, as it were, include hyping the assumed future returns earned by the pension plan, even as rational expectations for future returns deteriorated; post-merger accounting that creates a veritable “cookie jar” of reserves to be drawn on to create illusory earnings growth later on, even as we learn that some 61 percent of corporate mergers actually destroy shareholder value; failing to include the cost of stock options as a compensation expense (a practice now, happily, prohibited); and the concealment of debt by forming special-purpose entities, abused most notably by Enron. Under GAAP, these practices are all, well, legal. Surely it can be said, then, that the problem in such creative financial engineering isn’t what’s illegal. It’s what’s legal. (Indeed, even the back-dating of options—the most recent example of the malfeasance of corporate managers— when accounted for properly—is legal.) And so the management consultant’s bromide—“If you can measure it, you can manage it”—became the mantra of the chief executive.

” So when I add Gibbon’s conclusion—“(Yet) the Roman Empire would decline and fall, a revolution which will be ever remembered and is still felt by the nations of the earth”—few thoughtful readers will miss the point. But of course I hammer it home anyway: “Gibbon’s history reminds us that no nation can take its greatness for granted. There are no exceptions.” As one of two reviews of The Battle for the Soul of Capitalism—both very generous—that appeared in The New York Times noted, “Subtle Mr. Bogle is not.” No, I’m not writing off America. But my certain trumpet is warning that we must put our house in order. “The example of the fall of the Roman Empire ought to be a strong wake-up call to all of those who share my respect and admiration for the vital role that capitalism has played in America’s call to greatness.private

Another statue of Witherspoon also guards the Historical Society, depicting him with linked hands in prayerful repose. These three great men played major roles in the history of the Presbyterian Church (USA) and Witherspoon also played a major role in America’s struggle for independence. A passionate supporter of the Revolution, he was the only clergyman to sign the Declaration of Independence. When it was argued that America was not ready for independence, Witherspoon replied, “it was not only ripe for the measure, but in danger of rotting for the want of it.” While he was a powerful supporter of the need for a Constitution for our new nation, Witherspoon was not a delegate to the Convention. Otherwise, a third sculpture of him would be right there with the founding fathers in Signer’s Hall, just a few blocks away at our National Constitution Center. But his clerical voice was part of the Great Awakening, and surely influenced two other great men of American history whose lifelike statues do repose there. Important to our subject this evening, both had strong Protestant convictions.

market crash, and failing to impose discipline on mortgage bankers. Our banks and investment banks, which designed and sold trillions of dollars worth of incredibly complex and risky mortgage-backed bonds and tens of trillions of dollars of derivatives (largely credit default swamps). They were also left holding the bag with many of these toxic derivatives, held in highly leveraged balance sheets—sometimes by as much as 33 to one or more. Just do the math; a mere three percent decline in asset value wipes out 100 percent of shareholder equity. These institutions also brought us “securitization,” selling off loans to untested financial instruments and severing the traditional link between lender and borrower. With that change, the incentive to demand credit-worthiness on the part of those who borrow almost vanished as banks lent the money and then sold the loans to these new bond funds. In banking we’ve come a long, long way from community lending built on the financial probity and the character of the borrower, the kind of thing we saw in “It’s a Wonderful Life.” (Remember Jimmy Stewart as George Bailey and Lionel Barrymore’s crusty Mr. Potter?) Our market regulators, too, have a lot to answer for: The Securities & Exchange Commission was almost apathetic in its failure to recognize what was happening in the capital markets.

So perhaps their strategy should be—I apologize for thinking like a business school professor here—to keep prices high on those funds in which costs are not particularly visible (i.e., funds that are not “closet” index funds); and to cut prices for their largest shareholders, particularly on funds where costs are the obvious differentiator in providing superior returns—obvious at least to the intelligent adviser or intelligent investor—index funds, bond funds, and money market funds. But this strategy has already been tried by several of our peers, and it has failed. Why? Because ever since 1992, when we introduced our first high-minimum-investment, minimal-expense-ratio Admiral shares, we’ve cut prices to stay a step ahead of the competition. As I said to our Vanguard crew in 1992, “the Admiral concept is (based on) the obvious insight that, since the costs of handling a shareholder account are relatively fixed, larger investors generate substantial economies of scale . . . (It is) our way of firing a shot across the enemy’s bow—letting our rivals know that they’d better get ready for even tougher price competition.” That 1992 strategy, to state the obvious, lies at the root of the continuing expansion of our Admiral franchise, most recently in lowering the asset threshold for individual index fund investors from $100,000 to $10,000, with expense ratios running as low as 0.07 percent (seven basis points).

Hamilton came from nothing and spent his political career trying to create a world in which as many people as possible could replicate his amazing success. [He] saw a country destined to become the greatest empire of the earth, and sought to liberate and stir Americans to exploit the full range of their capacities. Hamilton believed in using government to enhance market dynamism by fostering more equitable competition. He believed government could usefully promote social revolutions . . . It was always the cause America represents—universal freedom—that was uppermost in Hamilton’s mind, spurring individual initiative, but also gathering the fruits of that energy in the cause of national greatness.” Coolidge was basically a Hamilton Republican.Hamilton:

While some of this activity is necessary to provide the liquidity that has been the hallmark of U.S. financial markets, it has grown into an orgy of speculation that pits one manager against another, and one investor (or speculator) against another—a “paper economy” that, as Minsky warned, can devastate the real economy where our citizens save and invest. It must be obvious that our present economic crisis was, by and large, foisted on Main Street by Wall Street—the mostly innocent public taken to the cleaners, as it were, by the mostly greedy financiers. The economist Henry Kaufman warned about this very problem in his book, On Money and Markets, published in 2000: 1 Using the valuation model developed by Dr. Robert Shiller of Yale, the valuations were even more extreme. In October 2007, stocks sold at prices equal to 27 times earnings during the prior ten years, compared to the long-term multiple of 16 times. Result (if you agree with his premise): at the market peak, phantom wealth totaled nearly $7 trillion.

Risk Management Strategy ∑ Mutual—Low portfolio risks and costs, but still providing competitive income yields. ∑ Manager—Reaching for higher yields, with higher risks, to compensate for their higher costs. 5. “Product” Strategy ∑ Mutual—Sell what you make: Middle-of-the-road funds; defined market segments; love index funds. ∑ Manager—Make what will sell: Aggressive funds and fad funds; hope for home runs; hate index funds. (Why? Low—if any—profit to managers.)

It may sound simple. But it is true. The mutual fund field is one in which investors, as a group, as a matter of mathematical certainty, not only do not get what they pay for, but get precisely what they do not pay for. Let me put the conclusion in its sharpest formulation: if investors pay nothing, they get everything—that is, 100 percent of the gains that our stock market is generous enough to bestow on us, and for that matter, 100 percent of the losses that our market can be mean enough to inflict on us. Costs Matter! In the short run, investment costs may seem inconsequential. But in the long run, costs can overwhelm stock market returns. As I’ve so often said, “the magic of long-term compounding returns virtually assures investment success for owners of stocks as a group . . . provided that it is not overwhelmed by the tyranny of compounding costs.” Here, let’s look at the facts. Let’s assume a nominal compound annual return on stocks of 7 percent over an investment lifetime—let’s say 60-years—and compare it with an investment system that incurs costs of 2 percent, delivering a net return of 5 percent. The 2 percent cost is a reasonable—maybe even conservative—estimate of equity fund all-in costs, including an expense ratio of 1 to 1 ¼ percent; plus turnover costs of ½ to 1 percent; plus (often) sales loads, when annualized, of ½ percent to 1 ½ percent.

It’s worth dwelling on that phrase: “the critical functioning structure that defines how the world works.” As the New Yorker writer John Lanchester observed: “That’s a hell of a big thing to find a flaw in.” Here’s another way of describing that flaw, Lanchester continued: “the people in power thought they knew more than they did. The bankers evidently knew too much math and not enough history—or maybe they didn’t know enough of either.” But they must have know nthat their financial self-interest would result in private opulence for them, even as it was destined, finally, to result in public penury. Adam Smith II – The Impartial Spectator There has also been a societal change that underlies the failure of modern-day capitalism. It was well-described in a letter I received a while ago from a Vanguard shareholder, who described it as “a crisis of ethic proportions.” Substituting ethic for epic is not only a fine turn of phrase; it accurately places a heavy responsibility for the meltdown on a broad deterioration in traditional ethical standards. (The Wall Street Journal retained that phrase as the title of my op-ed essay that was published in April of this year.) But the characters of that traditional ethical behavior seemed to fade, replaced by new values in our national culture. Simply put, we became what has been called a “bottom line” society, one in which progress and success are largely measured in monetary terms.

They retain the best investment consultants and financial planners they can find to advise them on how to select the right managers, who will then surely pick the right stocks. The consultants, of course, tell them they can do exactly that. “Just pay us a fee for our services,” the new Helpers assure the cousins, “and all will be well.” Alas, the family’s share of the pie tumbles once again. Alarmed at last, the family sits down together and takes stock of the events that have transpired since some of them began to try to outsmart the others. “How is it,” they ask, “that our original 100 percent share of the pie—made up each year of all those dividends and earnings—has dwindled to just 60 percent?those

So to realize the winning returns generated by businesses over the long term, the intelligent investor will minimize to the bare bones the costs of our financial system. That’s what common sense tells us, and it’s the truth. 2. Business Reality Trumps Market Expectations That brings us to my second relentless rule of humble arithmetic. Successful investing is not about the stock market, but about owning all of America’s businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation’s—and, for that matter, our world’s—corporations. For in the very long run, it is how businesses actually perform that determines the return on our invested capital. Dividend yields, plus earnings growth, account for substantially 100 percent of the return on stocks. Put another way, that wonderful parable about the Gotrocks family brings home the central reality of investing: “The most that owners in the aggregate can earn between now and Judgment Day is what their business in the aggregate earns,” in the words of Warren Buffett.the

And it is now arguably the largest mutual fund in the world.6 Yet the Vanguard model has yet to be copied, and we remain a renegade in our field. We prefer to be noted for our stewardship rather than our salesmanship; for our management rather than our marketing; for our focus on long-term investment rather than short-term speculation. In this sense we parallel the career of Isaiah Williamson, who made his fortune in trade by his own efforts and straight business dealing, not by speculation. Labor and Capital When capital is used for speculation rather than investment, the relationship between capital and labor in our society is distorted. Of course, as Abraham Lincoln reminded us, capital 4 David P. Billington and David P. Billington Jr., Oxford University Press, 2005. 5 In fact, in my 1951 thesis at Princeton University, I urged that mutual funds be operated “in the most efficient, economical, and honest way possible.” If honesty is understood to represent a certain kind of elegance, the ideas are identical. 6 Assets of our Index 500 funds total $125 billion; assets of our Total Stock Market Index Funds total $95 billion, a total of $220 billion.

hardly certain, has been remarkably stable. Corporate earnings have, with considerable consistency, grown at about the rate of the U.S. Gross Domestic Product (GDP). In the Great Depression, of course, corporate earnings plummeted, just as they have risen, seemingly inevitably, with the long-term growth of our productive, innovative, and competitive U.S. economy. The speculative return on stocks has proven to be, well, speculative. It has alternated from positive to negative over the decades. But usually when price/earnings ratios are historically low (say, below 10 times) they have been likely to rise over time. And when they are historically high (say, above 20 times) they have been likely to decline. (Of course in neither case do we know when the change is coming.) While certainty about the future never exists nor are probabilities always borne out, applying reasonable expectations to investment return and speculative return and then combining them has proved to be a sensible and effective approach to projecting the total return on stocks over the decades. Relying on this simple but proven methodology, then, it is reasonable to expect annual stock returns in the range of 7 percent in the coming decade, well below the long-term norm of 9.6 percent. The dividend yield is 2 percent (not the 4 ½ percent norm of yesteryear), and earnings generated could reach 6 percent, a total investment return of 8 percent.

The predominant focus of institutional investment strategy turned from the wisdom of long-term investing, based on the enduring creation of intrinsic corporate values, to the folly of short-term speculation, focused on the ephemeral prices of corporate stocks. The “own-a-stock” strategy of yore became the “rent-a- stock” strategy of today. In what I’ve called “the happy conspiracy” between corporate managers, directors, accountants, investment bankers, and institutional owners and renters of stocks, all kinds of bizarre financial engineering took place. Management became the master of its own numbers, and our public accountants too often went along. Loose accounting standards made it possible to create, often out of thin air, what passes for earnings, even under GAAP standards. One good example—which is already sowing the seeds of yet another financial crisis that is now emerging—is hyping the assumed future returns earned by pension plans, even as rational expectations for future returns deteriorated. * Investment Company Act of 1940, Section One. † Securities and Exchange Commission decision, March 15, 1981.

Traditionally, professions were expected to embody such characteristics as a commitment to the interest of clients and to the welfare of society; a special body of knowledge; a specialized set of skills and practices; a community responsible for the oversight and monitoring of quality; and, most importantly, the capacity to render judgments with integrity under conditions of ethical uncertainty. Yet today, unchecked market forces not only constitute a strong challenge to our professions; in some cases, these forces have totally overwhelmed traditional standards of professional conduct, developed over centuries. The dangers I describe have already come home to roost in some established professions, with incalculable harm to our society. Examples of the harsh consequences of this change are easy to come by. In public accounting, our once “Big Eight” (now “Final Four”) firms gradually came to provide hugely profitable consulting services to their audit clients, making them business partners of management rather than independent and professional evaluators of generally accepted (if loose) accounting principles.of

It was the final stamp of approval on what proved to be a new way of operating a fund complex that would ultimately lead to a major reordering of the fund industry. The rest, as they say, is history. “A Journey of a Thousand Miles” With that history as background, where are we today? In my view, the formation of Vanguard and its “shareholder first” structure marks the beginning of a long arc that is bending toward fiduciary duty. As it is said, “a journey of a thousand miles begins with a single step.” And thanks importantly to the determination of Assistant Secretary of Labor Phyllis Borzi, the DOL has given vital support to that fiduciary principle, recently approving a rule that requires both registered investment advisers (RIAs) and stock brokers to place the interests of their clients holding retirement plans before their own.

This area continues to provide the perfect environment for growth—excellent colleges and universities, world-class health care facilities, and remarkable cultural institutions (including our National Constitution Center). Keeping our roots firmly planted in the Philadelphia region was—and still is—the perfect choice for Vanguard and many other financial organizations and this region remains a major factor in the financial firmament. Back in the 1950s and 60s, investment management was focused on long-term time horizons and minimizing the impact of high taxes—capital gains taxes were an especially important consideration for the trust companies. The professional culture was based largely on prudence and fiduciary duty.Robert

He offered a striking statistic on brain-drain reversal: Wipro's annual attrition had long run at 13 to 14 percent, but just four years earlier almost all departing employees had left for US jobs; by 2006 only 1 percent of those leaving Wipro went to US companies. The flow had inverted, with Indian engineers returning home rather than chasing American salaries.

One good example— which is already sowing the seeds of yet another financial crisis that is now emerging—is hyping the assumed future returns earned by pension plans, even as rational expectations for future returns deteriorated. Other examples of financial engineering include post-merger accounting that allows the creation of a veritable “cookie jar” of reserves to be drawn on to create illusory earnings growth later on, even as we learn that some 61 percent of corporate mergers actually destroy shareholder value; failing to include the cost of stock options as a compensation expense (a practice now, happily, prohibited); the concealment of debt by forming special-purpose entities, abused most notably by Enron; and the unwillingness of financial institutions to “mark-to-market” the toxic mortgage-backed bonds that have destroyed their balance sheets. Banks, of course, hate the idea; let’s call their preference “mark to management.” Under GAAP, these practices are all, well, legal. Surely it can be said, then, that the problem in such creative financial engineering isn’t what’s illegal. It’s what’s legal.managers—when

One result of this crazy speculation—you all must know this by now—has been the unprecedented market turbulence I have described. A simple measure makes the point: During my first few decades in this business, we might have three or four days each year in which stocks rose or fell by two percent or more. Since July 2007, however, stocks have risen or fallen by that amount on 52 days, 21 up and 31 down—volatility without precedent in all history. But does this market craziness reflect reality? No it doesn’t. Since the October 2007 high, the total capitalization of the U.S. stock market has crashed from about $18 trillion to $10 trillion, at the low last Friday, a drop of some $8 trillion. But that’s “the market.” Does anyone here tonight really believe that the value of American corporate business in the aggregate has dropped by $8 trillion—by 40 percent! Well, I for one do not. Over the entire modern era, U.S. business has grown, with remarkably few interruptions, (for example the Great Depression), at about the pace of the real economy. Much of the responsibility for the crash in prices can be laid on Wall Street. Investment bankers, brokers, and money managers shifted their attention away from honoring, first and foremost, the interests of their clients and toward increasing their personal wealth and the earnings of their (largely publicly held) firms.

That promise depends on the broadest possible diversification and on minimizing the costs of investing, the principal characteristics that drive our enterprise. I also resonated to Commander Watson’s goal, “Act with Audacity.” (We even have a building on our campus named “Audacious,” one of Lord Nelson’s ships-of-the-line in his brilliant victory aboard HMS Vanguard at the historic Battle of the Nile in 1798.) Of course it was audacious to create this new mutual structure, to eliminate so many of the conflicts of interest that plague our industry, to start the world’s first index mutual fund, and to create an innovative bond strategy that was almost immediately copied by our peers.

By year-end, the assets of Admiral investors at Vanguard will likely top $450 billion, fully 30 percent of our asset base. Maintaining Leadership How long will Vanguard’s leadership last? Who really knows? But we’ve got a lot going for us in the years ahead: 1. Our rock-bottom costs will endure, and the idea that lower costs lead to higher returns will never go away.equals

Managements—those corporate principals— became the masters of the numbers, and our public accountants too often went along. In what I’ve called “the happy conspiracy” between corporate managers, directors, accountants, investment bankers, and institutional owners and renters of stocks, all kinds of bizarre financial engineering took place. The reported numbers met the demands of the expectations market, but often had little to do with the realities of the business market. Loose accounting standards made it possible to create, often out of thin air, what passes for earnings, even under GAAP standards. Under GAAP, these practices are all, well, legal. Surely it can be said, then, that the problem in such creative financial engineering isn’t what’s illegal. The problem is what’s legal. (Indeed, when accounted for properly, even the back-dating of options—a recent example of the malfeasance of corporate managers—is legal.) And so the management consultant’s ghastly bromide—“If you can measure it, you can manage it”—became the mantra of the chief executive. The Real Market and the Expectations Market Consider with me now how the erosion in the conduct and values of business has been fostered by the profound—and largely unnoticed—change in the nature of our financial markets. That change reflects two radically different views of what investing is all about, two distinct markets. One is the real market of intrinsic business value.

But our society, I think, is measuring the wrong bottom line: not only money over achievement, but form over substance; prestige over virtue; charisma over character; the ephemeral over the enduring; even mammon over God. Dollars became the coin of the new realm, and unchecked market forces totally overwhelmed traditional standards of professional conduct, developed over centuries. The result has been a marked change in our society. The traditional standard of conduct in which “there are some things that one simply does not do,” took a back seat to a new standard: “if everyone else is doing it, I can do it too.” I would describe this change as a shift from moral absolutism to moral relativism. The moral themes of virtue, loyalty, fidelity, faith, and honor have been debased. Business ethics has been a major casualty of that shift in our traditional societal values, and the idea of professional standards has been lost in the shuffle.

Nadar was openly critical of the headcount-obsessed model of Indian IT — comparing firms that proudly announce ever-larger employee counts to a football bouncing between Cognizant, HCL and Infosys — and argued that body-shopping without meaningful customer contribution would not survive, presaging the shift toward deeper, fewer customer relationships.

But I’m guessing that earnings multiples are likely to be lower a decade hence, with the speculative return reducing that figure by about a percentage point. In sum the economics of investing are unlikely to be as good as in the past. Here’s the point: When our markets are driven by economics, the underlying power of our corporations to earn a solid return of the capital invested by their owners drives the long-term returns that are earned by equity investors. But in the interim, when our markets are driven, as they are today, by emotions—hope, greed, and fear; the speculative, counterproductive swings from the ebullience of optimism to the blackness of pessimism—be ready for turbulence. The Age of Turbulence To be sure, every era has its times of turbulence and its times of stability and growth. But surely the 21st century, the new and present millennium, has begun with turbulence riding in the saddle of the stock market.stocks

“Unfettered financial entrepreneurship can become excessive—and damaging as well—leading to serious abuses and the trampling of the basic laws and morals of the financial system. Such abuses weaken a nation’s financial structure and undermine public confidence in the financial community . . . Only by improving the balance between entrepreneurial innovation and more traditional values— prudence, stability, safety, soundness—can we improve the ratio of benefits to costs in our economic system . . . When financial buccaneers and negligent executives step over the line, the damage is inflicted on all market participants . . . and the notion of financial trusteeship too frequently lost in the shuffle.” Dr. Kaufman’s early warning, of course, went unheeded. For our financial system is a greedy system, depending on high transaction volumes, high leverage, and rank speculation to maximize its own rewards. As a result, it consumes far too large a share of the returns created by our business and economic system. Writing in the Journal of Portfolio Management a year ago, I described the enormous costs of the financial sector: “. . . mutual fund expenses, plus all those fees paid to hedge fund and pension fund managers, to trust companies and to insurance companies, plus their trading costs and investment banking fees . . . totaled about $528 billion in 2007. These enormous costs seriously undermine the odds in favor of success for investors.

publicly-owned investment company he has run for 40 years, Buffett says, “When the stock temporarily over-performs or under-performs the business, a limited number of shareholders— either sellers or buyers—receive out-sized benefits at the expense of those they trade with. But over time, the aggregate gains made by Berkshire shareholders must of necessity match the business gains of the company. How often investors lose sight of that eternal principle! Yet the record is clear. History, if only we would take the trouble to look at it, reveals the remarkable, if essential, linkage between the cumulative long-term returns earned by business—the annual dividend yield plus the annual rate of earnings growth—and the cumulative returns earned by the U.S. stock market. Think about that certainty for a moment. Can you see that it is simple common sense? Need proof? Just look at the record since the twentieth century began. The average annual total return on stocks was 9.6 percent, virtually identical to the investment return of 9.5 percent—4.5 percent from dividend yield and 5 percent from earnings growth. That tiny difference of 0.1 percent per year arose from what I call speculative return, depending on how one looks at it. Perhaps it is merely statistical noise, or perhaps it reflects a generally upward long-term trend in stock valuations, a willingness of investors to pay higher prices for each dollar of earnings at the end of the period than at the beginning.

Their creation and promotion of infinitely complex credit instruments (often debt obligations collateralized by mortgages, known as CDOs) led to the mass marketing of mortgages of dubious creditworthiness bundled in packages. In addition, an enormous system of betting on whether these bonds would or would not default (using “credit default swaps,” or CDS) emerged, and spread its tentacles to financial institutions all over the globe. The notional value of CDS market—gambling on a bank’s creditworthiness—now totals an astonishing $62 trillion. Now the CDS is merely a way to speculate on whether a bond will default or not. Investors pay an insurance premium to bet “yes” or “no,” and the premium varies with how speculators regard the likelihood of default. Simple enough, until your realize that that $62 trillion is being bet on only $2 trillion of underlying bonds. Talk about gambling! A homely comparison: Let’s say you insure your house with $700,000 of fire insurance. Then, 62 of your neighbors bet that it will burn down, and 62 other neighbors take the other side, betting that it won’t. You might say, “what’s wrong with that”, to which I’d respond, “just watch out for arsonists.huge

Causes of the Recent Crisis The causes of that crisis are manifold. Metaphorically speaking, the collapse in our financial system has 1,000 fathers. The cavalier attitude toward risk of our bankers and investment bankers, holding a toxic mix of low-quality securities on enormously leveraged balance sheets. The lassiez-faire attitude of our federal regulators, reflected in their faith that “free competitive markets” would protect our society against excesses. The Congress, which rolled back legislative reforms going back to the depression years. “Securitization,” in which the traditional link between borrower and lender—under which lenders demanded evidence of the borrowers’ ability to meet their financial obligations—was severed. Reckless financial innovation in which literally tens of trillions of dollars of derivative financial instruments (such as credit default swaps) were created, usually carrying stupefying levels of risk and unfathomable levels of complexity. The radical increase in the power and position of the leaders of corporate America and the leaders of investment America has been a major contributor to these failures. Today’s dominant institutional ownership position of 70 percent of the shares of our (largely giant) public corporations compares with only about 8 percent of all corporate shares a half-century ago.

Here again, we can’t say that we hadn’t been warned well in advance. Speaking before the 1958 Convention of the National Federation of Financial Analysts Societies, Benjamin Graham, legendary investor and author of the classic, “The Intelligent Investor, described “some contrasting relationships between the present and the past in our underlying attitudes toward investment and speculation in common stocks.” In the past, the speculative elements of a common stock resided almost exclusively in the company itself; they were due to uncertainties, or fluctuating elements, or downright weaknesses in the industry, or the corporation’s individual setup . . . But in recent years a new and major element of speculation has been introduced into the common-stock arena from outside the companies. It comes from the attitude and viewpoint of the stock-buying public and their advisers—chiefly us security analysts. This attitude may be described in a phrase: primary emphasis upon future expectations . . . The concept of future prospects, and particularly of continued growth in the future, invites the application of formulas out of higher mathematics to establish the present value of the favored issues. But the combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wished, however high . . .

Ever the optimist, I believe that our president-elect will measure up to my conviction that he has the temperament and character to lead us through today’s struggles and challenges and return us to our nation’s founding values. If you’ll bear with me, hear Roosevelt just once more, for he got it right, not only for our president-to-be, but for each one of us, and especially for the students and teachers and managers of CCP. Here’s what he said: “In the last analysis, the most important elements in any man’s career must be the sum of those qualities which, in the aggregate, we speak of as character. We must have the right kind of character—character that makes a man,* first of all, a good man in the home, and a good neighbor, a private citizen [whom America offers] the best possible chance for development.” So let’s never forget that over the long term it is not things, nor power, nor money that form the heart of any nation. Rather, it is character and values, the very values, applied to our society that I have described here for us as individuals: the persistence, the determination, the resilience, the moral standards, and the virtue that have made this nation great. Everyone here in this room today, young and old, student and teacher, businessperson and professional alike can— and must—help in this great revival. * Of course, today we’d include woman, and I’m sure Theodore Roosevelt would approve.

com, professionals in more than 80 domestic metropolitan markets, aÇliates in more than 50 countries, almost twenty thousand apartment communities referring their tenants to CORT, many ancillary services, and its entr πee to the business community as a Berkshire Hathaway company, CORTline now seems to be moving in the right direction. We are pleased with the progress CORT made in the past two years. We are cautiously optimistic that, in future years, we will be able to look back to the recent past and consider it merely a cyclical aberration in CORT's growth. We note, however, that the number of furniture leases outstanding has been slightly declining in each of the past two years.

has its rights, worthy of protection; and property is the fruit of labor, a positive good in the world. This philosophy resonated with Theodore Roosevelt, who in 1910 cited Lincoln’s words and added: (We must) equalize opportunity, destroy privilege, and give to the life and citizenship of every individual the highest value both to himself and the commonwealth . . . the highest service of which he is capable . . . We should permit fortunes to be gained only so long as the gaining represents benefit to the community . . . for every dollar received should represent a dollar’s worth of service rendered—not gambling in stocks but in service rendered. “Not gambling in stocks but in service rendered” is a worthy standard. Yet when I look at our society today, I am appalled by our tendency to overvalue the managers of our financial sector and to undervalue those who are engaged in work and trade. A recent book entitled “The Craftsman”7 makes the case for the kind of valuable work that you have been trained to do: “making is thinking . . . for the work of the hand can inform the work of the mind . . . learning to work well enables people . . . to govern themselves so as to become good citizens.

shareholders, in the miniscule costs that they bear, and in the overwhelming trust that our shareholders have placed in us. But I couldn’t forget Kipling’s implicit warning, “if you can meet both Triumph and Disaster, and treat those two imposters just the same.” After my earlier brush with Disaster in my career, it was easy for me to understand that Triumph too is an imposter. Far better than preening over the past, please realize that it is focusing on the future that must be the order of the day. Creating a new kind of fund company defied the conventional wisdom. So did creating a new kind of fund which would not trade stocks in the market, but simply buy all of the stocks in the stock market—owning corporate America, and holding it, well, forever. The world doubted that this tiny new firm called Vanguard would make a go of it. In fact, our index fund was called “Bogle’s Folly” for years. (But no longer!) So, yes, “when all men doubt you,” as Kipling put it, simply “trust yourself.” And when opportunity knocks, don’t forget to answer the door! Reflections on Today’s Crisis In our present financial and economic crisis, Vanguard’s simple strategies have paid off in spades. In a fund industry now deeply troubled by its aggressive marketing of investment fads, its speculative policies, its excessive costs, and its periodic scandals, our firm remains vibrant, healthy, and pristine.

accounted for properly—is legal.) And so the management consultant’s bromide—“If you can measure it, you can manage it”—became the mantra of the chief executive, if not with the knowledge of the directors, at least with their tacit blessing. In short, the managers of our public corporations came to place their own interests ahead of the interests of their owners, exploiting the powers of their agency, yet unchecked by traditional gatekeepers such as directors, accountants, and regulators, and even the owners themselves. For true owners now play but a small and gradually vanishing role in our investment world. Our now-dominant money manager agents blithely accepted the new environment in which management self-interest held sway. Indeed, they fostered it by accepting as holy writ whatever earnings our corporations reported, and by generally ignoring corporate governance issues such as proxy access, executive compensation, board composition, and even mergers and acquisitions and dividend policy. Adam Smith presciently described the characteristics of today’s corporate and institutional managers (many of which are themselves controlled by giant financial conglomerates) with these words: Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail.2 So what’s to be done?

From College to Business Almost immediately, my move began from lofty ideas to their implementation in the real dog-eat-dog business of investing. Industry pioneer Walter Morgan, Princeton Class of 1920, read the thesis and, when I graduated in 1951, offered me a job at his Wellington Fund, the firm he founded here in Philadelphia in 1928. My great mentor—bless his soul!—liked me; he trusted me; he had confidence in me when I had little confidence in myself; and he gave me the break of 1 You can judge for yourself. It was published by McGraw-Hill in 2001 as the final chapter of my book John Bogle on Investing: The First 50 Years.

Here, I omit the costs of about 1 ½ percent to for investor behavior (buying hot funds after they had shot the moon) and the costs of 1 to 1 ½ percent for tax-inefficiency for funds held in taxable portfolios. (Those extra 3 percentage points in annual costs are rarely taken into account in industry studies.) But let’s be generous and stick to an annual cost of 2 percent. (Chart 2) Over an assumed 60-year investment lifetime, a $10,000 initial investment earning 7 percent would grow to $579,000. But at a net return, after costs, of 5 percent, that investment would grow to just a quarter as much, $177,000, a hit of almost 70 percent! The investor puts up 100 percent of the capital. The investor takes 100 percent of the risk. But the investor earns just 31 percent of the long-term return. That is not a fair deal!

6. Marketing Strategy ∑ Mutual— Demand pull. Minimal effort; low expense commitment. ∑ Manager— Supply push. Spend aggressively to gather assets. 7. Time Horizon Strategy ∑ Mutual—Long-term, value oriented; increase intrinsic values for fund shareholders; free from Wall Street pressures. ∑ Manager—Short-term and focused on price of the manager’s stock; subject to the whims of Wall Street. How Has It All Worked Out? The mutual structure—an experiment in mutual fund governance that has now had those strategies in place for more than 38 years—has yet to be emulated or copied. Vanguard’s structure remains unique in the annals of mutual fund history. How has it all worked out? The numbers tell the story. While I have no intention to “plug” the Vanguard line-up of mutual funds before this audience, I do believe you have a right to know whether our journey, so far, has been a productive one. So, let’s look at three facts: (1) Since our humble beginning with $1.4 billion of assets, today’s assets under management is now approaching $2 trillion—a compound annual growth rate of 21 percent. (Chart 5) As you can see, that growth has been almost a straight line, virtually uninterrupted.

One is George Washington. While his religious convictions were unclear (he is said to have been a Deist), he often referred to “the almighty and merciful Sovereign of the Universe,” prayed before meals, and called Jesus “the Divine Author of our religion.” In his Farewell Address, he famously wrote, “reason and experience both forbid us to expect that national morality can prevail in exclusion of religious principle.” The other is Alexander Hamilton—my favorite among the Founding Fathers. In drafting that address for Washington, Hamilton went even further, adding, “Does it (national morality) not require the aid of a generally received and divinely authoritative Religion?,” though Washington decided against using that phrase. Hamilton was a strong Christian who attended both Presbyterian and Episcopal churches. In fact, through his proposed Christian Constitutional Society, he sought to spread the word that America’s greatness depended upon “a Constitution formed under Christianity,” and esteemed our Constitution as “a system which without the finger of God could never have been agreed upon.” In none of the great statesmen of our nation’s history is the link between Christianity and government clearer than with Abraham Lincoln.

ownership of productive facilities, on prices set in free markets, and on personal freedom, we are the most prosperous society in history, the most powerful nation on the face of the globe, and, most important of all, the highest exemplar of the values that, sooner or later, are shared by the human beings of all nations: the inalienable rights to life, liberty, and the pursuit of happiness.” Something Went Wrong But something went wrong. “By the later years of the twentieth century, our business values had eroded to a remarkable extent”—the greed, egoism, materialism and waste that seems almost endemic in today’s version of capitalism; the huge and growing disparity between the “haves” and the “have-nots” of our nation; poverty and lack of education; our misuse of the world’s natural resources; the corruption of our political system by corporate money—all are manifestations of a system gone awry. And here’s where the soul of capitalism comes in. The book reads, “The human soul, as Thomas Aquinas defined it, is the ‘form of the body, the vital power animating, pervading, and shaping an individual from the moment of conception, drawing all the energies of life into a unity.’ In our temporal world, the soul of capitalism is the vital power that has animated, pervaded, and shaped our economic system, drawing all of its energies into a unity.

The great man is he who can express the unuttered opinions of his time, direct energy along profitable channels, divine the spirit of the people, and unify action under just and stable institutions of government. Such a man was Alexander Hamilton . . . Hamilton lived in the age which not only established the independence of our country, one of the most remarkable of achievements, but also saw the adoption of the federal Constitution and provided an economic system. These gave this nation liberty, order, and prosperity. His fame rests on the deep influence which he had in producing these results. When America ceases to remember his greatness, America will be no longer great. 2 Theodore Roosevelt Even more interesting, I think, was Coolidge’s admiration for Theodore Roosevelt, perhaps surprising since in some sense, Theodore Roosevelt was Coolidge’s antithesis. Roosevelt pressed for a graduated income tax3 and a steeply graduated inheritance tax. With the passage of the sixteenth amendment to the Constitution, he got both. He broke the all-powerful business trusts that dominated America in the late 19th century. His activist, interventionist leadership of our nation also included negotiating the settlement of the Russo-Japanese war (for which he won the Nobel Peace Prize) and protecting our nation’s natural resources by placing some 230 million acres under federal jurisdiction.

quantify the relationship between enterprise and speculation in shaping stock market returns, however, it occurred to me, decades later, to do exactly that by putting numbers on Keynes’s distinction. By the late 1980s, based on my own first-hand experience and my research on the financial markets, I concluded that, consistent with what Keynes had written, the two essential sources of equity returns were: (1) investment (Keynes’ “enterprise”), and (2) speculation (the word Keynes used). I defined Investment Return as the initial dividend yield on stocks plus their subsequent annual rate of earnings growth over a decade. I defined Speculative Return as the change in the price investors are willing to pay for each dollar of earnings (essentially, the rate of return on stocks that is generated by changes in the valuation that investors place on future corporate earnings). Simply adding speculative return to investment return, I concluded, produces the Total Return generated by the stock market. For example, if stocks begin a decade with a dividend yield of 4 percent and generate subsequent earnings growth of 5 percent, their investment return would be 9 percent. If the price-earnings ratio rises from 15 times to 20 times, that 33 percent increase, spread over a decade, would translate into an additional speculative return of about 3 percent annually. Simply adding the two returns together, the total return on stocks would come to 12 percent. It’s not very complicated!

The Commodity Futures Trading Commission allowed the trading and valuation of derivatives to proceed opaquely, without transparency, without demanding the sunlight of full disclosure, and without concern for the ability of the counterparties to meet their financial obligations if their bets went sour. And let’s not forget Congress, which passed responsibility for regulation of the derivatives market to the CFTC almost as an afterthought. Congress allowed—indeed encouraged—risk-taking by our government-sponsored (now essentially government-owned) enterprises—Fannie Mae and Freddie Mac—allowing them to expand far beyond the capacity of their capital, and pushing them to lower their lending standards. Congress also gutted the Glass- Steagall Act of 1933, which had separated traditional banking and investment banking, a separation that for more than 60 years well-served our national interest. Our professional security analysts also have much to answer for, especially in their almost universal failure to recognize the huge credit risks assumed by the new breed of bankers and investment bankers who were far more interested in earnings growth for their institutions than in the sanctity of their balance sheets.AAA

He emphasised that companies must deliberately design a culture of innovation: actively seek customer feedback, celebrate diversity in the workforce, and create an environment in which workers feel safe taking risks even when they fail. Innovation, in his view, is engineered through culture rather than left to chance.

On China, Murthy was emphatic that any top-five software services firm had to operate there: it was a fast-growing ten-percent market, a sourcing base for global clients who wanted China coverage, and a talent pool whose engineering output was rising rapidly. He framed Infosys's China move as strategic necessity rather than opportunism.

Ogilvie (1951-52); Edwin Crysler, CFA (1959-60); John Neff, CFA (1971-72); Paul Mecray (1991-92); and the first Vanguard crew member to serve as your president, Walter Lenhard, CFA (2007-08). Perhaps because of my creation and leadership of Vanguard, along with my voluminous writings on finance and investing, in 1991 your Society invited me to introduce Walter L. Morgan, founder of Wellington Fund and my great mentor, when he was honored with your Lifetime Award of Distinction. Two years later, I was honored to receive that same prize from your Society. To my humble delight, your award was presented to me by the late Elliott Farr (mentioned earlier), the paradigm of the trust officer whom we would all, well, trust. Some of his words were prophetic. Referring to the “Boston situation” I described earlier, Elliott said it was “probably a serious business mistake at the time, but it ultimately engendered something much more dynamic than if the original combination had been reasonably successful. Restructuring is now a buzzword, but Vanguard’s creation and evolution represents the quintessence of dynamic restructuring before the word had any currency at all.” You were right, Elliott, and I’m honored to remind today’s analysts of the high standards you set for our profession. III. The CFA Institute2 Now, I’d like to turn to the development of the international CFA Institute itself. To do that, I’ll take you back in time in the annals of financial analysis.

decade, would translate into an additional speculative return of about 3 percent annually. Simply adding the two returns together, the total return on stocks would come to 12 percent. It’s not very complicated! This remarkably simple numeric approach of separating enterprise and speculation—i.e., investment return and speculative return—has been borne out in practice. Indeed, I have the temerity (again!) to suggest that Lord Keynes would respect this mathematical extension of his concept. Decade after decade over the past century, we can account, with remarkable precision, for the total returns actually earned by U.S. stocks. Investment Return and Speculative Return The investment return on stocks has proven to be remarkably susceptible to reasonable expectations. The initial dividend yield—a crucial (but today underrated) factor in shaping stock returns—is a known factor at the moment one invests. The steady contribution of dividend yields to investment return during each decade over the past century has always been a positive, only once outside the range of 3 percent to 5 percent. (The yield was only 1 percent when the year 2000 began, a red flag that investors should have heeded.) The long-term rate of earnings growth, on the other hand, while hardly as given to precision as the current dividend yield, is relatively stable.

$1 $10 $100 $1,000 $10,000 $100,000 1909 1919 1929 1939 1949 1959 1969 1979 1989 1999 Investment Return 9.5 % (earnings growth plus yield) Market Return 9.6 % (includes speculative return*) Annual Growth Rate *Impact of change in price-earnings ratio Investment Return Versus Market Return Growth of $1 from 1900 5. But is this speculation by mutual fund managers and by other market participants healthy for investors? For financial planners? For our financial markets? Of course not. For when we put investment return and speculative return together and look at the past century, we see that the average annual total return on stocks over that long period was 9.6 percent (Chart 5). Of this total, fully 9.5 percent represented investment return, roughly 5 percent from the initial dividend yield and 4.5 percent from earnings growth. (Dare I remind you, however, that these totals do not reflect any deduction for the croupier costs of investing, such as advisory fees and transaction costs? We’ll talk about that later on.) What I call the speculative return—the annualized impact of any increase or decrease of the price-earnings multiple—came to but 0.1 percent, borne of a period-dependent increase in the P/E ratio from 10 to 18. The message is clear: In the long run, stock returns have depended almost entirely on the reality of the relatively predictable investment returns earned by business.

unnecessary extra taxes you’re paying come directly out of our family’s total earnings and dividends. Go back to square one and do so immediately. Get rid of all your brokers. Get rid of all your money managers. Get rid of all your consultants. Then our family will again reap 100 percent of however large a pie that corporate America bakes for us, year after year.” They followed the old uncle’s wise advice, returning to their original passive but productive strategy, holding all the stocks of corporate America, and standing pat . . . and the Gotrocks Family Lived Happily Ever After. Adding a fourth law to Sir Isaac Newton’s three laws of motion, the inimitable Warren Buffett puts the moral of his story this way: “For investors as a whole, returns decrease as motion increases.” Accurate as that cryptic statement is, I would add that the parable reflects the profound conflict of interest between those who work in the investment business and those who invest in stocks and bonds. The way to wealth for those in the business is to persuade their clients, “Don’t just stand there. Do something.” But the way to wealth for their investor/ clients in the aggregate is to follow the opposite maxim: “Don’t do something. Just stand there.” For that is the only way to avoid playing the loser’s game of trying to beat the market.

its client Enron in 2002, was but one example of the consequences of this conflict-riddled relationship. Think too about the increasing dominance of “state” (publishing) over “church” (editorial) in journalism, and the scandals that reached the most respected echelons of the press— The New York Times, The Los Angeles Times, The Washington Post. A similar transition has taken place in the medical profession, where the human needs of the patient human concerns of the caregiver have been overwhelmed by the financial interests of commerce, our giant medical care complex of hospitals, insurance companies, drug manufacturers and marketers, and health maintenance organizations (HMOs). Put another way, we’ve moved from a concept that there were certain things that one simply didn’t do (the moral absolutism of a profession, I suppose) to the idea that since everyone else is doing it, I can do it, too (surely a form of the moral relativism of a business). It is said, accurately, that professionals must accomplish their good works with a commitment to use their mastery to fulfill a “mission that inspires passion, a mission that gives beyond the self . . . (even though) pursuing a noble mission is often painful.” I see no reason that such a mission couldn’t also characterize the best businesses—those that serve their clients and customers as well as our society.

Consider with me now how the erosion in the conduct and values of business has been fostered by the profound—and largely unnoticed—change in the nature of our financial markets. That change reflects two radically different views of what investing is all about, two distinct markets. One is the real market of intrinsic business value. The other is the expectations market of momentary stock prices. Enterprise vs. Speculation It’s a curious fact that I’ve been concerned about this sharp dichotomy for my entire adult life. Really! In my senior thesis at Princeton University, completed way back in 1951, I cited the words of the great British economist John Maynard Keynes, in his wonderful Chapter 13 of The General Theory. There, Keynes drew the classic distinction between enterprise (“forecasting the prospective yield of assets over their whole life”) and speculation (“forecasting the psychology of the markets”). Keynes was deeply concerned about the societal implications of the growing role of short-term speculation on stock prices. “A conventional valuation [of stocks] which is established [by] the mass psychology of a large number of ignorant individuals,” he wrote, “is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really matter much to the prospective yield, since there will be no strong roots of conviction to hold it steady. . . resulting in unreasoning waves of optimistic and pessimistic sentiment.

RIAs have always been subject to the fiduciary duty test, but applying the test to stock brokers who serve retirement plan clients raises, at least theoretically, some challenging questions for a broker: 1) Do I serve my clients who have retirement plans differently from my other investor/clients without retirement plans? How? Why? 2) When client/investors hold both, do I handle their retirement plans any differently from their regular accounts, and hold myself to a lesser standard. How? Why? As a practical matter, I can’t imagine brokers serving their non-retirement plan clients with a lower standard of duty and care than their retirement plan clients. How could they possibly defend such actions? So, I would expect the brokerage system to move quickly to the all-encompassing application of the fiduciary standard to all of their clients. But the issue would be far better resolved if the SEC took parallel action to the DOL’s, and promptly established a fiduciary standard for all intermediaries in serving all of their clients. But, believe me, the creation of a tough federal standard of fiduciary duty will not end there. It is not only financial advisers and brokers handling client accounts who must subordinate their own financial interests to those of the investors that they serve. That fiduciary standard must be applied to every person and every entity that touches Other People’s Money (OPM), applied to every dollar entrusted by investors to our nation’s financial system.

In this sense, it is no overstatement to describe the effort we must make to return the system to its proud roots with these words: the battle to restore the soul of capitalism. (One reviewer thought that the title was, well, “inflated,” but liked the book anyway.) This idealism doesn’t let up. The reader doesn’t even finish the first page of Chapter I (What Went Wrong in Corporate America?) before reading: “At the root of the problem, in the broadest sense, was a societal change aptly described by these words from the teacher Joseph Campbell: ‘In medieval times, as you approached the city, your eye was taken by the Cathedral. Today, it’s the towers of commerce. It’s business, business, business.’ We had become what Campbell called a ‘bottom-line society.’ But our society came to measure the wrong bottom line: form over substance, prestige over virtue, money over achievement, charisma over character, the ephemeral over the enduring, even mammon over God.” What went wrong this time, as International Herald Tribune columnist William Pfaff described it, was “a pathological mutation in capitalism.system—owners’

This remarkable increase in ownership has placed these managers—largely of mutual funds (holding 25 percent of all shares), pension funds (20 percent), hedge funds, and endowment funds—in a position to exercise great power and influence over corporate America. But they have failed to exercise their power. In fact, the agents of investment America have failed to honor the responsibilities that they owe to their principals—the last-line individuals who have much of their capital wealth committed to stock ownership, including mutual fund shareowners and pension beneficiaries. The record is clear that, despite their controlling position, most institutions have failed to play an active role in board structure and governance, director elections, executive compensation, stock options, proxy proposals, dividend policy, and so on. Given their forbearance as corporate citizens, these managers arguably played a major role in allowing the managers of our public corporations to exploit the advantages of their own agency, not only in executive compensation, perquisites, and mergers and acquisitions, but even in accepting the “financial engineering” that has come to permeate corporate financial statements, endorsed—at least tacitly—by their public accountants.

Despite their differing philosophies of government, Coolidge also held Roosevelt in near-reverence: “One of the great men of American history—ambassadors of Providence . . . great captains, commanders of men; statesmen, ministering to the well- being of their country, inspirers of noble action, translating high ideals into the practical affairs of life . . . In all the criticisms that his zeal for the right, whatever the consequences, brought (Roosevelt), no one ever questioned his patriotism . . . In a 2 These quotations come from a speech Coolidge delivered in Chicago, honoring Hamilton, There were some 4,000 words in his speech, so likely nearly an hour in delivery and belying the “Silent Cal” caricature. 3 Roosevelt’s ideas echoed earlier comments by Andrew Carnegie who favored a progressive inheritance tax “designed to confiscate most of a decedent’s estate, leaving only a modest inheritance to one’s heirs.”

In fact, much of today’s crisis finds its roots in the very failures of our financial sector that I described in my ancient thesis, and, most recently, in my seventh book, published last November. In Enough. True Measures of Money, Business, and Life, I warn of too much cost and not enough value; too much speculation and not enough investment; too much complexity and not enough simplicity; too much counting and not enough trust; too much salesmanship and not enough stewardship; and so on; even too many 21st century values and not enough 18th century values—those values exemplified by the great philosophers of The Age of Reason—men such as Rousseau and Hume and Burke, and Adam Smith, and Tom Paine—who in turn helped shape the minds of our Founding Fathers—especially Washington, Jefferson, Madison, Franklin, and Hamilton. And all of these men, in turn, stood on the shoulders of earlier giants such as Socrates, Plato, and Aristotle. (Some of them are likely quoted in the halls you walk here each day. Read their words! Think about them! Gain their wisdom!)

For the investor feeds at the bottom of the costly food chain of investing, paid only after all the agency costs of investing are deducted from the market’s returns.” We Are All Indexers So what’s to be done? First, we need our citizens to understand the difference between investment and speculation, and to recognize that—simply because of the costs of the financial system—long-term investors must win and short-term speculators must lose. I dare say that the optimal solution lies right before our eyes: Owning the entire stock market as our equity position, and holding it forever. Yes, I’m speaking of the stock market index fund. But please don’t think about that as a self-interested statement on my part. Think, instead of this reality: As a group, we are all indexers.

Nadar told Wharton that HCL wanted to reduce its customer count from roughly 500 to 300 over a couple of years — explicitly the opposite of growth-at-all-costs — because without deep engagement, he said, HCL would be just a 'project company' that customers could drop without noticing.

Costs Matter! 10,000 100,000 1,000,000 1 10 20 30 40 50 60 Market Return: 7% Growth Rate Less 2% in Fees: 5% Growth Rate $579,000 $177,000 $ In year 1, costs consume 30% of return After 30 Years: Costs consume 50% of return By year 60, costs consume 69% of return As investors focus on the long term, and recognize the ever more powerful role of costs, there will be an awakening. “Knowledge is power.” Note now the role of costs in the allocation of market returns between investors and service providers. After year one, costs have consumed only 30 percent of the return; at year 10, it grows to 35 percent; after 25 years, to 46 percent; it crosses 50 percent in year 30, rises to 63 percent after 50 years and to 69 percent after 60 years. To borrow a phrase first coined by Justice Brandeis almost 100 years ago—there is simply no denying the Relentless Rules of Humble Arithmetic. How Is The Fund Industry Responding To The Cost Challenge? Yet, as I look around the competitive landscape, I see the apparent denial of this obvious tautology. While I have the greatest personal respect for BlackRock chief Lawrence Fink, his firm’s dominant position in exchange traded funds (ETFs) is threatened—caught on the horns of a nasty dilemma: On the one hand, he has a fiduciary duty to the shareholders of the BlackRock, Inc. to maximize assets under management, to maximize advisory fees, and to maximize profits.

bets—sub rosa, opaque, unreported—and with no idea whether the neighbor, as it were, on the other side of the bet (the “counterparty”) has the wherewithal to make good. But there is another far more subtle force that has played a huge role in the orgy of speculation that has affected our fiscal markets. During the past half-century, the very nature of capitalism has undergone a pathological mutation. We have moved from an ownership society in which 92 percent of stocks were held by individual investors looking after their own interests and only 8 percent by financial institutions, to an agency society in which our institutions now hold 76 percent of stocks and individuals hold but 24 percent. It is these agents who have been the driving force in changing the central characteristic of market participation from long-term investment—owning businesses that earn a return on their capital, creating value by reinvesting their earnings and distributing dividends to their owners—to short-term speculation, essentially trading stocks and betting on their future prices. It is not only hedge funds that are playing this game, but most mutual funds and many giant pension plans. These institutional agents have not only abandoned their traditional investment principles, but also betrayed the interests of the principals to whom they owe a duty of trusteeship.

When Wesco paid $386 million for CORT, about 60% of the purchase price was attributable to goodwill, an intangible balance sheet asset. Wesco's consolidated balance sheet now contains about $267 million in goodwill (including $27 million from Wesco's 1996 purchase of KBS). The Financial Accounting Standards Board adopted a rule which became eÅective in 2002 that no longer requires automatic amortization of acquired goodwill. (The requirement for such amortization has been replaced by a standard that requires an annual assessment to determine whether the value of goodwill has been impaired, in which event the intangible asset would be written down or written oÅ, as appropriate.) Earnings, not reduced by goodwill amortization, that we have reported since 2002 more closely reÖect microeconomic reality as we appraise it. More details with respect to CORT are contained throughout this annual report, to which your careful attention is directed. Precision Steel Warehouse, Inc. (""Precision Steel'') The businesses of Wesco's Precision Steel subsidiary, headquartered in the outskirts of Chicago at Franklin Park, Illinois, operated at after-tax proÑts of $1.2 million in both 2006 and 2005. These Ñgures reÖect after-tax LIFO inventory accounting adjustments decreasing after-tax income by $.6 million for 2006 and $.2 million for 2005. Precision Steel's operating results for 2006 also reÖect expenses, net of insurance recoveries, of $.

Such a change belies Adam Smith’s idealism. Even before he wrote The Wealth of Nations, Smith wrote The Theory of Moral Sentiments, in which he introduced us to the Impartial Spectator. While the Invisible Hand has become part of our language, the idea of the Impartial Spectator is barely known beyond Smith’s acolytes. The Impartial Spectator is the imaginary observer who becomes the force that arouses in us principles that are both generous and noble. While Smith described him as “the man within,” who gives us our highest calling, Smith also seems to see the Impartial Spectator as the powerful voice of the society in which we exist, perhaps even as the soul, or even as the Supreme Being. Listen to Smith’s words: It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct . . . It is this impartial spectator who calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn the real littleness of ourselves. It is this impartial spectator . . . who shows us the propriety of generosity and the deformity of injustice; the propriety of reining the greatest interests of our own, or the yet greater interests of others . . .

The moral of the story, then, is that successful investing is about owning all of America’s businesses and reaping the huge rewards provided by the dividends and earnings growth of our nation’s—and, for that matter, our world’s—corporations. The higher the level of our own activity by investors, the greater the costs of financial intermediation and taxes, the smaller the net returns that our business owners as a group receive. The lower the costs that investors as a group incur, the higher rewards that they reap. So to realize the winning returns generated by businesses over the long term, the intelligent investor will minimize to the bare bones the costs of our financial system. That’s what common sense tells us, and it’s the truth. 3. The Index Fund While on first impression it might seem intimidating to own a share in all of America’s businesses and thereby capture whatever returns our stock market is generous enough to deliver, in fact it is amazingly simple. It is, of course, by investing in an index mutual fund, that fund I mentioned early in these remarks, hinted at in my senior thesis and realized by Vanguard’s creation of the first index fund in 1975.

The other is the expectations market of momentary stock prices. This distinction between the Real Market and the Expectations Market was nicely expressed by Roger Martin, dean of the Rotman School of Business at the University of Toronto. Just think about it: In the Real Market of business, real companies spend real money and hire real people and invest in real capital equipment, to make real products and provide real services. If they compete with real skill, they earn real profits, out of which they pay real dividends. But to do so demands real strategy, real determination, and real capital expenditures, to say nothing of requiring real innovation and real foresight. Loosely linked to this Real Market is the Expectations Market. Here, market prices are set, not by the realities of business that I have just described, but by the expectations of investors.defined

ratings on securitized loans in return for enormous fees—handsomely paid in return by the very issuers who demanded those ratings, which allowed what proved to be largely junk bonds to be sold in the marketplace. (Yes, it’s called “conflict of interest.”) Yes, there’s plenty of blame to go around, finally rooted in the American citizenry at large with our insatiable demand for “more” and our growing appetite for self-indulgence rather than the well-being of our system. How Can We Fix Our Broken System? So we have a real mess on our hands. How does it ever get resolved? The first thing to recognize is that it’s our mess. In the economy, it will take considerable time to unwind the huge debt overload we have taken on in our mortgages, and our consumer debt, and considerable time for our banking system to re-liquefy its tattered balance sheets. The task will hardly be made easier when our hard-pressed families save more and spend less. We are living through “the paradox of thrift,” economist John Maynard Keynes’s formulation that described savings as good and necessary for the individual, even as those same savings are counterproductive for our consumer-driven economy, crying for the long awaited upsurge in business activity. How much time will it take? I’d guess—although I have neither great insight nor economic expertise—that it might take a year and a half to two years before the recession slows and business activity turns upward.

Compounding these returns over 106 years produced accumulations that are truly staggering. (Chart 1) Each dollar initially invested in 1900 at an investment return of 9.5 percent grew by the close of 2005 to $14,808. But let’s be fair. If we compound that initial $1, not at the nominal return of 9.5 percent but at the real (after -inflation) rate of 6.5 percent, the accumulation grows to $793. But increasing real wealth nearly eight times over is not to be sneezed at. Sure, few (if any) of us have 106 years in us, but, like the Gotrocks family over the generations, the miracle of compounding returns is little short of amazing—it is perhaps the ultimate winner’s game. Of course there are bumps along the way in the investment returns earned by our business corporations. Sometimes, as in the Great Depression of the early 1930s, these bumps are large. But we get over them. So, if you stand back from the chart and squint your eyes, the trend of business fundamentals looks almost like a straight line sloping gently upward, and those periodic bumps are barely visible.

The totally unpredictable perceptions of investors, reflected in momentary stock prices and in the changing multiples that drive speculative return, essentially counted for nothing. It is economics that controls long-term equity returns; the impact of emotions, so dominant in the short-term, dissolves. As I write in my Little Book, “the stock market is a giant distraction from the business of investing.” II. Future Market Returns As we look ahead, I must mention my conviction that viewing the future through the prism of history is nowhere near as useful as the prism that takes into account the sources of stock returns. Of what use, for example, is history that reflects a dividend yield that averaged 5 percent —as in the past century—when the current dividend yield is 2.3 percent, less than half as much?be

Asked about western backlash against white-collar offshoring, Murthy's reply was blunt: people in glass houses should not throw stones. He argued Indian firms were merely executing the liberalisation and openness that Western governments had preached to India in the 1980s, and that Western corporations were becoming more, not less, competitive as a result.

During the 1920s and 1930s, there was little consideration of security analysts as a separate part of the investment business. The people performing analytical functions were known as “statisticians." One observer said “analysts were statisticians with the professional rating and financial rewards of third-class library clerks.” Slowly, however, our statisticians began to develop some of the techniques of modern security appraisal. In those days it was not a glamorous job. Analysts were considered "back-office men who were expected to keep the salesmen posted on bond ratings, earnings, and interest coverage.” They were considered overhead, quickly terminated when commissions declined. 2 Many of the comments contained in this section of my remarks are based on Nancy Regan’s superb 2012 book called The Gold Standard—A Fifty-Year History of the CFA Charter. I hope all you will give it the close attention it deserves.

” You newly- minted Williamson graduates must already understand some of these essentials of useful knowledge cited by the author: 8 How to negotiate between autonomy and authority (as one must in any workshop); how to work not against resistant forces but with them; how to complete their tasks using “minimum force;” and how to meet people and things with sympathetic imagination; and above all how to play. And so—whether in your machine shop here, or in your masonry shop or your carpentry or paint shops, or your power plant, or even in your garden—you young craftsmen have already learned so much of what is important not only in work, but in life. And as you come to yourself, you will have learned even more. 7 Richard Sennett, Yale University Press, 2008. 8 By curious coincidence, the same theme was echoed in an article in The New York Times Magazine only five days ago. (Google it!) In “The Case for Working with Your Hands,” Matthew B. Crawford makes the point that for the craftsman, “the intrinsic satisfactions of work count—not least in the exercise of your own powers of reason.”

a lifetime—a job at his side, yet another life-changing opportunity with a man who has helped shape my values all through my career. I absorbed Walter Morgan’s conservative investment philosophy with relish and conviction. It made sense, and served investors well. Wellington Fund was a conservative balanced fund, with about two-thirds of its assets invested in stocks—for growth of income and capital—and one-third in bonds—for current income and conservation of capital. Wellington was broadly diversified, operated with low expenses, and focused on the long term. It was designed for investors, and was as far from the needs of speculators as one could possibly imagine. Unlike todays fund industry—in which a large fund manager usually operates as many as 200 funds or more—the firm’s entire asset base consisted of a single mutual fund with but $150 million in assets. The “Go Go” Era In the mid-1960s, the rules of the investment game changed. Our markets began to focus on stock prices (speculation) rather than intrinsic values (investment). It was one of the sorriest eras in the history of the mutual fund industry. Balanced funds like Wellington fell out of favor—“too conservative.” The New Breed on Wall Street (the title of a book of that time) praised that lamentable “Go-Go Era,” where hot young managers with little experience but loads of confidence appeared to create box-car returns for fund investors.

Premji told the Stanford audience that real progress comes as much from changing behaviour as from inventing new products. The line reflected a management philosophy that prizes adoption and execution over invention and IP — an appropriate stance for a services-led firm whose customers' needs set the agenda.

We’ve also tried to “Engage the Spirit” of those investor/clients whom we serve and those associates/crewmembers with whom we serve. Without a spirit of mutual trust, we would be a pale shadow of who we are today. And we, too, do our best to “Make Joy Count”, the joy of a job well done, the joy of service to others before service to ourselves. So, yes, principles-based, value-based organizations—even in fields as far apart as community philanthropy and investment trusteeship— can, under the right circumstances and the right leadership, make common cause in serving our constituencies, society, and our nation. America Today Let me close with a few brief thoughts about the challenges that our nation—certainly including its philanthropies and its financial service providers—are facing today. Events around the globe—wars, terrorism, uprisings—simply add to the uncertainty about America’s future. The shaky economy, the masses of unemployed, the threats to our environment, the growing gap between rich and poor will not be resolved for a long time. And, unless we take action promptly, our burgeoning federal debt has taken us on the road that will lead to an unimaginable crisis. Our political system is stalemated, and the powerful role of money in the system would have appalled our Founding Fathers. Courage and wisdom are what we need more than ever, but those are hardly the first two words that come to mind when talking about most of our political leaders.

Given the three ingredients of (a) optimistic assumptions as to the rate of earnings growth, (b) a sufficiently long projection of this growth into the future, and (c) the miraculous workings of compound interest—lo! the security analyst is supplied with a new kind of philosopher’s stone which can produce or justify any desired valuation for a really “good stock.” Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics the more uncertain and speculative are the conclusions we draw therefrom . . . Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment . . . Have not investors and security analysts eaten of the tree of knowledge of good and evil prospects? By so doing have they not permanently expelled themselves from that Eden where promising common stocks at reasonable prices could be plucked off the bushes? This obvious reference to Original Sin reflected Graham’s deep concern about quantifying the unquantifiable (and doing so with false precision). The implications of that bite into the apple of quantitative investing were barely visible when Graham spoke in 1958.this

began to tumble (admittedly, from a highly inflated level of 1,520 on the S & P 500 Index), plummeting to 770 in October 2002, the bottom of a bear market in which fully 50 percent of the values of U.S. stocks had been erased. Five years later, in October 2007, the S&P 500 had recouped all of the lost ground (plus a tiny bit), a 110 percent gain to 1580. (A reminder: down 50 percent and up 100 percent nets out to a return, not of plus 50 percent but of zero. Do the math!) Then, stocks tumbled to below 1300, a 16 percent retreat, still short of the 20 percent dip that Wall Street defines as a “correction,” today recovered to 1354, whatever exactly that means to a long-term investor. What’s more, while during the 1950s and 1960s the daily changes in the level of stock prices typically exceeded two percent only three or four times per year, since last July alone, we’ve witnessed 19 such moves, 10 downward and 7 upward. (Almost another one today – 1.7 percent.)This kind of volatility, to state the obvious, reflects the expectations of speculations, not the real returns of business sought by investors. Of course it’s tempting for investors to think they can take advantage of these extreme fluctuations. But the evidence goes the other way: Staying the course through thick and thin has been the winning strategy. For example, since 1950, the Standard & Poor’s 500 Stock Index has risen from a level of 17 to a recent level of 1,350, a compound (price-only) annual return of 8 percent.

This remarkably simple numeric approach of separating enterprise and speculation (i.e., investment return and speculative return) has been borne out in practice. Indeed, I have the temerity (again!) to suggest that Lord Keynes would respect this mathematical extension of his concept. Over the past century-plus, for example, we can account, with remarkable precision, for the total returns actually earned by U.S. stocks.

Vanguard Asset Growth 1,000 10,000 100,000 1,000,000 10,000,000 1974 1980 1990 2000 2012 Total Assets 2012 Total Assets: $1.93T 2000 $561 Bil 1990 $55.7 Bil 1974 $1.4 Bil $ (2) Of course, we were part of a burgeoning fund industry, whose assets rose from $50 billion to $12.5 trillion, thanks largely to (a) the greatest two-decade bull market in U.S. history (1980- 2000); (b) to the development of the money market fund; and (c) the huge increase in tax- deferred investment options such as the IRA and the tax-deferred thrift plans. But Vanguard grew far faster, (Chart 6) and our market share of 6 percent of industry stock and bond fund assets—after declining slightly through the late 1980s—has grown in each of the 26 years since, to today’s 17.4 percent. As far as I can tell, the previous highs in asset share for the industry’s largest firms regularly topped out at between 10 percent and 13 percent. So we are breaking new ground on industry dominance. Market Share of Long-Term Fund Leaders 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 1974 1980 1990 2000 2012 Vanguard Long-Term Market Share Market Share of Industry Leader* MFS 10.7% American 9.5% Fidelity 9.6% Vanguard 12.0% Vanguard 17.4% American 12.8% Fidelity 13.9% Fidelity 8.9% Fidelity 8.8% *Includes only firms with two or more years of leadership. Vanguard 4.1% Vanguard 10.6%

A Broader Fiduciary Standard Ultimately, then, the fiduciary standard must also encompass the behavior of all institutional money managers responsible for investing Other People’s Money, so far a curious omission from consideration in the debate. (Financial institutions hold some 70% of all U.S. stocks.) It must also include officers, directors, trustees, employees, custodians, and even certain marketing officials of these institutions. Alas, in a curious omission from the Dodd-Frank Act, the SEC is asked to report to the Congress on the subject of fiduciary duty, but it is barred from considering institutional money managers in its study. (One wonders which industry lobbyist snuck that one in, through which member of Congress?) The role of politics and money managers in this debate suggests that the full extension of the fiduciary standard will be a long battle.

As a whole, I believe that such firms will generate sustainable growth and will—even in this rapidly changing world—survive for the longest time. Thinking of “business as a calling,” if you will, may, paradoxically, insure commercial success. Business Enterprises Now let’s turn to the current state of our business enterprises—in particular, our giant publicly-held corporations—and our giant investment institutions—now themselves largely owned by giant publicly-held financial conglomerates. Of course both represent a peculiar mix of business and profession, but they have moved a long way from the traditional values of capitalism, which includes entrepreneurship and risk-taking, raising capital, free markets and vigorous competition, and earning profits for those who put up the capital. But those values also included the fundamental principle of trusting and being trusted. In the latter part of the 20th century, however, the very structure of capitalism began to erode.owners

I propose that we undertake the “Fiduciary Duty” solution: To create, out of our disappearing ownership society and our failed agency society, a new fiduciary society. Here, our money-manager agents would be required—by federal statute—to place the interests of their principals ahead of their own interests, a consistently enforced public policy that places a clear requirement of fiduciary duty on our financial institutions to serve exclusively the interests of the owner/principals whom they are duty-bound to serve. That duty would require the long overdue return of our institutional agents to traditional standards of professional stewardship; their effective and responsible participation in the governance of our publicly-owned corporations; pressing the managers of the business corporations whose shares are held in their portfolios to govern in the interest of their owners; and assuming an ethical responsibility to serve society at large. 2 In Smith’s era, profusion was defined as “lavish or wasteful expenditures, excess amount of money, squandering, waste, etc.”

” Then, prophetically, Lord Keynes predicted that this trend would intensify as even “expert professionals, possessing judgment and knowledge beyond that of the average private investor, who, one might have supposed, would correct these vagaries . . . would be concerned, not with making superior long-term forecasts of the probable yield on an investment over its entire life, but with forecasting changes in the conventional valuation a short time ahead of the general public.” As a result, Keynes warned, the stock market would become “a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.” In my thesis, I cited those very words, and then had the temerity to disagree.mutual

Ironically, however, Lincoln never joined any church, because, as he wrote, “I have found difficulty in giving my assent, without mental reservation, to the long, complicated statements of Christian doctrine which characterize their Articles of Belief and Confessions of the Faith. When any church will inscribe over its altar, as its sole qualification for membership . . . the Saviour’s condensed statement of both Law and Gospel, ‘Thou shalt love the Lord the God with all thy heart, and with all thy soul, and with all thy mind, and thy neighbor as thyself,’ that church will I join with all my heart and all my soul.” In those words, there’s a lot of food for thought for all of us. If those words do not persuade you of Lincoln’s deep religious faith, his timeless Second Inaugural Address surely will. It’s especially worth repeating some of those words this afternoon: “Both Northerners and Southerners read the same Bible, and pray to the same God; and each invokes His aid against the other . . . but let us judge not that we be not judged.” Quoting from the book of Matthew, he adds, ‘Woe unto the world because of offences! For it must needs be that offences come; but woe to that man by whom the offence cometh!’ . . . Fondly do we hope—fervently do we pray—that this mighty scourge of war may speedily pass away.”

the net returns that investors actually earn—and too powerful, too meaningful, and far too important to ignore. 2. Focusing on providing market returns and assuming market risks (but no more) is the obvious strategy for the low-cost provider—simplicity, and delivering to clients their fair share of what ever gains, or losses, the markets deliver. (The correlations of our funds average about 96 with their best-fit targets—call it “commoditization” if you will—compared with about 87 for our peers.) Our passive funds—index funds and virtual index funds, including nearly all of our bond funds—account for about 85 percent of our asset base. 3. It’s only a matter of time until investors recognize the bite that expenses take out of fund dividend yields, especially in today’s low-yielding markets. The 2.0 percent gross yield of the average equity fund, reduced by an expense ratio that averages 1.3 percent, slashes the yield to a pathetic 0.7 percent. How long will intelligent investors allow two-thirds of their dividends to be eaten up by expenses? 4. The no-load (direct distribution) segment of the industry has yet to fully realize its marketing potential. Amazingly, load funds currently represent fully 62 percent of industry sales volume, even higher (this surprised me!) than it was way back in 1996 (57 percent). Will investors continue to invest in bond funds in which the load consumes the first two years of income? I doubt it.

The fact is that (after-tax) corporate earnings have historically grown at about 5 percent (in nominal terms), roughly the same rate as the growth of our economy. Earnings have rarely represented less than 4 percent of our annual Gross Domestic Product, nor more than 8 percent. With the exception of the depression-ridden 1930s, the contribution of earnings growth was positive in every decade, usually composing between 4 percent and 7 percent per year of total stock returns. If we can but recognize that corporate earnings have, with remarkable consistency, grown at about the rate of the GDP, we can understand that the fundamentals of our economy drive long-term stock returns. But in the short-term, it is speculative return that calls the tune. Speculative return is, well, speculative, and has alternated from positive to negative over the decades, as price-earnings multiples are highly volatile. Over history, P/Es have generally ranged from 10 times to about 25 times (although as high as 40 times a decade ago!) When P/E ratios are historically low (say, below 10 times) they have been highly likely to rise over the subsequent decade.have

$1 $10 $100 $1,000 $10,000 $100,000 Investment Return Versus Market Return Growth of $1: 1900-2012 Investment Return Market Return Annual Growth Rate 9.3% 9.5% 1900 2012 1930 1960 1990 Chart 1 Note in Chart 1 that as cumulative investment return (blue line) has marched ever onward, ever upward, it is closely shadowed by the cumulative return produced in the stock market itself (red line). When the market return gets ahead of investment return, either it comes back down or the investment return comes up. When the market return falls behind the investment return, it catches up, a reasonably predictable pattern that reflects the omnipresent rule of the stock market, reversion to the mean (RTM). From 1900 to date, the nominal annual returns were: investment return, 9.3 percent; market return, 9.5 percent. Over shorter-term periods, however, the differences can be—and often are—substantial. For example, it’s illuminating to track the sources of these differences over the past decades since the 1900s.

been historically high (say, above 20 times) they have been highly likely to decline. But in neither case is it given to us to know when the change is coming. So, certainty about the future never exists, nor are probabilities always borne out. But applying reasonable expectations to investment return and speculative return and then combining them has proved to be a sensible and effective approach to projecting the total return on stocks over the decades. The point is this: Over the very long run, it is the economics of investing—enterprise— that has determined total return. The evanescent emotions of investing—speculation—so important over the short run, have ultimately proven to be virtually meaningless. In the past century, for example, investment return accounted for fully 9 percent of the 9.5 percent annual return on U.S. stocks (an average dividend yield of 4.5 percent plus average annual earnings growth of 4.5 percent). Speculative return—the result of an inevitably period-dependent increase in the price-earnings ratio from 13 times to 21 times—accounted for only 0.5 percent of the total. Long-term ownership of American business, then, has been a winner’s game. Hyman Minsky Adds the Crucial Ingredient These simple insights based on the sources of stock market returns provides a solid framework for understanding how markets work.

But Wall Street marketers and entrepreneurs loved this new system of complex products, quantification, innovation, and unconstrained risk, ignoring its destruction of their clients’ wealth and wallowing in the wealth it generated for themselves. Revenues of our stock brokerage firms, money managers, and the other insiders soared from an estimated $60 billion in 1990 to some $600 billion in 2007. For the outsiders—the market participants as a group, who inevitably feed at the bottom of the food chain of investing—that enormous sum represents a truly staggering hit to their earlier gains in the bull market, and a slap in their face in the bear market that followed. Any confidence in Wall Street that these participants once may have had has largely vanished, just as it should have. Of course, the speculators among us, and those of us who have forgotten the distinction between investment and speculation—two groups that inevitably display a large amount of greed—must share a portion of the responsibility for the financial bubble and the ensuing crash.to

Such a fiduciary society would guarantee that those last-line owners—largely the mutual fund shareholders and pension fund beneficiaries who have committed this capital to equity ownership and whose savings are at stake—their rights as investment principals. These rights must include: (1) The right to have their money-manager/agents act solely in their behalf. The client, in short, must be king. (2) The right to rely on high professional standards and due diligence on the part of our money managers and securities analysts who appraise securities for our portfolios.3 (3) The right to demand some sort of discipline and integrity in the mutual funds and financial products that they offer. (4) The assurance that our agents will act as responsible corporate citizens, restoring to their principals the neglected rights of stock ownership, and demanding that corporate directors and managers meet the fiduciary duty that they owe to their own shareholders. (5) The establishment of advisory fee structures that meet a “reasonableness” standard based not only on rates but dollar amounts, and, importantly, their relationship to the fees and fee structures available to other clients of the manager. (6) The elimination of all conflicts of interest that could preclude the achievement of these goals. Of course it will take federal government action to foster the creation of this new fiduciary society that I envision.

If saying that I’ve been fighting this battle since I wrote that thesis in 1951 is a push (and it is!), it is clear that I’ve been at it since at least 1971 (note that earlier speech) and surely since 1974, with the formation of Vanguard as the first mutual, shareholder-owned firm, driven ahead largely by our 1975 creation of the first and ultimate fiduciary-oriented, consumer-oriented mutual fund: the index mutual fund. Our First Index Investment Trust was designed to track the S&P 500 Index. The beginning of an indexing strategy that was the logical, even obvious, result of our mutual structure. Indeed, it was our first strategic move. That index fund began with an IPO in 1976 that was, to be blunt, a flop, raising only $11 million—far less than the underwriters’ goal of $150 million. But, now known as Vanguard 500 Index Fund, its assets exceed $450 billion. With its sister index funds at Vanguard, indexing strategies now account for some $2.4 trillion of the firm’s $3.2 trillion asset base. Most of my books touch on (pound on?) the same theme: “Put the investor first.” Bogle on Mutual Funds (1993), Common Sense on Mutual Funds (1999/2009), and The Battle for the Soul of Capitalism (2005) all emphasize this message of fiduciary duty.

But because providers of financial services are largely smart, ambitious, aggressive, innovative, entrepreneurial, and, at least to some extent, greedy, it is in their own financial interest to have investors ignore that reality. Think about it: Our financial system earns most of its money by persuading investors to trade stocks or by paying money managers to do their trading for them. Thus, this system pits one investor against another, buyer vs. seller. Each time a share of stock changes hands (and today’s daily volume averages some 10 billion shares), one investor is (relatively) enriched; the investor on the other side of the trade is (relatively) impoverished. But, as noted earlier, this is no zero-sum game. The financial system—the traders, the brokers, the investment bankers, the money managers, the middlemen, “Wall Street,” as it were— takes a cut of all this frenzied activity, leaving investors as a group inevitably playing a loser’s game. As bets are exchanged back and forth, our attempts to beat the market, and the attempts of our institutional money managers to do so, then, enrich only the croupiers, a clear analogy to our racetracks, our gambling casinos, and our state lotteries. So, if we want to maximize the returns earned by our citizen/investors, we must drive the money changers—or at least most of them—out of the temples of finance. Why? Because we investors collectively own the market.

The original creation was a fund (“First Index Investment Trust,” now Vanguard 500 Index Fund) that tracked the returns of the Standard & Poor’s 500 Stock Index, whose blue-chip components represent about 80 percent of the value of the U.S. stock market. Later, we created a fund that held 100 percent of the U.S. market (Vanguard Total Stock Market Index Fund), and now also offer an index fund that holds the world’s non-U.S. stocks (Vanguard Total International Index Fund). In some combination of these last two funds, then, an investor can easily hold a pro rata share in the ownership of the world’s equity securities.2 All these index funds do is capture the returns of the stock market indexes they mirror. They deduct only trivial amounts of costs (less than 0.2 percent per year) from those gross returns. In a stock market that delivers 8 percent per year, for example, the investor would earn a return of about 7.8 percent. That 0.2 percent cost is represented by the fund’s expense ratio—the amount it costs to operate the fund. By way of contrast, the typical mutual fund has an expense ratio of about 1.4 percent. But this typical actively-managed equity fund also incurs two additional costs that the index fund does not entail.

of our businesses—those whose capital was at stake—were relegated to a secondary role in the functioning of the system. One of the major forces behind this baneful change was the disappearance of the old “ownership society” in which the shares of our corporations were held almost entirely by direct stockholders. Since 1950, direct ownership of U.S. stocks by individual investors has plummeted from 92 percent to 26 percent, while indirect ownership by institutional investors has soared from 8 percent to 74 percent. Our old ownership society is now gone, and it is not going to return. In its place we have a new “agency society” in which our financial intermediaries now hold effective control of American business. But these new agents haven’t behaved as agents should. Our corporations, our pension managers, and our mutual fund managers have too often forgotten their professional roots and focused on their businesses. Most money managers have come to focus on the folly of short-term speculation, rather than the wisdom of long-term investment. They have put their own financial interests ahead of the interests of the principals whom they are duty-bound to represent, those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. As Adam Smith wisely put it 200-plus years ago, “managers of other people’s money (rarely) watch over it with the same anxious vigilance with which . . . they watch over their own . . .

distinctly commercial age marked by a consuming desire for financial success . . . (men) sought to increase the means for the production of wealth by great combinations which in some instances partook of monopoly. The man who finally brought the businessmen of the nation to see that their course was economically unsound, and therefore to be abandoned, and who roused the American people to the assertion again of their right to control their government for the public welfare, was Theodore Roosevelt. No man had done so much to destroy an unsound economic theory and to restore its true form of representative government since the days of Abraham Lincoln. (Roosevelt) reestablished a representative government of all the people, reopened the closing doors of opportunity, reawakened the soul of his country, and reinforced the moral fiber of America.” One other piece of guidance—one largely unobserved, I think—Coolidge might help us with today is the necessity of our nation’s elected officials to bring people with brains and integrity and determination to positions of leadership. This audience is well aware of the contributions made by Andrew Mellon and Dwight Morrow during Coolidge’s presidency, and perhaps many of you recall that it was Calvin Coolidge who appointed legendary Judge Learned Hand to the U.S. Court of Appeals for the Second Circuit, where he served with distinction for 27 years. Harlan Fiske Stone may top even that distinguished list.

Looking forward in 2006, Nadar predicted that future organisations would resemble IKEA — a brand-franchise model where manufacturing, design and distribution are redistributed across countries — and framed HCL's opportunity around this redistribution of work rather than the maintenance of legacy codebases.

It took a long time to create this economic crisis, and it will take a long time to fight our way out of it. But ultimately, given reforms in our system, the resilience of our American society and our American economy will reassert itself. I should point out that while the tools we use to stimulate the economy are now being chosen by our president and our congress, these remedies are uncertain and untested. They can help us through the crisis, but what we need most of all are the clarity and consistency necessary to restore confidence. The $789 billion stimulus package that is now on the track to the President’s desk is a long way from perfect, but it is largely doing the right things—increased unemployment benefits, tax cuts for those earning less than $200,000 per year, infrastructure improvements, help to mortgage holders. Imperfect as the bill surely will be, it’s impossible to argue that the federal government should ignore this ghastly economic crisis.

(3) Remarkably, our present share seems likely not to level off, but to increase at an even more rapid rate. Since 2008, we have accounted for almost 80 percent of the industry’s total cash flows, (Chart 7) including 170 percent of equity fund flows, driven largely by the rapidly- growing acceptance of index funds and the increasingly-recognized importance of low costs, which, simply put, divert the allocation of stock market returns away from the money managers and croupiers of Wall Street, and into the pockets of the nation’s families who are investing their hard-earned dollars to secure their retirement. -329 -101 -42 -500 -400 -300 -200 -100 Index Funds Active Funds Total Equity $ Billions Vanguard Rest of the Industry Equity Fund Cash Flow—2008-2012 $ $ $ Vanguard accounts for 56% of inflows of equity index funds; only 11% of outflows of active equity outflows; and 170% of total equity fund flows. $ $ $ $ $519 $-371 $148 Yes, our mutual structure is different from yours, but we remain as one in the notion that cooperative forms of structure, finally, are so often the most effective ways of meeting the needs of our clients and customers. In the years ahead, this concept can only grow in importance.

3 million, after taxes, in connection with environmental cleanup of an industrial park where a Precision Steel subsidiary has operated alongside approximately 15 other manufacturers for many years. Had it not been for the LIFO accounting adjustments or the environmental matter, Precision Steel would have reported after-tax operating income of $2.1 million for 2006 and $1.4 million for 2005. Precision Steel's business has been subject to economic cycles. Although the Ñercely competitive, chaotic pressures aÅecting its steel service center business (which we described at length in last year's shareholders' letter) have recently abated, Precision Steel is continuing to suÅer the ongoing eÅects of a long-term reduction in demand caused by customers' (or former customers') unsuccessful competition with manufacturers outside the United States. Precision Steel's revenues increased 2.8% in 2006, approximately half of which was due to an extraordinary order of shimstock and other industrial supplies from a customer of its Precision Brand Products subsidiary. Revenues for 2005 increased by 1.4% from those of 2004. In 2006, Precision Steel's service center volume was 46 million pounds, down from 69 million pounds sold as recently as 1999. This decline in physical volume is a serious reverse, not likely to disappear in some ""bounce back'' eÅect.

What’s more, many account executives are leaving the commission-driven broker field to form their own investment adviser firms, focused on no-load funds. That trend, I believe, will continue, and even accelerate. 5. ETFs (exchange traded funds) are sort of a wild card. For most ETFs, low cost is a big selling point, but giving investors the ability to trade in a nanosecond seems even a bigger one. (Too bad, since the actual returns realized by investors in 162 of the 173 ETFs with 5-year records have fallen short of the returns of the index of their choice by an average of 30 percent—amazing!) But Vanguard’s low cost is now making a huge impact, and our share of net cash inflow this year is the largest in the field (36 percent). Whatever the future of ETFs, they seem more of an opportunity than threat to Vanguard.

in order to obtain the greatest benefit to ourselves . . . It is not the love of our neighbor, it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, the love of what is honourable and noble, the grandeur, and dignity, and superiority of our own characters. With these powerful words—and the concept of the Impartial Spectator as the voice of our society—Adam Smith—yes, Adam Smith—seems to speak directly to the positive force of traditional ethical values. Adam Smith III – Managers of Other People’s Money Perhaps the most powerful single development that fostered the change in our societal values was a pathological mutation in capitalism—from traditional owners’ capitalism, in which the rewards of investing went primarily to those who put up the capital and took the risks, to a new and virulent managers’ capitalism, where an excessive share of the rewards of capital investment went to corporate managers and financial intermediaries.capitalism,

“Yet,” Lincoln adds “as was said three thousand years ago, so still it must be said, ‘the judgments of the Lord are true and righteous altogether,’” words from Psalm 19. He closes with this familiar but utterly breath-taking coda, “With malice toward none; with charity for all; with firmness in the right, as God gives us to see the right, let us strive on to finish the work we are in; to bind up the nation’s wounds; to do all which may achieve and cherish a just and lasting peace, among ourselves, and with all nations.” Those powerful—indeed, eternal—words could easily represent a prayer for our nation on this very afternoon. A Moral Society History tells us much, then, of men and milestones. But history also illuminates where we have fallen short, where we in our society have done what we ought not to have done, and not done what we ought to have done. Gradually, over the course of the past century, I fear that our society has lost much of stern morality that characterized our early religion’s leaders and statesmen. As I wrote in my recent book—The Battle for the Soul of Capitalism—“In medieval times, when a traveler approached the city, his eye was captured by the cathedral. Today, his eye is taken by the towers of commerce. It’s business, business, business, a bottom-line society in which we measure the wrong bottom line, form over substance, prestige over virtue, money over achievement, charisma over character, the ephemeral over the enduring, even Mammon over God.

capitalism—had been based on serving the interests of the corporation’s owners, maximizing the return on the capital they had invested and the risk they had assumed. But a new system had developed—managers’ capitalism—in which, Pfaff wrote, “the corporation came to be run to profit its managers, in complicity if not conspiracy with accountants and the managers of other corporations.” Why did it happen? “Because the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.” There were two major reasons for this baneful change: First, the “ownership society”—in which the shares of our corporations were held almost entirely by direct stockholders—gradually lost its heft and its effectiveness. It is now gone, and it is not going to return. Since 1950, direct ownership of U.S. stocks by individual investors has plummeted from 92 percent to 32 percent, while indirect ownership by institutional investors has soared from 8 percent to 68 percent. Instead of the old ownership society, a new “agency society” has developed, in which financial intermediaries now control American business. Agents vs. Principals But these new agents haven’t behaved as owners should.

On the other hand, he also has a fiduciary duty to the clients of BlackRock’s mutual funds and ETFs to maximize their returns. But since BlackRock’s mutual fund business is dominated by index funds, he can enhance their performance in only one way: by reducing fees.

In the 1940s, the landscape started to change. The SEC mandated disclosure of corporate financial information and required companies to make information available publicly. Many brokerage firms expanded their research departments. In 1934, Benjamin Graham and David Dodd published Security Analysis, based on the work they were doing at Columbia University. To this very day, I keep a mint condition copy of Security Analysis on my desk. Its essential message remains relevant. More than any other single person, it was Benjamin Graham who developed the idea of the professional financial analyst as a major factor in the emerging field of money management, leading the charge from his position as president of the New York Society of Security Analysts. The Two Great Debates The first great debate concerning financial analysis took place in 1945. Benjamin Graham favored professional ratings, and Wall Street trader and NYSSA President Lucian Hooper took the other side. It was a standoff. But by 1950, the push for a certification program for the National Federation of Financial Analysts Societies began in earnest, and would play a major role in the professionalization of the asset management industry over the years.

Who could have been stupid enough to believe that this rampant short-term speculation and those box-car returns could endure over the long term? Alas, to my shame, I was. I bit, as it were, at the opportunity to recast Wellington Management Company as one of the movers and shakers of the new era. Mr. Morgan had made me the head of the firm in 1965 when I was an overly-confident 35 years of age, and we were under great competitive pressure to follow the crowd. Mr. Morgan told me to take charge and “do whatever it takes” to fix our problems.Fund’s

But if you missed the returns achieved on the 40 market days in which it had its highest percentage gains—only 40 out of 14,588 days!—the Index would be at just to 280, an annual return of just 5 percent. There is a lesson to be learned here about the impossibility of successfully jumping into and out of the market, rather than simply staying the course. How Did We Get Here? The soaring volatility in the financial markets is a product of many forces. Surprisingly enough one is the institutionalization of the stock market. The change is dramatic: Over the past half-century, individual ownership of stocks by individual investors has dropped from 92 percent of the total to 26 percent. Institutional ownership—largely by mutual funds and corporate and government pension funds—has soared from 8 percent to 74 percent—quite literally, a revolution in stock ownership that has changed the nature and structure of our financial markets.

But there is always hope that courage and wisdom will ultimately prevail. As Churchill reminded us, “Americans always do what’s right…but only after they’ve tried everything else.” Yes, in many respects, “these are the times that try men’s souls.” So, as Tom Paine demanded, we all must stand by service to our country. If we fail, as Paine said, “we have no one to blame but ourselves.” So let’s make sure that we are chasing the real rabbit of life, doing our best—in a complicated, risky, and uncertain world—to serve our nation and our fellow man. Once we do that, let’s all keep running—and running, and running, and running!—the long race of a life well lived. We have quite enough lionizing of the notion of success as popularly defined by a certain kind of material wealth, fame, and power. But we do not have nearly enough of a more elevated notion of success, defined by a more spiritual kind of wealth, fame, and power, simply summed up in one word: character.

fund industry, would “supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic [italics added], a demand that is based essentially on the [intrinsic] performance of a corporation [Keynes’ enterprise], rather than the public appraisal of the value of a share, that is, its price.” Alas, the steady sophisticated, enlightened, and analytic demand I had predicted from our expert professional investors is nowhere to be seen. Quite the contrary! Our money managers, following Oscar Wilde’s definition of the cynic, seem to know “the price of everything but the value of nothing.” Portfolio turnover of equity mutual funds, then running steadily about 15 percent, year after year—a six-year average holding period for the average stock in a fund’s portfolio—actually soared skyward. In recent years, fund turnover has averaged above 100 percent—an average holding period of less than one year. So, a half-century after I wrote those words in my thesis, I must reluctantly concede the obvious: the worldly-wise Keynes was right, and that the callously idealistic Bogle was wrong. Call the score, Keynes 1, Bogle 0. It wasn’t even a close fight! “The Job of Capitalism is Likely to be Ill-Done” During the recent era, we have paid a high price for the shift that Keynes so accurately predicted.

When he wrote his essay all those years ago, Woodrow Wilson recognized the special moment that this commencement celebration represents for you graduates: To most men, coming to oneself is a slow process of experience, a little at each stage of life. A college man feels the first shock of it at graduation, when the boy’s life has been lived out and the man’s life begins. You have measured yourself with boys . . . but what the world expects of you have yet to find out, and it works, when you discover it, a veritable revolution in your ways of thought and action, your training was not for ornament or personal gratification, but to use yourself (for the greater good) and to develop faculties worth using. The man who receives and verifies the perfect secret of right living, the secret of social and of individual well-being, has discovered not only the best and only way to serve the world, but also the one happy way to satisfy himself. Then, indeed, have you come to yourself. Surely you have come to yourself only when you have found the best that is in you, and you have satisfied your heart with the highest achievement you are fit for. It is only then that you know of what you are capable and what your heart demands . . .

What rate of future earnings growth do you expect? Your Expectations for the Coming Decade, Part One a) 4 percent or less b) 5 or 6 percent (the long term norm) c) 7 or 8 percent d) 9 percent or more 6. even more obvious if we asked the relevance of, say, an historical bond yield of 6 percent when the present yield is 4 ¾ percent.) So I urge those of you who rely on Monte Carlo simulations that rely only on historical stock returns either to exchange them for the kind of source-based analysis we’ve just gone through; or, alternatively, to calculate those Monte Carlo simulations using market returns excluding dividend yields, and then add back today’s far lower dividend yield. Relying on these unarguable sources of return, let’s now consider what returns we might expect for stocks in the coming decade, starting from this very day. Just for fun (so we can see not what I expect, but what you expect), we’ll now do a quick poll to determine your own expectations on each of the sources of stock market returns. We’ll begin with investment return. We know that today’s dividend yield on stocks is about 2.3 percent, less than one-half of the historic norm of 5 percent. What should we add in the way of potential earnings growth for our publicly-held corporations? For reference, the long-term norm has been about 4.5 percent, though in the past 25 years it’s been more than 6 percent. Let’s have a show of hands on some reasonable choices.

It is the values of these giants of Western Civilization that have inspired me—yes, as you well know, the dead teach the living*—to speak out on the ethical failings of so many of the leaders of our corporations and our money managers, our regulators and our legislators. What we refer to as Wall Street has become a casino, one in which enormous—but momentary—changes in short-term stock prices are treated as intrinsic reality, rather than ephemeral perception. Think about it. All of today’s frenetic trading simply pits one speculator against another, with the only winners being the croupiers—the traders, the brokers, the investment bankers, and the money managers who facilitate those trades. If that undeniable reality reminds you of gambling in Las Vegas, or going to the race track, or hoping to hit the jackpot in the state lottery, well, you see where I’m coming from. The stock market casino has become a giant—and costly—distraction to the serious business of investing. Greed, recklessness, and self-interest ride in the saddle of today’s capitalism, and it is high time we undertake the necessary reform, with federal laws that demand the return of fiduciary duty and stewardship to their traditional role in the trusteeship of other people’s money. That is my dream. But in this case, I confess, I’ve failed Kipling, for that dream may indeed have become my master. (I don’t apologize for that!)

new form of investment behavior had become a dominant force that continues to be a major driver of the securities speculation that has overwhelmed our financial markets. Consider with me now how the erosion in the conduct, values, and ethics of business that I have described has been fostered by the profound—and largely unnoticed—change that has taken place in the nature of our financial markets. That change reflects two radically different views of what investing is all about, two distinct markets, if you will. One is the real market of intrinsic business value. The other is the expectations market of momentary stock prices. The British economist John Maynard Keynes described this dichotomy as the distinction between enterprise (“forecasting the prospective yield of the asset over its whole life”) and speculation (“forecasting the psychology of the markets”). Just as Keynes forecast, speculation came to overwhelm enterprise, the old ownership society became today’s agency society, and the values of capitalism were seriously eroded. It is little short of amazing that long ago, these prescient warnings were issued. Justice Stone warned us in 1934. John Maynard Keynes warned us in 1937. Benjamin Graham warned us in 1958. Isn’t it high time for us to heed the warnings of those three far-sighted intellectual giants?

Murthy endorsed the then-emergent concept of the globally integrated enterprise, telling YaleGlobal that Infosys's Phase Two M3+ programme aimed to extend the global delivery model beyond software into accounting, systems integration, equity research and customer service — turning India-based execution into a cross-functional corporate utility, not just a coding shop.

But the failures of our institutional investors go beyond governance issues to the very practice of their trade. These agents have also failed to provide the “due diligence” that our citizen/investors have every reason to expect of the investment professionals to whom they have entrusted their money. How could so many highly-skilled, highly-paid securities analysts and researchers have failed to question the toxic-filled leveraged balance sheets of Citicorp and other leading banks and investment banks and, lest we forget, AIG?* The ethics-skirting sales tactics of CountryWide Financial? Even earlier, what were these professionals thinking when they ignored the shenanigans of “special purpose entities” at Enron and “cooking the books” at WorldCom? Again, going back to the stock market high reached in 2007, how many analysts questioned the typical corporate assumption that their pension plans would earn future returns of 8½ percent per year, now obviously a deeply flawed assumption that is sowing the seeds of another crisis in the financing of our private and public retirement systems. The Role of Institutional Managers But the failure of our newly-empowered agents to exercise their responsibilities to ownership is but a part of the problem we face. The field of institutional investment management—the field in which I’ve now plied my trade for almost 58 years—also played a major, if often overlooked, role.

Stock market returns sometimes get well ahead of business fundamentals (as in the late 1920s, the early 1970s, the late 1990s). But it has been only a matter of time until, as if drawn by a magnet, they soon return, although often only after falling well behind for a time (as in the mid- 1940s, the late 1970s, the 2003 market lows). In our foolish focus on the short-term stock market distractions of the moment, we, too, often overlook this long history. We ignore that when the returns on stocks depart materially from the long-term norm, it is rarely because of the economics of investing—the earnings growth and dividend yields of our corporations. Rather, the reason that annual stock returns are so volatile is largely because of the emotions of investing. We can measure these emotions by the price/earnings (P/E) ratio, which measures the number of dollars investors are willing to pay for each dollar of earnings. As investor confidence waxes and wanes, P/E multiples rise and fall. When greed holds sway, we see very high P/Es. When hope prevails, P/Es are moderate. When fear is in the saddle, P/Es are very low. Back and forth, over and over again, swings in the emotions of investors momentarily derail the long-range upward trend in the economics of investing. While the prices we pay for stocks often lose touch with the reality of corporate values, in the long run, reality rules.

in multiple ways. What is more, we not only allow but seemingly encourage the chief executive, whose real job is to build real corporate value, to bet in the expectations market, where his stock options are priced and exercised. That practice should be explicitly illegal, just as it is illegal in say, pro football (i.e., National Football League quarterbacks are not allowed to bet on the pre- game spreads). Today, stock option compensation, even in its present form, creates huge distortions in our financial system. But I don’t want to tar all business leaders with that dark brush. One exception is Bill George, former chief executive of Medtronic and one of our nation’s most respected business leaders, now teaching at Harvard. In his wonderful book, Authentic Leadership, Mr. George describes his business principles and how he implemented them. Authentic leaders genuinely desire to serve others through their leadership. They are more interested in empowering the people they lead to make a difference than they are in power, money, or prestige for themselves. They are as guided by qualities of the heart, by passion and compassion, as they are by qualities of the mind . . . Authentic leaders lead with purpose, meaning, and values. They build enduring relationships with people. They are consistent and self-disciplined. When their principles are tested, they refuse to compromise. Their authentic companies create performance. [Dare I say real performance?]

simply put, was the growth of giant business corporations—corporate America—controlled not by their own shareholders, but by the money manager agents of the ultimate owners—investment America. Two major trends set the stage for this baneful change: First, the old ownership society shrank radically in size and importance. Only a half-century ago, 92 percent of all shares of our corporations were held by direct stockholders. Today individual investors own barely 30 percent of all shares. Ownership of U.S. stocks by institutions, on the other hand, has soared more than seven times over—from 8 percent of shares all those years ago to more than 70 percent today. But in our new agency society, with financial intermediaries as a group now holding clear voting control of corporate America, our agents have failed to behave as owners. Indeed, in far too many cases, they have placed their own interests ahead of the interest of their principals—largely the 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans—a direct violation of the traditional concept of fiduciary duty. Fiduciary duty, of course imposes a high standard of morality upon those entrusted with managing the property of others. It’s not that we have not been warned about the consequences of our failure to honor the fiduciary principle that “no man can serve two masters.

In addition to the stimulus package, of course, we’re dealing with a separate financial package designed to rescue our banking system—another $1 trillion (public and private) and counting, and $1 billion of Federal loan backing. (We seem immune to shock over the nearly $3 trillion of Federal commitment out there!) Treasury secretary Geithner’s recent proposals seemed to fall on deaf ears, and the stock market—in its inevitably speculative unwisdom—immediately gave him a failing grade. But there is no miracle cure. Nonetheless, the essence of the Treasury plan is correct: we need to engage private capital as well as public capital in order to enable our banks—one by one—to clean up their balance sheets and resume normal lending practices. The secretary also promised “stress tests” designed to assess their financial health, again, bank by bank. (One might have thought this had been a long-standing practice of bank managers and bank regulators alike. But that was not the case.) And surely banks that don’t pass the test—and there may be quite a few—will have to be liquidated, with their deposits largely guaranteed under existing federal law. If the federal government pays the bank piper, of course, it has the right to call the tune. That’s the right of ownership, and it brings up the issue of nationalization our—let’s face it— already partially-nationalized system.

Nadar argued that HCL's contrarian bets — building hardware when peers fled, writing a relational database when Indian firms weren't even computerised, refusing body-shopping — came from having 'no mental baggage', a deliberate refusal to inherit the assumptions of the existing IT-services playbook.

We can never have enough character. Our society needs every one of us to be part of the mission that will place character at the top of our national agenda—and assure that every one of our citizens has all of the opportunities America has pledged to provide. We can do it, but only if we make that noble task our own.

performance returns had slipped significantly—even relative to other conservative balanced funds—and I was sure that we needed new portfolio managers. But, contrary to the lessons of investment history that I had learned at Mr. Morgan’s knee, I naively believed that we also needed to offer our own Go-Go fund, and to expand into the burgeoning business of managing money for corporate pension funds, a market then controlled by the leading New York banks. (These banks, alas, would also succumb to the “new era” illusion. That I had plenty of company in my arrogant stupidity is no excuse whatsoever.) I was eager to make my mark, and I arranged a merger with one of the hottest new firms of the era—the Boston firm of Thorndike, Doran, Paine, and Lewis. They were among the stars of the new era, stars that soon turned out to be comets and quickly burned out. But suddenly we had our Go-Go fund, our new money managers, and our entry into the field of pension management. The large, established, conservative firm combined with the young, far smaller, Go-Go upstart. To make the merger happen, I shared with them my voting control of Wellington Management Company, and we merged in 1966. “Rock, Paper, Scissors” In a sense, that unwise and counterproductive merger was a harbinger of the crazy merger boom among American corporations that took place decades later. As I would write a few years ago, the urge to merge was like the children’s game of “Rock, Paper, Scissors.

Values begin with telling the truth, internally and externally. Integrity must run deep in the fabric of an organization’s culture. It guides the everyday actions of employees and is central to its business conduct. Transparency is an integral part of integrity. The truth, both successes and failures, must be shared openly with the outside world. Authentic companies [dare I say real companies?] value the importance of stewardship to the people they serve—customers, employees, shareholders, and communities. Stock price is not the best measure [of shareholder value] because it is so heavily influenced by . . . investor expectations, market psychology, and the overall trend of the market. Sustained growth in revenues and earnings per share, cash flow, and return on investment are still the best measures of how well a company is performing. The best path to long-term growth in shareholder value comes from having a well-articulated mission that inspires employee commitment and the confidence and trust of clients. Focusing on a mission that calls on leaders of character and courage to develop commitment, confidence, and trust is simply another reflection of Adam Smith’s Impartial Spectator who, as I’ll quote at length later on, calls on each of us to be “honorable and noble, to live up to the grandeur and dignity and superiority of our own character.” No, this goal will never be totally achieved. I know that.that

But it has only been in later years that I have come to understand the extent to which speculation in the financial economy is interlinked with productivity in the business economy, and can profoundly influence changes in it. When I learned of the work of the great American economist, Hyman Minsky (1919-1996), who dedicated his late career largely to what he described as the “financial instability hypothesis”—essentially, that stability leads to instability—I knew I had found not only many important insights into how the world works, but a distant early warning of the financial storm we are now weathering. In 1974, Minsky observed the fundamental linkage between finance and economics: “The financial system swings between robustness and fragility, and these swings are an integral part of the process that generates business cycles.” According to Minsky, the prevailing financial structure is a central determinant of the behavior of the capitalist economy. Likewise, the dynamism of profit-driven motives influences economic activity within the context of a given institutional structure, a structure that is itself ever changing. Resonating to the ideas of economist Joseph A.that:

Together, these advantages seem powerful and durable, and I believe that Vanguard is on the right side of history to maintain our leadership position, to wear the crown for a long time. What we’ll need is the wisdom to stick to our founding values; to revel in our mutual structure; to avoid marketing fads; to beware of complacency; to remember where we came from, and to do nothing to violate the remarkable level of trust that our clients have placed in us. Even then, I can’t guarantee that we’ll remain the market leader over the next quarter-century, for what keeps resonating deep within my mind and spirit is that unsettling phrase: Uneasy lies the head that wears the crown. So let’s all get together 25 years from now in 2035—heck, maybe I should be more realistic and say (optimistically!) 2015—and see who is wearing the crown of leadership.

In recent years, BlackRock’s considerable success in the ETF marketplace has been increasingly threatened by competitors with far lower fee rates. A few weeks ago, Mr. Fink accepted the inevitable: slashing fees on some of BlackRocks ETFs, and offering other similar copy-cat funds at competitive costs while maintaining the present (higher) expense ratios of the originals. Forced by competition to make these decisions, Mr. Fink was not amused. According to The Wall Street Journal, he railed against competitors that “sell investment products at cost,” i.e., without profit to the manager. You can call that fee pressure, Mr. Fink said. But he also had another word for it: “stupidity.” As the creator of Vanguard’s mutual “at-cost” strategy way back in 1974, I accept the fact that, from his perspective, I’m stupid. But our tens of millions of Vanguard shareholders—now accounting for almost 20 percent of assets of all long-term mutual funds—don’t seem to feel the same way. Day after day, whether BlackRock likes it or not, investors are becoming more aware that costs matter. I call it the CMH—the Cost Matters Hypothesis—which simply reflects the obvious concept that investor returns are ultimately determined by, I emphasize again, the allocation of financial market returns between financial service providers and the investors they are duty- bound to serve. When investment costs are minimized, investors, in aggregate, maximize their returns.

In 1924, in the wake of Harding’s “Teapot Dome” scandal, Coolidge named Stone, his friend and classmate at Amherst, as attorney general. A year later, Coolidge named Stone to the U.S. Supreme Court, his only appointment during two terms as president. Stone’s judicial record was so compelling that in 1941 Franklin D. Roosevelt named him as chief justice of the United States—a rare if not unique event in which a justice named by a Republican was named chief by a Democrat (or vice versa), a stirring tribute to Coolidge’s selection of Stone based on his personal character and professional competence. Our Nation’s Financial System This reference to Justice Stone gives me an opportunity to digress for a moment, and turn to the over-reaching of our financial sector in the recent era.Law

No thoughtful person ever came to the end of their life, and had time and a little space of calm from which to look back upon it, who did not know and acknowledge that it was what you had done unselfishly and for others, and nothing else, that satisfied you in the retrospect, and made you feel that you had played as a human being. So as your lives as men begin today, I wish each of you the power, the stamina, the determination, the wisdom, the spirit of sharing and building, and the passion to leave everything that you touch—each job, each trade, each project, each system—better than you found it, the sheer pride in a job well done. And while you’re about it, try also to leave every person whose life you touch a better person. Then, you will have come to yourself. Then you will have come to yourself. More than that I cannot wish you. May God bless you all.

Isn’t it high time we stand on their shoulders and shape national policy away from the moral relativism of peer conduct and greed and short-term speculation—gambling on expectations about stock prices? Isn’t it high time to return to the moral absolutism of fiduciary duty, to return to our traditional ethic of long-term investment focused on building the intrinsic value of our corporations—prudence, due diligence, and active participation in corporate governance? So, yes, now is time for reform. Today’s agency society has ill-served the public interest. The failure of our money manager agents represents not only a failure of modern-day capitalism, but a failure of modern-day capitalists. As Lord Keynes warned us, “when enterprise becomes a mere bubble on a whirlpool of speculation, the job of capitalism will be ill-done.” That is where we are today, and the consequences have not been pretty. In all, our now-dominant money management sector has turned its focus away from the enduring nature of the intrinsic value of the goods and services created, produced, and distributed by our corporate businesses, and toward the ephemeral price of the corporation’s stock—the triumph of perception over reality.of

Above all else, it must be unmistakable that government intends, and is capable of enforcing, standards of trusteeship and fiduciary duty under which money managers operate with the sole and exclusive purpose of serving the interests of their beneficiaries. In short, allowing “no man to serve two masters.” Together, these changes will compel—and perhaps even inspire—the principals of our corporations and our money managers to improve their own ethical principles. (One more play on that important distinction!) But we also need to raise our society’s expectations that our leaders meet high standards of ethical conduct. So, in addition to Adam Smith’s almost universally- 3 Peter Fisher, widely-respected BlackRock executive and former Treasury Department official, believes we should force institutional investors to do a better job of investment research, and develop and enforce higher minimum standards of competence for security analysts.

As a group, we veered off-course almost 180 degrees from stewardship to salesmanship, in which our focus turned away from prudent management and toward product marketing. We moved from a focus on long-term investment to a focus on short- term speculation. The driving dream of our advisor/agents was to gather ever-increasing assets under management, the better to build their advisory fees and profits, even as these policies came at the direct expense of the investor/principals whom, under traditional standards of trusteeship and fiduciary duty, they were duty-bound to serve. Conflicts of interest are pervasive throughout the field of money management, albeit different in each sector. Private pension plans face one set of conflicts (i.e., minimizing plan contributions helps maximize a corporation’s earnings). Public pension plans another (i.e., political pressure to invest in pet projects of legislators). And labor union plans yet another (i.e., * I’m speaking here of the “buy-side” analysts employed directly by these managers. The conflicts of interest facing “sell-side” analysts were exposed by the investigations of New York Attorney General Spitzer in 2002-2003.

As its Professional Ethics and Standards Committee confronted this issue, the Federation did what any responsible organization does when faced with a challenge—they appointed a new committee to study the issue of professional standards, and recommend a future course of action. A. Moyer (“Abe”) Kulp, Senior Vice President of Wellington Management Company, was named to lead the committee. I was proud to be a colleague of Mr. Kulp. He was a highly respected professional and a strong believer in a certification process for security analysts. He recognized that other professions set specific standards for their members, and firmly advocated that a challenging and meaningful examination process should be instituted for security analysts. Eventually, a favorable consensus developed. The first CFA exam took place in 1963. 268 candidates were awarded CFA charters. Abe Kulp and Elliott Farr were among those who became the first CFAs in our field. (The 94 percent pass rate on that first test has been exceeded only once, as the exams got longer—and tougher.) The second great debate came in 1990. It centered on whether the profession would be better served by having a single professional organization.the

move the financial sector away from the extraordinary popular delusions of today’s crowds and the madness of today’s speculators, returning to the wisdom of long-term investing. The financial crisis, which took a decade or more to reach full fruition, has now spread into the real economy of business and commerce, of consumers and families. There is little that can be done except to work out the problems over time, and to hope that our Federal government is successful in freeing up the credit markets and relieving—at a staggering cost to taxpayers— the banks of the responsibility for their foray into speculation and their embrace of the toxic securities that now crowd their balance sheets. This economic process will take some years to restore itself. The need to restore confidence in Wall Street goes beyond the financial sector, and indeed beyond the real economy in which each of our citizens has a stake. We need to return capitalism to its traditional roots as a system focused on long-term investing, not short-term speculation. For as the great British economist John Maynard Keynes reminded us more then 70 years ago, words I cited in my Princeton University thesis in 1951, and most recently in my newest book (out in 2 weeks), Enough. The True Measures of Money, Business, and Life. “When investment becomes a mere bubble on a whirlpool of speculation, the job of capitalism will be ill done.” Especially at this dire time, that is the one thing that our nation cannot afford.

The Clash of the Cultures (2012) even has the temerity to set forth 15 objective standards by which investors can measure the extent to which their mutual funds are being operated by managers who are meeting the fiduciary standards, “The Stewardship Quotient.” The SQ, for example considers management fees and expense ratios, portfolio turnover, sales loads, longevity of portfolio managers, fund share ownership by insiders, board composition, and so on. The SQ sets a high standard, one which too many fund groups fail to meet. Adam Smith to the Fore Now think about this: it may not matter when and even if my expansive goals for the fiduciary standard are achieved. For we live in an Age of Consumerism in which consumers are empowered to demand that businesses serve their needs, and businesses that fail to satisfy those demands face a dim future. This represents the most powerful single economic force in all human history. With today’s rapidly expending availability of information, technology has radically reordered the consumer markets, and continues to do so. In finance, this new age will bring much improved disclosure, more transparency, investor education that separates fact from fiction, and raises “red flags” on key issues such as returns, risks, costs, and management quality. Today’s Age of Consumerism shows no sign of abating; more likely, it will accelerate.

they very easily give themselves a dispensation. Negligence and profusion must always prevail.” And so negligence and profusion among our corporate directors and money managers have indeed prevailed in present-day America. Business and the Media It seems to me that the media has given this sea change short shrift, perhaps because the press has a difficult time differentiating between business results and stock prices. Most businesses, truth told, change at a glacial pace. Not much happens from one day—to say nothing of one minute—to the next. So the daily grinding out of business performance as such is not very newsworthy, and provides only periodic bursts of potential interest—mergers and acquisitions, for example, and failures and bankruptcies. But the momentary movements of the stock market seem to transfix the media—fortunes made and lost, instant gratification (or catastrophe). Every change in the market—say the S&P 500—or in a stock’s price is treated like a newsworthy event—even though it is an event that simply enriches some participants, inevitably at the expense of others. (The stock market is essentially a “closed system.”)

Part of the problem is that these giant institutions, once focused on management, began to focus on marketing, in order to build their own profitability. Let’s call that: the triumph of salesmanship over stewardship. Innovation became the watchword, but it was innovation that served managers rather than investors, exemplified by “hot fund products” and complex and risky derivatives. If these institutional agents—targeting our nation’s pension managers and mutual fund managers (34 percent of U.S. stock alone!)—had continued focused solely on the interest of their principals, the consequences of that remarkable mutation could have been modest. But these agents—now largely controlled by giant U.S. and international financial conglomerates—have too often put their own interests ahead of the interests of those whom they are duty-bound to serve, those 100-million-plus fund shareholders and pension beneficiaries who inevitably feed at the bottom of the food chain of investing. This innovation contributed to the soaring cost of the investment food chain, now estimated at $560 billion per year. (Up from about $25 billion in 1990.) Why is that a problem? Because the aggregate of the manager’s fees, expenses, and profits, plus portfolio trading commissions and other costs, are deducted from whatever gross returns our financial markets are generous enough to deliver, and the investors who put up the capital get only what’s left.

So, while investors seem to intuitively accept that the past is inevitably prologue to the future, any past stock market returns that have included a high speculative stock return component are a deeply flawed guide to what lies ahead. To understand why past returns do not foretell the future, we need only heed the words of the great British economist John Maynard Keynes, written 70 years ago: “It is dangerous . . . to apply to the future inductive arguments based on past experience, unless one can distinguish the broad reasons why past experience was what it was.” But if we can distinguish the reasons the past was what it was, then, we can establish reasonable expectations about the future. Keynes helped us make this distinction by pointing out that the state of long-term expectation for stocks is a combination of enterprise (“forecasting the prospective yield of assets over their whole life”) and speculation (“forecasting the psychology of the market”). (The General Theory, Chapter 12).lifetime

While the passively-managed index fund has virtually no turnover of the stocks in its portfolio, the average equity fund buys and sells stocks at an astonishing rate, currently about 100 percent per year, adding a hidden (but nevertheless very real) further cost of about 0.5 percent to 1.0 percent per year. Further, while most index funds are available without sales loads, most mutual funds carry a front-end load of about 5 percent, adding an annual cost of another 0.5 percent to 1.0 percent per year (depending on how long the investor holds his or her shares). Total annual “all-in” cost, then: Index fund, 0.2 percent, regular equity fund roughly 2 percent to 3 percent.3 Doesn’t seem like much, does it? Well consider its impact over say, a 50-year investment lifetime. $10,000 invested at a return of 8 percent would grow to a total of $469,000. On the other hand, $13,000 invested at 5 ½ percent (8 percent less a 2 ½ percent cost) would grow to just $139,000 or less than 30 percent of the return offered by the index fund. 2 Index funds also exist for other sectors of the U.S. and global stock markets, as well as for a variety of taxable and tax-free bonds. 3 And I haven’t mentioned taxes. Index funds, which sell stocks only when they are removed from the index (a fairly rare occurrence), are highly tax-efficient. Managed equity funds, with their astonishing levels of buying and selling are highly tax-inefficient.

When we individually compete to beat our fellow market participants, we lose. But when we abandon our inevitably futile attempts to obtain an edge over other market participants and all simply hold our share of the market portfolio, we win. Corporate Citizenship In addition to its excessive costs, the speculation that permeates today’s financial system has another unfortunate consequence. Investors must care about corporate governance. Speculators do not care, and arguably—much as I hate to say it—should not care. So when our money management agents fail to exercise the rights and responsibilities of corporate ownership, in particular, by assuring that the governance of the corporations in our portfolios is focused on serving the interests of the shareholders of those corporations rather than the interests of their management. The massive substitution of agency ownership of stocks for personal ownership, then, is one of the major challenges of twenty-first-century capitalism, and it is high time for our agents to represent their principals.

Our corporations, pension managers, and mutual fund managers have too often put their own financial interests ahead of the interests of their principals, those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. As Adam Smith wisely put it 200-plus years ago, “managers of other people’s money (rarely) watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail.” And so they have, in present day America. The second reason is that our new investor/agents not only seemed to ignore the interests of their principals, but also seemed to forget their own investment principles. In the latter part of the twentieth century, the predominant focus of institutional investment strategy turned from the wisdom of long-term investing to the folly of short-term speculation. During the recent era, we entered the age of expectations investing, where growth in corporate earnings—especially earnings guidance and its subsequent achievement—became the watchword of investors, never mind that the reported earnings were too often a product of financial engineering that seemed in the interest of both corporate managers and Wall Street security analysts.

” Our so-called “bottom line society” has not proved hospitable to our religious institutions. Few of those early universities that were formed with a strong sectarian heritage remain closely linked to churches. As our older generations go to their rewards and our younger generations seem to revel more in the seen than the unseen, more in the material things of life than in the spiritual, and, yes, more in the ephemeral than the eternal, church membership is falling. Surely it is no coincidence that our ethical standards too are ebbing. These trends seem to pervade our society and particularly our business community. It is not so much that too many of our principals, our business leaders, seen less ethical, it is that our principles seem less ethical, somehow diluted. There seem to be far fewer absolute standards in the conduct of our affairs—the things that one just doesn’t do.on

As professional institutional investors moved their focus from the wisdom of long- term investment to the folly of short-term speculation, “the capital development of the country [became] a by-product of the activities of a casino.” Just as he warned, “when enterprise becomes a mere bubble on a whirlpool of speculation, the job of capitalism is likely to be ill- done.” In the recent era, its job has indeed been ill-done. The triumph of emotions over economics that has been reflected in the casino mentality of so many institutional investors has had harsh consequences. Yet when perception—the precise but momentary price of the stock— vastly departs from reality—the hard-to-measure but enduring intrinsic value of the corporation— the gap can be reconciled only in favor of reality.stock

But while the crisis was created largely by Wall Street, it is Main Street that is paying the price. And I’m sure that many of you students have a father or a mother who has been stung by the stock market crash or by the severe recession we are enduring. It won’t be easy, but I hope that they have the strength after Kipling, to “force their heart and nerve and sinew to serve their turn” until the crisis at last abates and our country again moves forward. Which we will. And when in your own lives you “watch the things you gave your life to, broken”—which will surely happen to some of you and your families—remember to “stoop and build ‘em up with worn out tools”. Wrapping Up Let me conclude with a final lesson for you, expressed in the last few lines of Kipling’s poem. Recall them with me: * The motto on Roxbury Latin’s crest is mortui vivos docent.

Nor do we expect another sharp rise in prices like the approximately 40% rise that recently occurred, holding dollar volume roughly level despite a precipitous drop in physical volume. Although Precision Steel's recent after-tax operating earnings of approximately $1 million per year may signal improvement when compared with its after-tax operating loss of $.9 million for 2003, we do not consider present operating results to be a satisfactory investment outcome. Recent earnings of Precision Steel compare unfavorably with operating earnings which averaged $2.3 million, after taxes, for the years 1998 through 2000. Because the steel warehouse business may revert to even more diÇcult conditions, more decline for Precision Steel may lie ahead.

(Chart 6) While just one of you expects that 9 percent-plus earnings growth, the clear majority expects earnings growth of 5 to 6 percent. So let’s add 5 ½ percent earnings growth rate to the divided yield of 2.3 percent. Result: your rational expectations are for an investment return on stocks of about 7.8 percent, more or less, in the coming decade.

He emphasised that to stay relevant Infosys had to become domain experts in customers' businesses rather than just write code. The strategy was to deepen market readiness — hiring accountants, equity analysts and systems engineers alongside programmers — so that Infosys spoke the client's industry language rather than only its technical dialect.

The investment return on stocks proves to be remarkably susceptible to reasonable expectations. The initial dividend yield (red)—a crucial but generally underrated factor in shaping stock returns—is a known factor, and the steady contribution of dividend yields to investment return during each decade has always been a positive, only once—in the decade of the 2000s—outside the range of 3 percent to 7 percent. The secular rate of earnings growth, (blue) on the other hand, while hardly certain, is relatively stable. There were few surprises in long-term investment returns, and even the sharp earnings drop in the Great Depression was within the 95 percent probability range. Chart 3 2% 3% 4% 5% 6% 7% 8% 9% 10% 1929 1938 1947 1956 1965 1974 1983 1992 2001 Corporate Profits as a Percentage of GDP 2011 Note that, with the exception of the depression-ridden 1930s, the contribution of earnings growth was positive in every decade, usually running between 4 percent and 7 percent per year. (During the past decade however, thanks to the near-collapse of our financial system, earnings growth was only barely positive.) Only twice (in the 1930s and in the 2000s to date) were total investment returns (top line) less than 6 percent annually, and only twice more than 12 percent. But if we recognize that corporate earnings have, with remarkable consistency, grown at about the rate of the U.S. gross domestic product, this relative consistency is hardly surprising (Chart 3).

a company’s stock than it is to build the intrinsic value of the corporation itself. And we seem to have forgotten Benjamin Graham’s implicit caution about the transience of short-term perception, compared to the durability of long-term reality: “In the short run, the stock market is a voting machine; in the long run it is a weighing machine.” The Mutual Fund Industry My strong statements regarding the failure of modern day capitalism are manifested in grossly excessive executive compensation; financial engineering; earnings “guidance,” with massive declines in valuations if it fails to be delivered; enormous, casino-like trading among institutional investors; staggering political influence, borne of huge campaign contributions; and, in the financial arena, bestowal of wealth to traders and managers that is totally disproportionate to the value they add to investors’ wealth. Indeed, the financial sector actually subtracts value from our society. Finance is what is known to economists as a “rent-seeking” enterprise, one in which our intermediaries—money managers, brokers, investment bankers—act as agents for parties on both sides of each transaction. Our intermediaries pit one party against another, so what would otherwise be a zero-sum game becomes a loser’s game, simply because of the intermediation costs extracted by the various croupiers. (Other examples of rent-seekers include casinos, the legal system, and government. Think about it!)

known Invisible Hand, we need to call on his almost universally-unknown Impartial Spectator, from Smith’s earlier Theory of Moral Sentiments. Just who is this Impartial Spectator? It is, Smith tells us, “the voice who calls to us . . . capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn the real littleness of ourselves. It is this Impartial Spectator . . . who shows us the propriety of generosity and the deformity of injustice; the propriety of resigning the greatest interests of our own, for the yet greater interests of others . . . in order to obtain the greatest benefit to ourselves. It is not the love of our neighbour, it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, the love of what is honourable and noble, the grandeur, and dignity, and superiority of our own characters.” Alan Greenspan and the Bubble It is fair to say that the failure to honor those lofty standards played an important role in creating the recent crisis.

Noting India's 40 percent illiteracy at the time, Murthy said the software industry alone could not solve national development. He framed Infosys's success as a partial answer that needed complementary investment in low-tech manufacturing and primary education — candidly acknowledging the limits of an IT-led growth narrative for a continental economy.

” Paper companies with outlandish financial prospects and inflated stock prices were able to take over rock companies which actually made products and provided necessary services. One of the worst examples was when, in 2002, the rock that was Time-Warner was covered by paper issued by AOL. The merger failed miserably. So did we. Here, Wellington was the rock and the Boston firm the paper.a

What P/E do you expect to prevail in June of 2018? Your Expectations for the Coming Decade, Part Two a) Much higher—21 times or more b) Somewhat higher—19 or 20 times c) About the same—18 times d) Somewhat lower—15 to 17 times e) Much lower—14 times or less. 7. Investment Advisor Consensus 8. Initial dividend yield: 2.3% Earnings growth: +5.5 Investment return: 7.8% Speculative return: -0.6% Total return: 7.2% Now let’s find out the impact you believe speculative return will have on that investment return. The P/E that I’ll use for today is 18 times, based on the reported earnings of the S&P 500 over the past twelve months. (I should note that the P/E would be 16 times if we use projected operating earnings, but we’ll work with the 18 number.) So question two is: (Chart 7) What P/E ratio do you expect to prevail in June 2018? While you’re a little divided here, and I see some hands voting for much higher PEs, it looks like you’ve clustered between “about the same” and “somewhat lower” valuations. If we use a central number of 17 times for the 2018 P/E, speculative return would subtract almost a percentage point from your, 7.8 percent investment return. Result: the clear consensus of you professional financial planners is that stock returns will likely average about 7.2 percent in the decade ahead. (Chart 8) According to a recent survey in Business Week, your clients happen to be more optimistic— expecting a return of 11.8 percent per year!

honors society as a whole, even as it holds as its highest priority serving the interests of the stock owners who invest and risk their own capital, we can make meaningful progress toward achieving these noble ideals for our citizens and our nation. Only if we hold high the ethical principles that must be the foundation of any business worthy of our trust, and then demand that they be honored by ethical principals who are authentic leaders, can we fully measure up to the promise of capitalism. II. Profession vs. Business My second theme focuses on the gradual but substantial mutation of our professional associations into business enterprises. This baneful trend is among the most obvious, and troubling, manifestations of the change from the stern traditional values of yore to the flexible values of our modern age—today’s “bottom line” society. Consider this sea change in values. It was a mere 45 years ago that Daedalus, the Journal of the American Academy of Arts and Sciences, proudly declared: Everywhere in American life, the professions are triumphant. But today, the contrary proposition tells the story. Driven by the pressures of new technologies and the growing importance of making money, the new reality is clear: Everywhere in American life, business standards are superseding professional standards. Let’s consider for a moment what we mean when we talk about professions and professionals.

Terry Piper, who became Precision Steel's President and Chief Executive OÇcer in 1999, has done an outstanding job in leading Precision Steel through very diÇcult years. But he has no magic wand with which to compensate for competitive losses among his best customers. Tag Ends from Savings and Loan Days All that now remains outside Wes-FIC but within Wesco as a consequence of Wesco's former involvement with Mutual Savings, Wesco's long-held savings and loan subsidiary, is a small real estate subsidiary, MS Property Company, that holds tag ends of appreciated real estate assets consisting mainly of the nine-story commercial oÇce building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which we are building a multi-story luxury condominium building. We are also seeking city approval of our plans to build another multi-story luxury condominium building on a vacant parcel of land in the next block. For more information, if you want a very-high-end condominium, simply phone Bob Sahm (626-585-6700). MS Property Company's results of operations, immaterial versus Wesco's present size, are included in the breakdown of earnings on page 1 within ""other operating earnings.'' Other Operating Earnings Other operating earnings, net of interest paid and general corporate expenses, amounted to $.2 million in 2006, versus $5.2 million in 2005. Had it not been for favorable income tax adjustments of $4.

My own view is that the government has not driven nearly a hard enough bargain with the institutions for which it has provided capital. Indeed, I suspect that, say, Dubai, would have demanded a lot more equity for a $55 billion capital infusion into Citigroup than a low-yielding preferred stock and warrants that might entitle it to own less than 1 percent of the company. (For the record, the current market value of Citigroup is about $19 billion, down from $274 billion as recently as 2006. Citi also has some $500 billion of short- and long-term debt, which simple mathematics tells us must also be, to one degree or another, on the endangered species list.) The Heart of the Matter But little attention has been given to the broader systemic issues that have contributed to this crisis. Two overarching changes in capitalism have clearly played a major role. The heart of the matter goes to the very issue of the ownership of our giant publicly-held corporations.of

If you can fill the unforgiving minute With sixty seconds’ worth of distance run, Yours is the Earth and everything that’s in it, And—which is more—you’ll be a Man, my son! Today, the Earth, as it were, needs leaders with the insight and wisdom that you have the opportunity to develop right here at your extraordinary school, and with determination and virtue that, perhaps without your even realizing it, you are already beginning to develop right here at Roxbury Latin as you grow to maturity. You can help—you must help—to make our world a better place. So do your best, every day, to develop the will which says to you, “hold on.” Hold on to your values, and live a full and active life. And do what’s right for your family, your school, your community, your nation. Although none of you is my son—and only one of you is even my grandson—let me pretend for a moment that you are all my sons. So it is that I close by taking the liberty to urge each of you to live your own life, and to give it your best shot over those many exciting decades that lie before you. Run your own distance, at your own pace, with your own values, with your own brains and your own character. Trust yourself. Trust yourself, and be worthy of the trust of others. Live a life of honor. Then, I assure you, young gentlemen of Roxbury Latin, that “yours will be the Earth, and everything that’s in it,” and, which is more, you’ll all be men, my sons.

ICFA (Institute of Chartered Financial Analysts) and the FAF (Financial Analysts Federation, including the regional societies) had overlapping constituencies. But in form, function, and culture, they were very different. The ICFA, focused solely on the CFA program, was robust, growing, and fiscally sound. The FAF had grown significantly since its origins and had a broader mandate, but was struggling financially. Mergers are Never Easy! The debate over the merger continued for two years. It was at times heated and not always pleasant. In 1992, the final meeting regarding the merger was described as “contentious,” “frank,” “eloquent,” “fierce,” and “tense.” It also involved some old-fashioned, back-room “horse trading” for votes. At last, the initial deadlock was broken; the final vote 6 to 4 in favor of the merger—in my terms, a “landslide.” That’s a word I kept in mind during the various contentious board decisions that we faced in the creation of Vanguard, often a messier process than you could possibly imagine. But any victory, however narrow, was (for me) a landslide. The process of creating Vanguard and the CFA merger have many similarities. Both remind me of the song “Bui Doi” from the musical Miss Saigon, which describes the children of American soldiers born in Vietnam as "conceived in Hell and born in strife.” After our respective births, however, both the CFA merger and Vanguard’s creation proved to be remarkably durable. (Elliot Farr was right.)

Financial markets will not only respond to profit-driven demands of business leaders and individual investors, but also as a result of the profit-seeking entrepreneurialism of financial firms. Nowhere are evolution, change, and Schumpeterian entrepreneurship more evident than in banking and finance, and nowhere is the drive for profits more clearly the factor making for change. In Minsky’s theory, “the financial system takes on special significance not only because finance exerts a powerful influence on business activity, but also because this system is particularly prone to innovation, “as would become abundantly evident during our recent era . . . Since finance and industrial development are in a symbiotic relationship, financial evolution plays a crucial role in the dynamic patterns of the economy.” Minsky placed a heavy focus on a firm’s financial structure, under which, in return for debt capital, the firm contracts for a schedule of repayments to its lenders. He defined three ways in which a given firm (or government) can use its assets to fund its liabilities: (1) Hedge financing, in which the prospective cash flows are sufficient to cover both interest payments and amortization of debt. (2) Speculative financing, in which cash flows are sufficient to pay the interest, but insufficient to pay the principal amounts as they fall due. (3) Ponzi financing, in which cash flows from operations are insufficient to meet interest payments.

and meet the demands of the expectations market. But the job of building intrinsic value in the real business market over the long term is a tough, demanding task, accomplished only by the superior corporation. This focus on stock prices and speculation holds dire consequences for our society (but not, of course, for our stock brokers, investment bankers, and money managers), even as any economically-strong society depends on the continuing creation of intrinsic value in our corporate world. I raised this same issue rather more tartly in a speech I gave at Princeton University’s Center for Economic Policy Studies in 2002, the core ideas of which in turn found their way to a prominent role in my Battle book. The theme of that speech—entitled “Don’t Count On It. The Perils of Numeracy”—was that “in our society, in economics, and in finance, we place too much trust in numbers. But numbers are not reality. At best, they’re a pale reflection of reality. At worst, they’re a gross distortion of the truths we seek to measure . . . (Yet) we worship hard numbers and accept the momentary precision of stock prices rather than the eternal vagueness of intrinsic corporate value as the talisman of investment reality.” The Real Market and the Expectations Market Perhaps this distinction between the Real Market and the Expectations Market was best expressed by Roger Martin, dean of the Rotman School of Business at the University of Toronto.

relative standards—“Everyone else is doing it, so I can do it, too”—a concept that would have appalled the Reverends Makemie, Edwards, and Witherspoon, as well as our founding fathers. Such a formula for the perpetuation of selfish behavior is light-years away from the Ten Commandments and the Sermon on the Mount, both of which—I’m guessing here—would have appealed to the great Lincoln. So I reach back in history to another great figure, one that I imagine will surprise you. Yet he shouldn’t. For this great Scot, like the Presbyterian Church, was a product of—and a contributor to—that Great Awakening of the early 18 th Century which was taking place abroad— notably in Scotland, England, and Germany—as well as in the colonies. While Adam Smith is best known for his treatise, The Wealth of Nations, published, as it happens on July 4, 1776—now there’s a coincidence!—where he set down the concept of the invisible hand. Here’s the context: “In the uniform and uninterrupted effort to better (man’s) condition, the principle from which (both) public and private opulence is originally derived, is powerful enough to maintain progress. Each individual neither intends to promote the public interest, nor knows how much he is promoting it . . . (but) by directing his industry in such a manner as to its produce may be of the greatest value, he is led by an invisible hand to promote an end which was no part of his intention.

Only a few weeks ago, the impact of costs was also recognized by two high-cost providers of Target Date Funds. After a failed foray into the TDF sector, both Goldman Sachs and Oppenheimer threw in the towel. After it became apparent that investors had no interest in buying, holding, or trading their Target Date Funds, they shut them down. In their few years of operation, Goldman had attracted only $55 million in assets; Oppenheimer, only about $500 million. The fact is that when competitive TDFs are available at as little as 0.18 percent, no sensible investor or trader would buy a TDF with an expense ratio of 1.22 percent per year (Goldman) or 1.52 percent (Oppenheimer). Of course, their fund performance was dragged down by these debilitating costs, with five-year annual returns averaging a loss of -2.0 percent, a shortfall of fully 3.averaging

When long-term owners of stocks become short-term renters of stocks, and when the momentary precision of the price of the stock takes precedence over the eternal vagueness of the intrinsic value of the corporation, concern about corporate governance is the first casualty. The single most important job of the corporate director is to assure that management is creating value for shareholders; yet investors seemed not to care. If the owners of corporate America don’t give a damn about corporate governance, I ask you, who on earth should? And so in corporate America we have the staggering increases in executive compensation, unjustified by corporate performance and grotesquely disproportionate to the pathetically small increase in real (inflation-adjusted) compensation of the average worker; financial engineering that dishonors the idea of financial statement integrity, and the failure of the traditional gatekeepers we rely on to oversee corporate management—our auditors, our regulators, our legislators, our directors. In investment America, control has devolved to a new class of institutional owners. The 25 largest institutional investors alone hold nearly 40 percent of all stocks, yet all we hear from these agent-owners on corporate malfeasance is the sound of silence.

But the failure of our professional institutional money managers to act as responsible corporate citizens is only part of their contribution to the present crisis. Another factor is at least as critical: their apparent failure to do their job as professional investors, thoroughly evaluating, analyzing, and appraising the financial positions—the balance sheets and the income statements—the managements, and the strategies of the corporations they cover. How on earth did our smart, well-educated, seasoned analysts miss what was going on at Bear Sterns, at Lehman, at Citicorp, at AIG, and (in an earlier cycle) at WorldCom and at Enron? If our investment professionals, responsible for the prudent investing of other peoples’ money, didn’t undertake adequate research of those corporations, shame on them. And if the information they needed and demanded was not provided, and they still held the stocks, shame on them for that. Let me summarize the major issues I’ve presented. (1) Our old ownership society has pretty much vanished and will never return. (2) The agency society that has largely replaced it has failed to honor first and above all the interests of its principals—largely mutual fund shareholders and pension beneficiaries. (3) Our financial sector has abandoned its traditional investment principles; moving from long-term investment to short-term speculation.

Review, written in 1934 in the aftermath of the Great Depression. See if you don’t agree that it was eerily prescient in describing a major force in creating the economic problems we are facing today. . . . When the history of the financial era which has just drawn to a close comes to be written, most of its mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that ‘a man cannot serve two masters,’ . . . The separation of ownership from management, the development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to that principle . . . Yet those who serve nominally as trustees, but relieved, by clever legal devices, from the obligation to protect those whose interests they purport to represent, corporate officers and directors who award to themselves huge bonuses from corporate funds without the assent or even the knowledge of their stockholders . . . financial institutions which, in the infinite variety of their operations, consider only last, if at all, the interests of those whose funds they command, suggest how far we have ignored the necessary implications of that principle. The loss and suffering inflicted on individuals, the harm done to a social order founded upon business and dependent upon its integrity, are incalculable.

” Indeed, it was way back in 1934—75 years ago—in the aftermath of the Great Crash in the stock market that Supreme Court Justice Harlan Fiske Stone warned: The separation of ownership from management, the development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to [the] principle [that “no man can serve two masters] if the modern world of business is to perform its proper function. Yet those who serve nominally as trustees, but [are] relieved, by clever legal devices, from the obligation to protect those whose interests they purport to represent; corporate officers and directors who award to themselves huge bonuses from corporate funds without the assent or even the knowledge of their stockholders; [and] financial institutions which, in the infinite variety of their operations, consider only last, if at all, the interests of those who funds they command, suggest how far we have ignored the necessary implications of that principle. The loss and suffering inflicted on individuals, the harm done to a social order founded upon business and dependent upon its integrity, are incalculable.

We could hardly expect even a man with the wisdom, intelligence, logic and clear vision of Adam Smith to have anticipated in detail the various streams—really rivers—of commerce of today’s business and technological environment. But his overarching vision was surely a harbinger of this Age of the Consumer. As Adam Smith wrote in 1776: Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident, that it would be absurd to attempt to prove it . . . [T]he interest of the consumer . . . [must be] the ultimate end and object of all industry and commence. Applying Smith’s insight to the investment industry, I firmly believe Smith would endorse not only the power of the consumer, but it’s implications for the principle of fiduciary duty. Paraphrasing that final sentence: The interest of the investor must be the ultimate end and object of the entire financial system. Whatever fabric the pattern of these threads of history ultimately weaves, many of you in this audience today can take pride in being, dare I say, in the vanguard of this movement. Today begins “The Campaign for Investors” of the Institute for the Fiduciary Standard. It will lead to greater financial freedom for America’s citizen/investors, and will serve, in the words of the Investment Company Act of 1940, “the national public interest” as well.

So it is that through the deduction of a “mere” 2.5 percent in annual costs, the miracle of compounding returns is overwhelmed by the tyranny of compounding costs. For in the investment field, time doesn’t heal all wounds. It makes them worse. Where returns are concerned, time is your friend. But where costs are concerned, time is your enemy. The investor in this example, who put up 100 percent of the capital and assumed 100 percent of the risk, earned less than 30 percent of the market return. Our system of financial intermediation, which put up zero percent of the capital and assumed zero percent of the risk, essentially confiscated 70 percent of that return—surely the lion’s share. An investment in a low-cost index fund, held for the long term, eliminates all of the terribly harmful costs of financial intermediation, and thus guarantees that you’ll earn your fair share of whatever returns our stock market offers. If it sounds like I’m pushing Vanguard’s index funds on you, well, there’s something to that. But only because soundly-operated index funds are the ideal way to invest for the long- term, by reason of their rock-bottom costs and long record of tracking their respective indexes with a remarkable precision. But don’t take my word for it. The index fund has received incredibly strong endorsements from the most respected financial experts in the nation.

career that followed) on the mutual fund industry. It was entitled, “The Economic Role of the Investment Company.” This dual nature of returns is reflected when we look at stock market returns over the decades. Using Keynes’s idea, I divide stock market returns into two parts: (1) Investment Return (enterprise), consisting of the initial dividend yield on stocks plus their subsequent earnings growth, which together form the essence of what we call “intrinsic value”; and (2) Speculative Return, the impact of changing price/earnings multiples on stock prices. Let’s begin with investment returns on the average annual investment return on stocks over the decades since 1900. (Chart 2a) Note first the steady contribution of dividend yields to total return during each decade; always positive, only once outside the range of 3 percent to 7 percent, and averaging 4.5 percent. Then note that the contribution of earnings growth to investment return, with the exception of the depression-ridden 1930s, was positive in every decade, usually running between 4 percent and 7 percent, and averaging 5 percent per year. Result: Total investment returns (the top line, combining dividend yield and earnings growth) were negative in only a single decade (again, in the 1930s). These total investment returns—the gains made by business—were remarkably steady, generally running in the range of 8 percent to 13 percent each year, and averaging 9.5 percent. Enter speculative return.

On average, after-tax corporate profits have represented about 6 percent of GDP, and have but rarely moved outside of the range of 4 to 8 percent. (Is last year’s 9 ½ percent level—an all time high—a warning sign? We shall see. Non-U.S. profits? A weak dollar? Low interest costs? Accounting chicanery?)

pressure to employ money managers who are willing to “pay to play”). But it is in the mutual fund industry where the conflict between fiduciary duty to fund shareholder/clients often directly conflicts with the business interests of the fund manager. Perhaps we shouldn’t be surprised that our money managers act first in their own behalf. Indeed, as Vice Chancellor Leo E. Strine, Jr., of the Delaware Court of Chancery has observed, “It would be passing strange if . . . professional money managers would, as a class, be less likely to exploit their agency than the managers of the corporations that make products and deliver services.” In the fund industry—by far the largest of all financial intermediaries—that failure to serve the interests of fund shareholders has wide ramifications. Ironically, the failure has occurred despite the clear language of the Investment Company Act of 1940 that demands that, “mutual funds should be managed and operated in the best interests of their shareholders, rather than in the interests of (their) advisers.”** Here, in summary form, are just a few examples of how far so many fund managers have departed from that basic fiduciary principle, clearly enunciated in the 1940 Act: 1. The domination of fund boards by chairmen and chief executives who also serve as senior executives of the management company that controls the funds. 2.

If the market’s annual return proves to be 7 percent over the coming decade, and if the costs of investing are 2 ½ percent (as in mutual funds), these investors as a group will earn 4 ½ percent. Gross return, minus cost, equals net return. What I call (after Brandeis), “the relentless rules of humble arithmetic.” ( If we adjust for 2 ½ percent inflation, that nominal return would be only 2 percent per year. (Leave out taxes which cost investors in active funds another 1 percent per year) And to make matters worse, precisely the opposite of what I predicted in my thesis has happened. Money managers have largely failed to supply the stock market with demand that is (as I said earlier) “steady, sophisticated, enlightened and analytic . . . focused on corporate performance rather than share prices.” In fact, our money managers have done precisely the reverse. I would argue, then, that our now-dominant institutional agents have not only failed to honor the interest of their shareholders/beneficiary principals, but they have also abandoned the time-honored investment principles that focused on the wisdom of prudent long-term investment, and turned instead to an excessive focus on short-term speculation.

For long-term investors as a group, owning businesses is a winner’s game. After all, businesses earn a return on their capital, and they pay dividends, and they grow with our economy. Trading stocks with other investors, on the other hand, is inevitably, a zero-sum game—Peter’s gain is Paul’s loss. But only before costs. After the huge costs paid to the croupiers of Wall Street day after day—hundreds of billions of dollars each year—on all that frenetic activity that we read about as billions of shares of stock change hands day after day, that zero-sum game of beating the market is converted—magically, but mathematically—into a loser’s game. The minute by minute fluctuations of the market, using Shakespeare’s metaphor, are truth told “a tale told by an idiot, full of sound and fury, signifying nothing.” (You’ll know that’s Macbeth, Act V.) Even as the media covers this sound and fury if it were of surpassing importance, financial journalists ignore the fact that essentially 100 percent of the long-term return on stocks is based on the profitability of our corporate businesses. Short-term speculation does little to enhance or diminish that return. (The stock market’s long-term nominal annual return of about 9 ½ percent, for example, was produced almost entirely by dividend yields averaging 4 ½ percent and annual earnings growth averaging 5 percent.)

I know something about how the financial system works, for I’ve been part of it for my entire 58-year career. The mutual fund industry is the paradigm of what’s gone wrong with capitalism. Here are just a few examples of how far so many fund managers have departed from the basic fiduciary principle that “no man can serve two masters,” despite the fact that the 1940 Act demands that the principal master must be the mutual fund shareholder: 1. The domination of fund boards by chairmen and chief executives who also serve as senior executives of the management companies that control the funds, an obvious conflict of interest and an abrogation of the fiduciary standard. 2.financial

(Chart 2b) Compared with the relative consistency of dividends and earnings growth over the decades, truly wild variations in speculative return punctuate the chart as price/earnings ratios (P/Es) wax and wane. A 100 percent rise in the P/E, from 10 to 20 times over a decade, would equate to a 7.2 percent annual speculative return. Curiously, without exception, every decade of significantly negative speculative return was immediately followed by a decade in which it turned positive by a correlative amount—the quiet 1910s and then the roaring 1920s, the dispiriting 1940s and then the booming 1950s, the discouraging 1970s and then the soaring 1980s—reversion to the mean (RTM) writ large. Then, amazingly, there is an unprecedented second consecutive exuberant increase in speculative return in the 1990s, a pattern never before in evidence. By the close of 1999, the P/E ratio had risen to an unprecedented level of 32 times, setting the stage for the return to sanity in valuations that soon followed.stock

The new analysts’ organization was called the Association for Investment Management and Research (AIMR), a somewhat awkward formulation that was later superseded by the organization’s current name, the CFA Institute. (My friend Ted Aronson, the last person to hold the title of President of AIMR in 2003-04, led the charge to get that wise change approved.) And that's where we are today. The CFA Institute has proved to be a huge step forward in the professionalization of the industry, thanks to its leadership, beginning with is first president Eugene Vaughan, who each year at Christmastime sent his many friends in the industry good wishes and inspirational quotations from poets and philosophers. Gene was later succeeded by Darwin Bayston, who often expressed his high opinion of my essays in the Financial Analysts Journal (now eight in number, including one soon to be published). In the early 1990s, he was asked by a Dow-Jones-Irwin editor, “who could pen a ‘home run’ book about mutual funds?”

The obvious options for such a firm or government are either to increase its indebtedness, or to default. These definitions, which Minsky set forth in 1994, represent an almost prescient warning about the failures of our flawed financial system that would be so harmful during the recent era. They also stand as a warning of the fragile financial underpinning of our federal government (and many state and local governments, too) today. Minsky recognized the obvious perils of securitization. “(Financial innovators and marketers) did not hazard any of their wealth on the longer term viability of underlying packages of mortgages. Obviously, in such packaged financing the selection and supervisory functions of lenders and underwriters are not as well done as they might be when the fortunes of the originators (remain at risk) over the longer term.earn

Speculative return is, well, speculative (shown in green in Chart 2). It has alternated from positive to negative over the decades. But note that every decade of significant negative speculative return has been followed by a decade of positive speculative return—the terrible 1910s, then the booming 1920s; the awful 1940s, then the great 1950s; the nasty 1970s, then the booming 1980s and 1990s—an unprecedented double decade of large speculative returns. But over the full century, speculative return had virtually no influence on the general level of stock returns, contributing only 0.2 percent to the 9.5 percent total investment return (shown in orange in Chart 2). The point is this: Over the very long run, it is the economics of investing—enterprise—that has determined total return; the evanescent emotions of investing—speculation—so important over the short run, have ultimately proven to be virtually meaningless. As we show, in the past eleven decades, the 9.5 percent average annual return on U.S. stocks has been composed of 9.3 percentage points of investment return (an average dividend yield of 4.5 percent plus average annual earnings growth of 4.8 percent), and only 0.2 percent of speculative return, borne likely of an inevitably period-dependent increase in the price-earnings ratio during this long period. Over the long term, ownership of American business has been a winner’s game. III.

innovation and experimentation. To the extent that mangers sit unchecked in the driver’s seat, feathering their own nests at the expense of their owners, capitalism cannot flourish. During the past half-century, the very nature of capitalism has undergone a pathological mutation. We have moved from an ownership society in which 92 percent of stocks were held by individual investors looking after their own interests and only 8 percent by financial institutions, to an agency society in which our institutions now hold 75 percent of stocks and individuals hold but 25 percent. These institutional agents have not only betrayed the interests of the principals to whom they owe a duty of trusteeship, but have also abandoned their traditional investment principles. For it is these agents who have been the driving force in changing the central characteristic of market participation from long-term investment—owning businesses that earn a return on their capital, creating value by reinvesting their earnings and distributing dividends to their owners—to short-term speculation, essentially trading stocks and betting on their future prices. It is not only hedge funds that are playing this game, but most mutual funds and many giant pension plans. Today, we are witnessing an orgy of speculation the likes of which have never been seen before. Turnover in the U.S.

Chanda observed that Murthy's personal net worth by 2006 was roughly equal to India's entire 1991 foreign reserve figure of 1.2 billion dollars — a striking symmetry that framed both how far Infosys had climbed and how constrained the country itself had been at the moment of liberalisation.

gains of +1.3 percent annually—a cumulative shortfall of 20 percentage points in just five-years for the investors in the high-cost TDFs. As in BlackRock’s case, I recognize that Goldman is merely trying to earn the highest possible returns for the firm’s public stockholders and partners; and Oppenheimer to increase the returns to (ironically) the mutual life insurance company that bought the firm in order to generate additional profitability. But the message here is clear: If mutual fund owners are not earning their fair share of market returns, their management companies will have a struggle—ultimately a losing struggle—in the competition for investor favor. Income Matters! Let me turn to my final subject: the importance of investment income, and how the dividend income of a mutual fund is shaped by its cost structure. Today, interest rates on bonds are at an all-time low (1.6 percent on the benchmark 10-year U.S. Treasury note). Dividend yields on stocks—currently about 2.1 percent—are less than half of the long-term historical norm of 4 ½ percent. (Chart 3) This steep decline in bond yields as well as stock yields has profound implications for future returns on financial assets. Lesson number one, surely, is that whatever the long-term returns on bonds and stocks have been, they are irrelevant. What will drive stock and bond returns in the coming decade is today’s yield.

bracing snap that culminated in a 50 percent bear market decline. But although my new partners were the money managers who failed our shareholders, I was the chief executive of the firm. In January 1974, my new partners banded together, fired me, and took over Wellington Management Company. While that struck me then (as it does now) as political, capricious, and grossly unfair, I have to acknowledge that, in doing the merger, I had made a truly disgraceful decision, and I had paid a terrible price in return. But isn’t that the essence of fairness? Enter Vanguard The story of how Vanguard was born, phoenix-like, out of this cataclysm is too complicated to describe tonight. (You’ll find it all in The Clash of the Cultures.) All you really need to know is that I don’t take defeat easily. I quickly fought back with a passion, and took a new and untried approach to mutual fund management that had never existed before. Whether by accident or design, the values of the new firm I created were virtually identical to the values I had expressed in that Princeton thesis of 23 years earlier. (Continuing—if not pushing—my earlier analogy, Vanguard became the scissors that cut the Boston paper that had covered the Wellington rock.) Running funds for the exclusive benefit of shareholders would eliminate the inherent conflict of interest that prevails between principals and agents, between fund shareholders and fund management companies.

The mutual fund “time zone trading” scandals that came to light in 2003, in which some 23 companies—including many of the largest firms in the field—were implicated. 3. “Pay-to-play” distribution agreements using fund brokerage commissions (“soft dollars”) to finance share distribution that benefits the adviser. 4. As fund assets soared during the 1980s and 1990s, fund fees grew even faster, reflecting higher fee rates, as well as the failure of managers to adequately share the enormous economies of scale with fund shareholders. 5. Rising expense ratios for established funds; the average ratio of the seven largest funds of 1960 rose from 0.48 percent to 1.02 percent in 2003, an increase of 144 percent. 6. Managing assets for giant pension funds for fees that are dwarfed by those that they charge the mutual funds that they control. Three of the largest advisers, for example, ** Securities and Exchange Commission decision, March 15, 1981. ***2002 data: page 199, The Battle for the Soul of Capitalism, by John C. Bogle, Yale University Press, 2005.

Jack Bogle’s Stock Market Expectations 9. Initial dividend yield: 2.3% Earnings growth: +6.0 Investment return: 8.3% Speculative return: -1.2% Total return: 7.1% Indeed my own expectations are for earnings growth of about 6 percent, bringing investment return to about 8.3 percent. I believe that 16 times is a reasonable expectation for the P/E a decade hence, resulting in a speculative return of more than -1 percent. Result: total return of 7.1 percent. (Chart 9) So, for the sake of simplicity, let’s agree on a compromise figure of 7 percent per year as the most likely return on stocks over the coming decade. A return of 7 percent per year on U.S. stocks is well below the historical norm of 9.6 percent. But that shouldn’t be surprising. After all, the current dividend yield of 2.3 percent is more than three full percentage points less than the long-term norm of 5 percent—a dead-weight drag on the future investment returns that stocks can generate, and the P/E today is well above the long term norm of 15 times. Our rational, and mutual, expectations simply reflect that change in the simple realities of investing. Of course each of you has the right to disagree with these estimates, and with me. So make your own individual forecast: Just add your own earnings growth estimate to today’s 2.3 percent dividend yield, and calculate the investment return. Then calculate the speculative return by taking a guess at the prevailing P/E multiple ten years hence.

Indeed, one Vanguard shareholder described it as “a crisis of ethic proportions” (a nice variation on the standard “epic” proportions), the title that I used for my op- ed essay published in The Wall Street Journal a week ago. For the decline in ethical values played a major role in the failure of managerial capitalism and—managerial capitalists—that led to the financial bubble, and the burst that inevitably followed. While former Federal Reserve Chairman Alan Greenspan believed that competition and free markets would reward trust and integrity, he seemed unmindful of this sea-change in capitalism that was occurring. To his credit, Greenspan admitted his mistake. In his testimony before Congress last October, he acknowledged that the crisis had been prompted by “ . . . the collapse of a whole intellectual edifice . . . Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity—myself especially—are in a state of shocked disbelief,” he said. This failure of self-interest to provide self-regulation was, he added, “a flaw in the model that I perceived as the critical functioning structure that defines how the world works.”

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!

The Daedalus article defined a profession as having these commonplace characteristics: 1. A commitment to the interest of clients in particular, and the welfare of society in general. 2. A body of theory or special knowledge, requiring a specialized set of skills, practices, and performances unique to the profession. 3. The capacity to render judgments with integrity under conditions of ethical uncertainty, overseen by a professional community responsible for the monitoring of quality in both practice and professional education. The article then added these wonderful words: “The primary feature of any profession [is] to serve responsibly, selflessly, and wisely . . . and to establish [an] inherently ethical relationship between the professional and the general society.”

9 million recorded in 2005, other operating earnings would have been $.3 million in 2005. The sources of the $.2 million of other operating earnings in 2006 were (1) rents ($3.7 million gross in 2006) principally from Wesco's Pasadena oÇce property (leased almost entirely to outsiders, including Citibank as the ground Öoor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) general corporate expenses plus minor expenses involving tag-end real estate. Realized Investment Gains There were no realized investment gains in 2006. Wesco's 2005 earnings contained investment gains of $216.6 million, after income taxes. Only $.5 million was realized through the sale of investments; the balance, $216.1 million, resulted from the tax-free exchange of common shares of The Gillette Company (""Gillette'') owned by Wesco, for common shares of The Procter & Gamble Company (""PG'') in the fourth quarter of 2005 in connection with the merger of Gillette with PG. Accounting standards promulgated by the Financial Accounting Standards Board require that the fair (market) value of shares received in such an exchange be recorded as the new cost basis as of the date of the exchange, with the diÅerence between the new basis and the historical cost realized in the audited Ñnancial statements as an investment gain.

The Recent Turbulence To be sure, financial institutions have held the majority of all U.S. equities—and, arguably, been in a position to control corporate America—since 1980, and their focus on short- term expectations has been in place even longer. So what is it that accounts for the recent surge of market turbulence? To begin with, in this new environment, the raison d’être for money managers, and basis by which they are held accountable, became the maximization of the value of the investments made by their clients, measured over periods as short as years or even quarters. Even as institutional managers turned increasingly to speculation (versus investment, just as Keynes had predicted), corporate executives became increasingly attuned to short-term profits and the stock-market valuations of their firms. I call this a “happy conspiracy” among institutional owners of stocks and corporate managers and directors to focus more on stock prices than on long-term intrinsic values. Again, prices are speculation, values are investment. A second relatively new development is the rise of derivative instruments such as futures and options on the stock market—which, paradoxically, can be used with equal effectiveness both for risk control and for rank speculation. These future and option markets are also a contributing cause of the recent turbulence. Another cause is the availability of cheap credit, as global savings soared and an avalanche of dollars chased debt instruments.

Not only are they more likely to be short-term speculators than long-term investors, but because they are managing the pension and thrift plans of the corporations whose stocks they hold, they are faced with a serious conflict of interest where controversial proxy issues are concerned. As one manager has said: “There are only two types of clients we don’t want to offend: actual and potential.” And in mutual fund America, an industry lost its way. Once a profession with elements of a business, mutual funds became a business with elements of a profession—and too few elements at that. Once dominated by small, privately-held organizations run by investment professionals, the mutual fund industry is now dominated by giant, publicly-held financial conglomerates run by businessmen hell-bent on earning a return on the firm’s capital, not the return on the capital invested by the fund shareholders. Result: over the past twenty years, the typical fund investor has captured only about 20 percent of the compound return on stocks there for the taking by holding a simple S&P 500 index fund. (I’m speaking, of course, about the Vanguard 500 Index Fund.)

(4) In our parochial interest in winning the investment game by betting against other market participants, we have defied the mathematical certainty that the higher the costs of investing, the lower the returns that, as a group, investors earn. (5) Together, these trends have led to an abandonment of investor concerns about corporate governance, and the inadequacy of investment research and security analysis. While these issues may be different from those of the past, the principles are age-old. Consider this warning from Adam Smith way back in the 18th century: Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail. And so in the recent era, negligence and profusion have prevailed among our money manager/agents, even to the point of an almost complete disregard of their duty and responsibility to their principals. Too few managers seem to display the “anxious vigilance” over other people’s money that once defined the conduct of investment professionals.

But the news media, competing to attract public attention and readership, needs news that is interesting, exciting, dramatic, and—of course—frequent. And financial markets provide just that, with their constant price changes in real-time. While these changes ultimately must reflect the reality of those glacial changes in corporate cash flow, the stock market is primarily an expectations market, a market that reflects human emotions, surges of optimism and pessimism based on hope, greed and fear. Business on the other hand, is about the real market, a market that reflects on the delivery of real goods and services, produced, Manufactured, and delivered by real people, using real strategies, that result in real earnings and real dividends. In short, those that invest (as a group) win: those that speculate (as a group) loose. This is the central message of “The Evolution of an Investor” from Conde Nast’s Portfolio, included in your materials. It is the story of a successful stockbroker who comes to understand the system and the damage it does to investors, turns his back on speculation, and adopts instead a new approach that focuses on long-term investment.which

Justice Stone’s words, excerpted from his 1934 essay in The Harvard Law Review, are equally relevant—perhaps even more relevant—at this moment in history. Indeed, they sound like they were written, well, yesterday. They could hardly present a more appropriate analysis of the causes of the present-day collapse of our financial markets and the resultant economic crisis now facing our nation and our world. In short, the managers of our public corporations came to place their own interests ahead of the interests of their owners, exploiting the powers of their agency, yet unchecked by traditional gatekeepers such as directors, accountants, and regulators, and even the owners themselves. For true owners now play but a small and gradually vanishing role in our investment world. Our now-dominant money-manager agents blithely accepted the new environment in which management self-interest held sway. Indeed, they fostered it by accepting as holy writ whatever earnings our corporations reported, and by generally ignoring corporate governance issues such as proxy access, executive compensation, board composition, and even mergers and acquisitions and dividend policy. Indeed, these agents turn over their portfolios with such alacrity that is fair to say that the old own-a-stock industry is now a rent-a-stock industry.

Just think about it: In the Real Market of business, real companies spend real money and hire real people and invest in real capital equipment, to make real products and provide real services. If they compete with real skill, they earn real profits, out of which they pay real dividends. But to do so demands real strategy, real determination, and real capital expenditures, to say nothing of requiring real innovation and real foresight. Loosely linked to this Real Market is the Expectations Market. Here, market prices are set, not by the realities of business that I have just described, but by the expectations of investors. Crucially, these expectations are set by numbers, numbers that are to an important extent the product of what our managements want them to be, too easily managed, manipulated, and defined in multiple ways. What is more, we not only allow but seemingly encourage the chief executive, whose real job is to build real corporate value, to bet in the expectations market, where his stock options are priced and exercised. That practice should be explicitly illegal, just as it is illegal in say, pro football (i.e.pre-

One of Coolidge’s comments on our banking system affirms that he would have agreed with Justice Stone’s harsh indictment. “A bank is not a private institution responsible to itself alone, or to a few,” Coolidge said, “It is a public institution under a moral obligation to be administered for the public welfare.” Our new-era banking system, a major contributor to the crisis America is now fighting her way through, hardly meets that standard of how a bank ought to operate. How Would Coolidge Guide Us Today?the

” This is the classic formulation of how a virtuous society is produced by the invisible hand of self-interest. But it has somehow gone awry. Trusting and being trusted were essential elements explaining why the invisible hand worked for society, but today we seem to rely far less on these essentials. Despite the vital role of self-interest in providing the plenty of modern society, we need something more. We need to restore trust and we need to raise our society’s expectations of the proper conduct of our citizens, and especially of our leaders. To do so, we need again to call on Adam Smith. Smith was inspired by John Locke, Frances Hutcheson, and David Hume, and in turn inspired our Founding Fathers. But seven years before The Wealth of Nations, he wrote The Theory of Moral Sentiments, and introduced us to the Impartial Spectator. While the Invisible Hand has become part of our language, the idea of the Impartial Spectator is barely known beyond Smith aficionados.

game spreads). Today, stock option compensation, even in its present form, creates huge distortions in our financial system. These problems require a whole new way of thinking about investing. We need more investors and fewer speculators, and we need investors—institutional and individual alike—to understand three simple facts: (1) Investing for the long term—buying and holding all of the publicly-held corporations in America, for example—is a winner’s game. In the long run—since 1900—the 9.6 percent nominal annual return on stocks was created almost entirely from the real returns earned by business. Dividend yields averaging 4.5 percent and earnings growth averaging 5 percent gave us 9.5 percentage points of that total. Only 1/10 of 1 percent came from the expectations market. But if long term investing is a winner’s game, as it is, consider the next fact: (2) Trading stocks with one another—as we now do to the tune of 4 billion shares—say, $100 billion!—every business day makes beating the market a zero sum game, but only before the deduction of the money we spend on all of that busy trading. And so, Q.E.D., Fact (3): After those costs, the lavish rewards we bestow on our financial croupiers—our stock brokers, our investment bankers, our money managers—beating the market (essentially what all those short-term speculators are trying to do) becomes a loser’s game.

It’s worth dwelling on that phrase: “the critical functioning structure that defines how the world works.” As the New Yorker writer John Lanchester observed: “That’s a hell of a big thing to find a flaw in.” Lanchester continued: “the people in power thought they knew more than they did. The bankers evidently knew too much math and not enough history—or maybe they didn’t know enough of either.” Think about it: In our financial system, we have ignored both math and history, and largely focus our expectations on the returns that the financial markets may deliver. We’ve also ignored the exorbitant costs extracted from our returns by Wall Street traders and money managers, costs that substantially diminish—indeed often overwhelm—our participation in the returns that our corporations earn and the excessive taxes that we incur in this era of record levels of speculative trading. Together, these costs have devastated the real (inflation-adjusted) returns that remain for investors. In all, our now-dominant money management sector has turned its focus away from the enduring nature of the intrinsic value of the goods and services created, produced, and distributed by our corporate businesses, and toward the ephemeral price of the corporation’s stock—the triumph of perception over reality. We live in a world in which it is far easier to hype the price of a company’s stock than it is to build the intrinsic value of the corporation itself.

continues to provide news stories at lightening speed under deadlines that demand news every moment, appealing, of course, to the short-term concerns of their readership. Executive Compensation Let me close with a few comments about how the business world and the media handle executive compensation. I hold, deeply, the conviction that the vast majority of our corporate CEOs are substantially overpaid, many grossly overpaid. As is well-known, while the real (inflation adjusted) compensation of the average employee has remained pretty much flat during the past 25 years (now at $35,000), the real compensation of the average CEO (now about $10,000,000) has risen eight-fold. Yet, there’s no evidence that CEOs as a group have created much extra value. Indeed, during that quarter-century, they’ve projected that the earnings of their companies would grow at 11 percent (in nominal dollars), but delivered growth of 6 percent, only half as much even as our economy has grown at a 6.2 percent rate. But CEO pay is not based on corporate performance. It is based on the pay of corporate peers. And since each corporate board seems to believe that its own CEO is well above average, whenever the CEOs pay ranks in the bottom quartile among his peers, he gets moved up a few quartiles. Of course, some other CEO is thus inevitably cast into the bottom quartile, and so on.

benefits to fund managers and brokers, and commensurately great costs to fund investors. 3. Failure to exercise adequate due diligence in the research and analysis of the securities selected for fund portfolios, enabling corporate managers to engage in various forms of earnings management and speculative behavior, largely unchecked by the professional investment community. 4. Failure to exercise the rights and assume the responsibilities of corporate ownership, generally ignoring issues of corporate governance and allowing corporate managers to place their own financial interests ahead of the interests of their shareowners. 5. Soaring fund expenses. As fund assets soared during the 1980s and 1990s, fund fees grew even faster, reflecting higher fee rates, as well as the failure of managers to adequately share the enormous economies of scale in managing money with fund shareholders. Example: the average expense ratio of the ten largest funds of 1960 rose from 0.51 percent to 0.96 percent in 2008, an increase of 88 percent. (Wellington Fund was the only fund whose expense ratio declined. Excluding Wellington, the increase was 104 percent.) 6. Charging fees to the mutual funds that managers control that are far higher than the fees charged in the competitive field of pension fund management. Three of the largest advisers, for example, charge an average fee rate of 0.08 percent of assets to their pension clients and 0.

And yet another, related to cheap credit, is the mind-numbing complexity of derivative instruments that appeared to offer higher returns for those who borrowed short and invested long. Any one of these relatively new (for this cycle) developments would have added to market turbulence. Together, their combined impact has been devastating. Let me give you one specific example of how our investment system has been overwhelmed by a system of speculation. In 1957, the market value of the stocks in the S&P 500 Index was $220 billion, and Index futures and options markets did not ever exist. By 1982, the value of S&P 500 had soared to $1.2 trillion and newly-created S&P futures and options outstanding totaled $438 billion, about one-third of the value of the Index itself. By the beginning of 2007, with the S&P 500 valued at $12 trillion, futures and options contracts on the Index had soared to $20 trillion, an “expectations market” valued at almost double the value of the “real market.” It should go with out saying that when derivatives such as futures and options are short-term bets on stock prices, (as happened in that $7 billion debacle at Societe’ General), it is the very essence of speculation.

market prices gave us our comeuppance. With earnings continuing to rise, the P/E currently stands at 18 times, compared with the 15 times level that prevailed at the start of the twentieth century. As a result, speculative return has added just 0.1 percentage points to the annual investment return earned by our businesses over the long term. When we combine these two sources of stock returns, we get the total return produced by the stock market. (Chart 2c) Despite the huge impact of speculative return—up and down— during most of the individual decades, there is virtually no impact over the long term. The average annual total return on stocks of 9.6 percent, then, has been created almost entirely by enterprise, with only 0.1 percentage point created by speculation. The message is clear: in the long run, stock returns depend almost entirely on the reality of the investment returns earned by our corporations. The perception of investors, reflected by the speculative returns, counts for little. It is economics that controls long-term equity returns; emotions, so dominant in the short- term, dissolve. After almost 55 years in this business, I have little conviction about how to forecast these swings in investor emotions, nor when they will occur, although it is clear that when p/es are high (say above 25) they are apt, ultimately to decline and when they are low (say, below 12) they are apt ultimately to rise.

You will not be surprised to learn that Adam Smith presciently described the characteristics of today’s corporate and institutional managers (many of which are themselves controlled by giant financial conglomerates) with these words: Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail.4 Like Justice Stone’s warning about the consequences that follow when business operates in its own self-interest, Smith’s ancient warnings about the consequences of money-manager capitalism—agency capitalism—could hardly have been more accurate. So what’s to be done? I propose that we undertake the “Fiduciary Duty” solution: To create, out of our disappearing ownership society and our failed agency society, a new fiduciary society. Here, our money-manager agents would be required—by federal statute—to place the 4 In Smith’s era, profusion was defined as “lavish or wasteful expenditures, excess amount of money, squandering, waste, etc.”

4. Our Financial Economy If you’ve been following my argument, you might well be thinking that the reason that the index fund does so well is that it doesn’t fall prey to the shortcomings of our financial system as a whole, yet our financial system now dominates over economies that fact that over the past two centuries, our nation has moved from being an agricultural economy, to a manufacturing economy, to a service economy, and now to a predominantly financial economy. But our financial economy, by definition, subtracts from the value created by our productive businesses. Think about the Gotrocks family again. While investing in American business is a winner’s game, beating the stock market before those costs is a zero-sum game. But after intermediation costs are deducted, beating the market—for all of us as a group—becomes a loser’s game. Yes, the more that our financial system takes, the less our investors make. Yet the financial field is where the money is made in modern-day America, the breeding ground for the wealthiest of our citizens. (If you made less than $140 million dollars last year, you didn’t make enough to rank among the 25 highest-paid hedge fund managers.)

Facing Up to the Reality It must seem obvious that there is an urgent need to face up to these and other failures in the changing world of capitalism. But despite the contentious nature of the issues I’ve just described—broadly reflecting the triumph of the powerful economic interests of the oligarchs of American business and finance over the interests of our nation’s last line investors—it is remarkable that so little public discourse has been in evidence. In the investment community, I have seen no defense of the inadequate returns delivered by mutual funds to investors, nor of the industry’s truly bizarre, counterproductive ownership structure; no attempt by institutions to explain why the rights of ownership that one would think are implicit in holding shares of stock remain largely unexercised; no serious criticism of the virtually unrecognized turn away from the once-conventional and pervasive investment strategies that relied on the wisdom of long-term investing, toward strategies that increasingly rely on the folly of short-term speculation; and, until recent months, almost no discussion of the huge deficits that we are facing in our public and private systems of retirement plan funding. If my book helps to open the door to the introspection by our corporate and financial leaders that is so long overdue, and then corrective action, perhaps the needed changes will be hastened.

nation’s investment process. In their spirit, I continue to press on in that battle. In today’s wrongheaded version of capitalism, corporate managers—agents of the shareholders— hold awesome power in their own hands and for their own purposes. These managers are in charge of our business wealth, virtually unchecked by traditional gatekeepers— directors, auditors, regulators, even their own shareholders. It doesn’t help that our institutional money managers—who control corporate America through their holdings of some 70 percent of all shares of stock—are too heavily focused on the folly of short-term speculation on stock prices and too lightly focused on the wisdom of long-term investment—growing intrinsic corporate value—to concern themselves with challenging the domain of our corporate managers. So here we are tonight, in an economic and political environment which is light- years away from the environment to which President Coolidge pointed with pride and pleasure, an environment in which his belief in small government, budget surpluses, and low taxes helped the private sector of our economy to flourish. What guidance would he offer? Cut taxes and slash social welfare? Raise taxes on all? On the wealthy? Fix Social Security? Undo the recent healthcare reform? Add to the so-called “stimulus,” or stop it in its tracks? How would he balance the power of the Federal government with the needs of so many in our society?

Building a Fiduciary Society So what we must do is develop a new fiduciary society which guarantees that our last- line owners—those mutual fund shareholders and pension fund beneficiaries whose savings are at stake—their rights as investment principals. These rights must include: (1) The right to have their money-manager agents act solely in their behalf. The client, in short, must be king. (2) The right to rely on due diligence by managers, in the services, the mutual funds, and the financial products that they offer. (3) The guarantee that our agents will be responsible corporate citizens, restoring to their principals the neglected rights of ownership of stocks. (4) The elimination of all conflicts of interest that could preclude the achievement of these goals. Of course it will take federal government action to foster the creation of this new fiduciary society that I envision. Above all else, it must be unmistakable that government intends, and is capable of enforcing, standards of trusteeship and fiduciary duty under which money managers operate with the sole purpose and in the exclusive benefit of the interests of their beneficiaries— largely the owners of mutual fund shares and the beneficiaries of our pension plans. While the government action is essential, however, the new system should be developed in concert with the private investment sector, an Alexander Hamilton-like sharing of the responsibilities.

But no matter how flawed the nature of our financial system has become, invest we must. It is our responsibility to put our money to work where the money changers and croupiers to the tune of $362,950 per person mail room) in the last year alone, great country, or what?”) I know that many of you share my equity index funds is the optimal strategy guarantees your clients their fair share of whatever returns tenets apply to owning the bond market through a low strategy that is as simple as it is profound empire of parsimony.” If you favor actively-managed over the long term is not easy. Even if you or her fund portfolio will inevitably roll over again and again. But no matter how flawed the nature of our financial system has become, invest we must. It is our responsibility to put our money to work and then stay out of the casino— croupiers of Wall Street sit in the dealer’s chair and get rich . . . per person (including everyone from partners to those who labor , the average salary reported just a few weeks ago many of you share my belief that a strategy focused largely on low equity index funds is the optimal strategy—simply because it focuses on the long fair share of whatever returns our stock market delivers. apply to owning the bond market through a low-cost bond index fund.)

Sources of Bond Returns The sources of bond returns are even simpler than the simple system for stocks that I’ve just described. The entire investment return on a bond is based on its initial yield. While in shorter periods, bond returns have a speculative component based on fluctuations in the general level of interest rates, over the longer run that speculative component must approach zero. After all, a ten-year bond is destined to be redeemed for par when it matures. (Chart 4) So the ten-year total return on an intermediate-term bond (blue line) is determined primarily by the interest rate, (i.e., the yield-to-maturity) on the date of purchase (red line).

But this Impartial Spectator is a wonderful concept—the imaginary spectator who is the force that arouses in us principles that are both generous and noble. While Smith described him as “the man within,” who gives us our highest calling, he also seems to see him as the powerful voice of the society in which we exist, perhaps even as the soul, or even as the Supreme Being. Listen to Smith’s words: “It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct.” It is this impartial spectator, Smith tells us—and please listen carefully to these wonderful words—“who calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn the real littleness of ourselves. It is this impartial spectator . . . who shows us the propriety of generosity and the deformity of injustice; the propriety of reining the greatest interests of our own, for the yet greater interests of others . . . in order to obtain the greatest benefit to ourselves. “It is not the love of our neighbour,” Smith continues, “it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues.

their stipend was skill avoiding obvious fraud and in structuring the package.” Remarkably, Minsky had this insight in 1994, long before the issuance of the complex and highly risky credit default swaps, collateralized debt obligations, and structured investment vehicles that characterized the era that has now come to its crashing conclusion. Business Values and Investment Values Gone Awry Let me now sum up how our business values and investment values have gone awry and the consequences of this failure. I’ll first cite the grave concerns of both Keynes and Minsky, and then add my own perspective. Keynes’ famous paragraph can hardly be more incisive: As the organization of investment markets improves, the risk of the predominance of speculation does however increase. Speculators do no harm as bubbles on a sea of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job (of capitalism) is likely to be ill done. And Minsky comes out with a similar conclusion: In a capitalist economy, the past, the present, and the future are linked not only by capital assets and labor force characteristics but also by financial relations. The key financial relationships link the creation and the ownership of capital assets to the structure of financial relations and changes in this structure.

For tax return purposes, the securities acquired were recorded at the original cost of the securities exchanged. Thus, no income tax was due or paid. Although the realized gain had a material impact on Wesco's reported 2005 earnings, it had no impact on Wesco's shareholders' equity.included

When we think of professionals, most of us would probably start with physicians, lawyers, teachers, engineers, architects, accountants, and clergy. I think we could also find agreement that both journalists and trustees of other people’s money are—or at least should be— professionals as well. And yet, profession by profession, the old values are clearly being undermined. The driving force is what we have come to call “the bottom line society.” Unchecked market forces not only constitute a strong challenge to our professions; they pose a significant threat to traditional standards of professional conduct, developed over centuries. In most of our professions, these standards, in sad reality, have already been undermined. And with that change has come a serious erosion in the idea that professionals must accomplish their good works with a commitment to use their mastery to fulfill a “mission that inspires passion, a mission that gives beyond the self.” Of course we’re all aware, as yet another more recent article in Daedalus expressed it, “that pursuing a noble mission is often painful . . . and that not letting the mission get out of hand is possible only for those who truly believe in the mission and have enough self-perspective to remain wary of dangers such as arrogance, megalomania, misguided beliefs, and distorted judgments.” Recent examples of the harsh consequences of this change are easy to come by.

Annualize the change, and then combine the two. But never forget that it's unwise in the extreme to forecast stock returns based on historical norms rather than on evaluating the broad forces that have shaped them in the past and will continue to shape them in the future. But whatever returns the stock market is generous enough to deliver in the years ahead, please don't make the mistake of thinking that those pre-inflation, pre-investment-cost figures have anything to do with reality.are

stock market is at the previous high in 1929 was 140 percent; it fell to about 25 percent during my first few decades in this business. Last year, turnover was about 350 percent, speculators trading with other speculators, each with the idea of taking advantage of those on the other side of the trade, creating—to state the obvious—zero in economic value. It is the rise of speculation that explains why in a typical year the market never moved by daily increments of 3 percent or more (up or down) but have experienced 50 such days since 1/1/08. Speculation is in the Driver’s Seat But Wall Street marketers and entrepreneurs loved this new system of speculation in complex products, quantification, innovation, and unconstrained risk, for it made them billions in profits. So it was easy for Wall Street insiders to wallow in the wealth it generated for themselves, and ignore its destruction of their clients’ wealth. Revenues of our stock brokerage firms, money managers, and the other insiders soared from an estimated $60 billion in 1990 to some $600 billion in 2007.

The managers are in business to maximize the return of their capital, while the shareholders seek to maximize the return on their capital. (If you understand the Biblical warning that “no man can serve two masters,” you’ll get what I mean.) Eliminating (or at least managing) that conflict demanded mutual funds that were actually mutual—with the management focused solely serving shareholders, and operating on a non-profit basis.sales

Darwin identified me. Given his persistence, I finally caved in and in 1993 wrote Bogle on Mutual Funds. Darwin quickly wrote back “Jack, you hit a home run!” A fine memory indeed. That bestseller was, I imagine, partly responsible for my being honored in 1998 with the CFA Institute’s highest honor: the Award for Professional Excellence. I was introduced at the awards dinner by both Warren Buffett and John Neff. IV. Has Our Profession Lived Up To Its Potential? My fourth and final subject is our too-frequent failure to meet the high standards of professionalism that we have put in place. We have the right mission, but we have often fallen short in practice, especially in recent decades. Yes, security analysis has been professionalized, but too many participants in our financial system, including financial analysts, have lost sight of some of their basic professional responsibilities. For one thing, far too many analysts have focused on ephemeral stock prices, giving short shrift to intrinsic corporate values. As a result, during the recent era we’ve seen the folly of short-term speculation crowding out the wisdom of long-term investment. Well ahead of his time, Benjamin Graham saw it coming. In his 1958(!)

charged an average fee rate averaging 0.08 percent to their pension clients and 0.61 percent to their funds, resulting in annual fees averaging $600,000 for the pension funds and $56 million for the mutual funds (presumably while holding the same stocks in both portfolios). 7. Spending enormous amounts on advertising—almost a half-billion dollars in the last two years alone—to bring in new fund investors, using money obtained from existing fund shareholders. 8. Creating exotic and untested “products” that have far more ephemeral marketing appeal than investment integrity. Given such failures as these, doesn’t Justice Stone’s warning that I cited at the outset seem even more prescient? Let me repeat the key phrases: The separation of ownership from management . . . corporate structures that. . . vest in small groups control over the resources of great numbers of small and uninformed investors . . . corporate officers and directors who award to themselves huge bonuses . . . financial institutions which consider only last, if at all, the interests of those whose funds they command. Just as we ignored the fiduciary principle all those years ago, so we have clearly continued to ignore it in the recent era. The result in both cases, using Justice Stone’s words: the loss and suffering inflicted on individuals, the harm done to a social order founded upon business and dependent upon its integrity, are incalculable.

When we add up all those hedge fund fees, all those mutual fund management fees and operating expenses; all those commissions to brokerage firms and fees to financial advisors; investment banking and legal fees for all those mergers and IPOs; and the enormous marketing and advertising expenses entailed in the distribution of financial products, we’re talking about some $580 billion dollars per year. That sum, extracted from whatever returns the stock and bond markets are generous enough to deliver to investors, seriously undermines the odds in favor of success for our citizens who are accumulating savings for retirement. Yet the fact is that the finance sector has become by far our nation’s largest generator of corporate profits, larger even than the combined profits of our huge energy and health care sectors, and almost three times as much as either manufacturing or information technology.4 Twenty–five years ago, financials accounted for only about 6 percent of the earnings of the 500 giant corporations that compose the Standard & Poor’s 500 Stock Index. Ten years ago, the financial sector share had risen to 20 percent. And last year, the financial sector profits had soared to an all-time high of 27 percent. If we add the earnings of the financial affiliates of our 4 For the record, the 2006 operating earnings of the S&P 500 totaled $787 billion.

And we seem to have forgotten the legendary Benjamin Graham’s warning against focusing on short-term perception, rather than on long-term reality: “In the short run, the stock market is a voting machine; in the long run it is a weighing machine.” An Historic Distinction Consider with me now how the erosion in the conduct, values, and ethics of business has been fostered by the profound—and largely unnoticed—change that I have described in the nature of our financial markets. That change reflects two radically different views of what investing is all about, two distinct markets. One is the real market of intrinsic business value. The other is the expectations market of momentary stock prices. It’s a curious coincidence that I’ve been concerned about this sharp dichotomy ever since I first encountered it in my study of economics at Princeton University. Really!Keynes

(If these relentless rules of humble arithmetic are a plug for the low-cost, no-load, buy-and-hold, all-stock-market-index fund I began to design 31 years ago, well, so be it.) The Invisible Hand While fixing the system will not be easy, it’s easy to conceptualize the two parallel paths we need to follow. One is what I call the “Adam Smith Solution,” the Invisible Hand of competition that he described in The Wealth of Nations. If each individual investor out there— those who hold their stocks directly and those who hold their stocks through their mutual funds— would only look after his or her own economic interests, then great progress would be made. Intelligent investors would move away from the costly folly of short-term speculation to the priceless (and price-less!) wisdom of long-term investing—abandoning both the emotions that betray sound investment strategy and the expenses that turn beating the market into a loser’s game.a

interests of their principals ahead of their own interests, a consistently enforced public policy that places a clear requirement of fiduciary duty on our financial institutions to serve exclusively the interests of the owner/principals whom they are duty-bound to serve. That duty would require the long overdue return of our institutional agents to traditional standards of professional stewardship: ∑ Focus on long-term investing rather than short-term speculation. ∑ Due diligence in security analysis and investment research. ∑ Effective and responsible participation in the governance of our publicly-owned corporations. ∑ Pressing the managers of the business corporations whose shares are held in their portfolios to govern in the interest of their owners. ∑ An ethical responsibility to serve society at large. ∑ Elimination of all conflicts of interest that inhibit the placing first and foremost the interest of the investor/principals. Adam Smith IV – Wealth, Greatness, Invention, and Ennoblement It is high time for our corporations and our money managers to return to the idea of stewardship and faithful service. We need to restore the integrity of our system of capital formation. We need to demand that our financial institutions focus on long-term investment rather than on short-term speculation. We need our corporations to be run to benefit their outside owners, not their inside managers to return to the way capitalism operated when it began all those years ago.

in income taxes payable, on its consolidated balance sheet. Thus, the entire after-tax gain on the non-cash merger had been reÖected in the unrealized gain component of Wesco's shareholders' equity as of September 30, 2005. That amount was merely switched from unrealized gain to retained earnings, another component of shareholders' equity. This accounting entry had no economic eÅect on Wesco, and you should ignore it when you are evaluating Wesco's 2005 earnings. Consolidated Balance Sheet and Related Discussion As indicated in the accompanying Ñnancial statements, Wesco's net worth, as accountants compute it under their conventions, increased to $2.40 billion ($337 per Wesco share) at yearend 2006 from $2.23 billion ($313 per Wesco share) at yearend 2005. The main causes of the increase were appreciation in fair value of investments, and net operating income after deduction of dividends paid to shareholders. The foregoing $337-per-share book value approximates liquidation value assuming that all Wesco's non-security assets would liquidate, after taxes, at book value. Of course, so long as Wesco does not liquidate, and does not sell any appreciated securities, including the PG shares Wesco received in connection with PG's acquisition of Gillette in 2005, discussed above in the section, ""Realized Investment Gains,'' Wesco has, in eÅect, an interest-free ""loan'' from the government equal to its deferred income taxes, subtracted in determining its net worth.

In public accounting, our once “Big Eight” (now “Final Four”) firms gradually came to provide hugely profitable consulting services to their audit clients, making them business partners of management rather than independent and professional evaluators of generally accepted (if loose) accounting principles. Think too about the increasing dominance of “state” (publishing) over “church” (editorial) in journalism, and the scandals that reached the most respected echelons of the press—the New York Times, the Los Angeles Times, the Washington Post. A similar transition has taken place in the medical profession, where the human concerns of the caregiver and the human needs of the patient have been overwhelmed by the financial interests of commerce—our giant medical care complex of hospitals, insurance companies, drug manufacturers and marketers, and health maintenance organizations (HMOs). In all, professional relationships with clients have been increasingly recast as business relationships with customers. In a world where every user of services is seen as a customer, every provider of services becomes a seller. Put another way, when the provider becomes a hammer, the customer is seen as a nail. Please don’t think me naive. I’m fully aware that every profession has elements of a business.the

As I talk about turbulence with you, I find it ironic that former Federal Reserve Chairman Alan Greenspan chose “The Age of Turbulence” as the title for his recent book. As skilled as he may have been in directing our central bank, he did much to bring that turbulence about. His adamant refusal to have the Fed take a stand in setting stringent credit standards for bank lending and mortgage issuance has been well documented, and his determination to hold down interest rates far longer than economic conditions seemed to dictate did much to feed speculation in the bond and stock markets. It will be interesting to see how history finally treats this icon of central banking. (Chou En-Lai on the French Revolution.) So it is with so many things. “Too soon to tell!” Today’s turbulence reflects in important measure the failure of our commercial banks and investment banks to consider the extraordinary risks of the securities they were creating and marketing, and earning billions in fees and commissions, even as they were left with tens of billions of dollars—even hundreds of billions—on their own balance sheets. Given Wall Street’s ever-pressing need to have something, anything, to sell in the way of “new product”—it is hardly surprising that these collateralized debt obligations (CDOs) became ever more complex, with risk even more deeply concealed.

So while trading back and forth with one another—foolish as it is—is by definition a zero-sum game, once the costs of our Wall Street croupiers are deducted it is a loser’s game. (Think Las Vegas, think the Atlantic City Race Track. Heck, think Governor Rendell’s lottery.) So for investors as a group—who inevitably feed at the bottom of the food chain of investing receiving whatever market returns remain after the croupiers costs—trading is a loser’s game, by the amount of these costs. That $600 billion in 2007 plus many hundreds of billions in earlier years, obviously represent a truly staggering hit to the gains investors earned in the bull market, and a financial slap in their face in the bear market that followed. Any confidence in Wall Street that our investors once may have had has largely vanished, just as it should have. The speculators among us, and those of us who have forgotten the distinction between investment and speculation—two groups that inevitably display a large amount of greed—must share a portion of the responsibility for the financial bubble and the ensuing crash. When an own-a-stock industry becomes a rent-a-stock industry, concern about corporate governance is the first casualty—a harbinger that our capitalistic system is not working properly.

This “ratchet effect,” the product of the compensation consultants who, I can assure you, don’t make a living by recommending salary cuts, is a real problem, to which the only solution is a demand by stockholders to require corporate performance—not peer compensation—as a condition of compensation above a certain (modest) norm. But, as I’ve noted, since our all-powerful institutions have serious conflicts of interest and behave more like speculators than investors, don’t hang by your thumbs awaiting this reform. The other major culprit enabling excessive executive compensation is the heavy reliance on stock options. They seem to be “free,” but they’re not. So as seemingly reasonable as they may seem, such options can significantly dilute the interest of the “real” shareholders of the company. To avoid such dilution, companies typically buy back stock in the market, whether or not these prices are reasonably related to company achievement. Further, stock prices (as I’ve already noted) often have little to do with the amount of real intrinsic value the company, and its executives and staff, are creating (or dissipating). The idea that stock options link the interest of executives with the interests of shareholders turns out to be, simply, a canard.

Today, as you know, much of that harm can be calculated all too easily, amounting to several trillions of dollars. So, this time ‘round, let’s pay attention, and demand a return to fiduciary principles. A Piece of History While the overwhelming majority of financial institutions operate primarily in the interests of their agents and at the expense of their principals, not quite all do. So I now draw on my personal experiences in the mutual fund industry to give you one example of my own encounter with this issue. As far back as 38 years ago, I expressed profound concern about the nature and structure of the fund industry. Only three years later, my convictions led to action, and 35 years ago this September, I founded a firm designed, to the best of my ability, to honor the principles of fiduciary duty.

But, largely because the arithmetic of investing is so basic, I can forecast the long-term economics of investing with remarkably high odds of success. Why? Simply, it is investment returns—the earnings and dividends generated by American business—that are almost entirely responsible for the returns delivered in our stock market. Put another way, while illusion—the momentary prices we pay for stocks—often loses touch with reality —the intrinsic values of our corporations—in the long runit is reality that rules. To drive this point home, think of investing as consisting of two different games. Here’s how Roger Martin, dean of the Rotman School of Management of the University of Toronto, describes them. One is “the real market, where giant publicly held companies compete. Where real companies spend real money to make and sell real products and real services, and, if they play with skill, earn real profits and pay real dividends. This game also requires real strategy, real determination, and real expertise; real innovation and real foresight.” Loosely linked to this game is another game, the expectations market. Here, prices are not set by real things like sales margins or profits.when

It is an strategy that is as simple as it is profound—I once described it as “the majesty of simplicity in an managed funds, you already know that picking winning managers over the long term is not easy. Even if you never liquidate one of your client’s fund holdings, fund portfolio will inevitably roll over again and again. In the years ahead But no matter how flawed the nature of our financial system has become, invest we must. —that casino and get rich . . . who labor in the just a few weeks ago. (“Is this a that a strategy focused largely on low-cost simply because it focuses on the long-term and delivers.years

presidential address at the National Federation of Financial Analyst Societies, he warned his colleagues with these prescient words: In the past, the speculative elements of a common stock resided almost exclusively in the company itself; they were due to uncertainties, or fluctuating elements, or downright weaknesses in the industry, or the corporation’s individual setup. . . . But in recent years a new and major element of speculation has been introduced into the common-stock arena from outside the companies. It comes from the attitude and viewpoint of the stock- buying public and their advisers—chiefly us security analysts. This attitude may be described in a phrase: primary emphasis upon future expectations. Mathematics is ordinarily considered as producing precise and dependable results; but in the stock market the more elaborate and abstruse the mathematics, the more uncertain and speculative are the conclusions we draw therefrom. . . .is

61 percent to their funds, resulting in annual fees of just $600,000 for the pension fund and $56 million for the comparable mutual fund (and presumably holding the same stocks in both portfolios). 7. Diluting the value of fund shares held by long-term investors, by allowing hedge fund managers to engage in “time zone” trading. This vast near-industry-wide scandal came to light in 2003. It involved some 23 fund managers, including many of the largest firms in the field—in effect, a conspiracy between mutual fund managers and hedge fund managers to defraud regular fund shareholders. 8. “Pay-to-play” distribution agreements with brokers, in which fund advisers use fund brokerage commissions (“soft dollars”) to finance share distribution that benefits primarily the adviser. 9. Spending enormous amounts on advertising—almost a half-billion dollars in the last two years alone—to bring in new fund investors, using money obtained from existing fund shareholders.

Equity Fund Returns Over the Coming Decade 2.0% 4.5% 6.0% (2.5%) (-1.0%) -2% 0% 2% 4% 6% 8% Earnings Growth Dividends P/E Impac t Inflation Real Return Sources Uses 10a. 7% 7% Equity Fund Returns Over the Coming Decade 2.0% 2.5% (2.0%) 6.0% (2.5% ) (-1.0%) -2% 0% 2% 4% 6% 8% E arnings Gr owth Dividends P/E Impact Inflation Net Real Fund Return Sources Uses 7% 7% Expenses 10b. Equity Fund Returns Over the Coming Decade 0.50% 2.0% (2.0% ) 6.0% (2.0%) (-1.0%) (2.5% ) -2% 0% 2% 4% 6% 8% E arnings Gr owth Dividends P/E Impact Inflation Net Real Investor Return Sources Uses 7% 7% Expenses Timing/Selection Penalty 10c. far lower. To explain why this is the case, we need only to understand these simple mathematics of investing: 1. Inflation will almost certainly erode the nominal returns we’ve just calculated. Assuming that inflation averages 2 ½ percent per year (as expected today), the nominal return on stocks of 7 percent over the coming decade would be reduced to 4 ½ percent. (Chart 10A) 2. All investors as a group must necessarily earn precisely the market’s real return, but only before the costs of investing are deducted. So if equity funds, on average, incur costs of only 2 percent per year, a conservative figure in the light of combined fund costs—fund expense ratios, sales loads, and turnover costs—their average annual net real return would be just 2 ½ percent. (Chart 10B) 3.

The task of returning capitalism to its ultimate owners will take time, true enough. But the new reality—increasingly visible with each passing day—is that the concept of fiduciary duty is no longer merely an ideal to be debated. It is a vital necessity to be practiced. What’s at stake here is the very role of capitalism in our society. Should it serve corporate managers and money managers? Or should it serve the citizens who invest their capital? Is speculation to ride in the saddle, or will investment call the tune? Some 70 years ago the eminent British economist John Maynard Keynes warned us: “When enterprise becomes a mere bubble on a whirlpool of speculation, the consequences may be dire . . . when the capital development of a country becomes a by- product of the activities of a casino . . . the job (of capitalism) will be ill-done.”

Institutional complexity may result in several layers of intermediation between the ultimate owners of the communities’ wealth and the units that control and operate the communities’ wealth. Like all (profit-seeking) entrepreneurs in a capitalist economy, bankers are aware that innovation assures profits. Thus, bankers (indeed, all intermediaries in finance) are merchants of debt who strive to innovate in the assets they acquire and the liabilities they market. This newest stage of capitalism, money manager capitalism . . . became a reality in the 1980s as institutional investors, by then the largest repositories of savings in the country, began to exert their influence on financial markets and business enterprises . . . The raison d’être for money managers, and basis by which they are held accountable, is the maximization of the value of the investments made by their clients.surprisingly,

Or would he do nothing, and leave the solution to our private enterprise system? Even as many will predict with an air of complacent certainty how Coolidge would guide us on these matters today, the fact is that what he would do is utterly unpredictable. We just don’t know. Character Counts But that hardly means that this remarkable President has no guidance for us. That his presidency was distinguished for character more than for heroic achievement is not a criticism, but a tribute. Indeed his guidance may well be eternal: Revere the Constitution and the Founding Fathers. Listen carefully to Hamilton (for “when America ceases to remember his greatness, America will cease to be good”). Demand persons of high integrity and high intelligence, without preconceived political agendas, to serve in the executive branch, in the legislative branch, and in the judicial branch of our government.

commissions and offering funds directly to investors; and emphasizing funds that focused on broad, discrete market sectors offering returns that are relatively predictable. Of course the apotheosis of this strategy is the market index mutual fund, which, given its minimal costs, can consistently and closely match the returns generated by the entire stock market (or the entire bond market). It’s fair to say that the fund industry hated these ideas. It’s also fair to say that, at the outset, even investors themselves barely understood their implications. But in September 1974 when the new firm began, I had no doubt that we would ultimately revolutionize mutual fund investing and become the industry leader. That’s why I chose the name “Vanguard.” Our first decision was to start the world’s first index mutual fund. Originally dubbed “Bogle’s Folly,” that once tiny index fund is now the largest equity fund of all. As I have often said, “I took on my new job as head of Vanguard under the same circumstances that I left my old job as head of Wellington: “Fired with enthusiasm.” And so I was indeed fired with enthusiasm as I set out to build a better mousetrap and, finally, to build a better financial world. The Financial Markets Today Now, let’s move from the human side of enterprise to the business side, and talk a bit about our American financial markets today. These lessons are also reflected in The Clash of the Cultures.

Chart 4 1926 1935 1944 1953 1962 1971 1980 1989 1998 2007 The Bond Market Current Yields vs. Future Returns* Initial Yield Return 10 Years Hence % *Intermediate-term Government Bond R-squared: 0.90 2011 This relationship meets the test of logic, and has been quite stable through time. For example, the correlation between the initial yield on an intermediate-term U.S. Treasury bond and its subsequent ten- year return has been a remarkable 0.90. While reversion to the mean in P/E ratios has been a powerful force in stock returns, interest rates have no reason to revert to the mean. The fact that bonds have earned, on average, 5 percent per year in the post-World War II era is utterly irrelevant. What matters is today’s 3 percent yield on a portfolio of treasuries and investment-grade bonds of intermediate-to-long maturity. The yield on a bond or a bond portfolio so nicely matches Lord Keynes’ concept of enterprise—“the yield on an asset over its entire life.” Today, with the continuing decline in interest rates, the yield-to-maturity on a blended bond portfolio is a far cry from that halcyon era. With the 10-year Treasury at 1.6 percent, the 30-year Treasury at 2.6 percent, and investment-grade corporates at 3.3 percent, the combined yield is approximately 3 percent at best, a far cry from the 9.5 percent annual return we enjoyed during the decades of the 1980s and 1990s.

It is a stronger love, a more powerful affection, the love of what is honourable and noble, the grandeur, and dignity, and superiority of our own characters.” With these powerful words, Adam Smith—yes, Adam Smith—seems to speak not only to the force of traditional societal values, but also to traditional religious values. Lincoln reaffirmed them a century later, and we should reaffirm them today. So, as the Presbyterian Church (USA) proudly and properly celebrates her 300-year milestone and recognizes the church’s great leaders and the durable universities they established, let’s look ahead to this new century in which we must build a better society and a better nation. Of course it will be different from the wonderful 18 th century world that has inspired my remarks this afternoon. But those fundamental values of yore—spiritual rather than temporal, religious rather than sectarian—must remain our highest aspiration. If we understand our history, and learn from our great religious and political leaders and from history’s lessons of virtue and commitment, that goal need not be utopian. Perhaps now is the time for another “Great Awakening.” It is hardly a moment too soon.

This process, I conclude, must begin with a return to the original values of capitalism, to that virtuous circle of integrity—“trusting and being trusted”. When ethical values go out the window and service to those whom we are duty-bound to serve is superseded by service to self, the whole idea of the capitalism that has been a moving force in the creation of our society’s abundance is soured. In the era that lies ahead, the trusted businessman, the prudent fiduciary, and the honest steward must again be the paradigms of our great American enterprises. I know it won’t be easy, but if we all work long enough and hard enough at the task, we can build, out of our long-gone ownership society and our failed agency society, a new “fiduciary society,” one in which the citizen-investors of America will at last receive the fair shake they have always deserved from our corporations, our investment system, and our mutual fund industry. Support from the Present and the Past That’s the substance of The Battle, so now for a little background. As I mentioned at the outset of my remarks this evening, many of the ideas in my book are consistent with the ideas of some of our best and brightest economic thinkers.investment

In this ideal sense, full-market capitalism is a thing of beauty. In this fourth quotation from the master, hear now Smith’s vivid description: The pleasures of wealth and greatness strike the imagination as something grand and beautiful and noble, well worth the toil and anxiety . . . [they] keep in continual motion the industry of mankind, to build houses; to found cities and commonwealths, to invent and improve all the sciences and arts, which enoble and embellish human life; which have entirely changed the whole face of the globe, and [have paved] the great high road of communication to the different nations of the earth. I can’t imagine that anyone here this afternoon would use those words to describe modern-day capitalism. I certainly wouldn’t!original

IV. Reasonable Investment Expectations for the Coming Decade Now let’s review and look ahead. Relying on the sources of market returns has proved in the past to be an exceptional way to establish reasonable expectations for the future returns on stocks. We know more than we think. The initial dividend yield at the start of the decade is already a known factor, and corporate earnings are likely to continue to grow at a rate closely related to the growth of our nation’s GDP. While the level of the P/E ratio a decade hence can hardly be known in advance, we do know that RTM comes heavily into play. If the P/E ratio was below 12 at the start of a past decade, it was highly likely (90 percent probability) to rise by its conclusion. If the P/E ratio was above 18, it was highly likely (80 percent probability) to decline over the decade. So let’s look at what we might expect in the decade beginning in mid-2012 (Chart 5). Today’s dividend yield on the S&P 500 is 2.0 percent. Annual earnings growth in the range of 5 percent seems a reasonable possibility. Result: an investment return in the range of 7 percent per year. With outstanding earnings in 2011, the P/E now stands at around 16, close to the long-term historical average, so I don’t expect that P/E to be a lot different when 2022 begins. Result: a speculative return of zero, more or less.

gone by, you’re certain to run through scores of funds and fund managers. History suggests that about 3,500 of today’s 7,000 active funds will go out of business during the coming decade. And even if a fund that you favor endures, the data tell us that in the next 25 years alone, it’s likely to be run by five different managers. Even if your client owns, say, four mutual funds and—defying the odds—all survive, his or her money will have been run by 20 different managers, with little regard to tax efficiency. In 50 years, there will likely be 40 managers! Given their high costs, the chances of a portfolio of funds outpacing the index fund over the very long term are insuperable, if not inconceivable. Only the index fund is a fund for a lifetime. Looking Ahead In a New York Times piece in August, I was quoted (correctly) as saying “this is the worst time for investing that I’ve ever seen.” Why? Because the prospects for future returns on stocks are highly likely to be well below long-term norms. Nonetheless, based on the methodology I developed for realistic return expectations a quarter-century ago—a model that has met the test of time—they should be nicely positive. My idea was to separate stock returns into two components: investment return, and speculative return. It turns out that ten-year investment returns are fairly predictable, speculative returns much less so. (Chart 4) Speculative Return: Impact of P/E Change 0.8% -3.4% 3.3% 0.3% -6.3% 9.3% -1.0% -7.5% 7.7% 7.2% -3.

I expressed these principles when doing so was distinctly counter to my own self-interest. Speaking to my partners at Wellington in September 1971—1971!—I cited the very same words of Justice Stone with which I opened my remarks this evening. I then added: I endorse that view, and at the same time reveal an ancient prejudice of mine: All things considered, absent a demonstration that the enterprise has substantial capital requirements that cannot be otherwise fulfilled, it is undesirable for professional enterprises to have public stockholders. This constraint is as applicable to money managers as it is to doctors, or lawyers, or accountants, or architects. In their cases, as in ours, it is hard to see what unique contribution public investors bring to the enterprise. They do not, as a rule, add capital; they do not add expertise; they do not contribute to the well-being of our clients. Indeed, it is possible to envision circumstances in which the pressure for earnings and earnings growth engendered by public ownership is antithetical to the responsible operation of a professional organization. Even though the field of money management has elements of both, there are, after all, differences between a business and a profession . . (So we must ask ourselves this question): if it is a burden to our fund and counsel clients to be served by a public enterprise, should this burden exist in perpetuity?

10. Creating exotic and untested “products” that have proved to have far more ephemeral marketing appeal than enduring investment integrity. Each one of these ten practices, it seems clear, represents a violation of the fiduciary principle. A Piece of History While the overwhelming majority of financial institutions are operated primarily in the interests of their manager/agents and at the expense of their principals, not quite all do so. I now present one exception to this rule, drawing again on my personal experiences in the mutual fund industry. As far back as 38 years ago, I expressed profound concern about the nature and structure of the fund industry. Only three years later, my convictions led to action, and 35 years ago this September, I founded a firm designed, to the best of my ability, to honor the fiduciary principle. I expressed this principle when doing so was distinctly counter to my own self-interest. Speaking to my partners at Wellington Management Company in September 1971—1971!—I cited the very same words of Justice Stone which I cited earlier in these remarks. I then added: I endorse that view, and at the same time reveal an ancient prejudice of mine: All things considered . . . it is undesirable for professional enterprises to have public stockholders. This constraint is as applicable to money managers as it is to doctors, or lawyers, or accountants, or architects.

most noble of faith-based institutions—will long exist. But as so many of our nation’s proudest professions—of which accounting, journalism, and medicine are hardly the only examples— gradually shift their traditional balance away from that of trusted profession serving the interests of the community and toward that of commercial enterprises seeking competitive advantage, the human beings who rely on those services are the losers. Crime and Punishment I reserve some of my harshest criticism for the financial world, including the mutual fund sector in which I’ve spent my entire career. The traditional notion of the trustee was as a financial or legal professional whose overriding duty as a fiduciary was to serve the interests of those whose assets were entrusted to his care. Yet, with the dominance of the agency world of institutional money management that I described earlier, the trustees of “Other People’s Money” (OPM) seem to have turned away from stewardship in favor of building assets under management, increasing fee revenues, carefully controlling costs (even investment management costs), marketing, and taking advantage of any short-cuts available to achieve these goals, carefully avoiding breaking the letter of the law but hardly its spirit. My 2008 book Enough.

Once a profession in which business was subservient, the field of money management has largely become a business in which the profession is subservient. That job is indeed being ill-done today. Business enterprise has taken a back seat to financial speculation. The multiple failings of our flawed financial sector are jeopardizing, not only the financial security of our nation’s savers but the economy in which our entire society participates. Fiduciary Duty Let me take a moment to be clear and explore what we mean by fiduciary duty, a concept that goes back some eight centuries in British common law. Fiduciary duty is essentially a legal relationship of confidence or trust between two or more parties, most commonly a fiduciary or trustee and a principal or beneficiary, who justifiably reposes confidence, good faith, and reliance in his trustee. The fiduciary acts at all times for the sole benefit and interests of another, with loyalty to those interests. A fiduciary must not put personal interests before that duty, and must not be in a situation where his fiduciary duty to clients conflicts with a fiduciary duty to any other entity. Whether we like it or not, fiduciary duty is, in a sense, creeping up on us. ERISA requires companies that sponsor defined contribution plans to be subject to the standard of fiduciary duty—even as it exempts (oddly enough!) some plan service providers, usually mutual fund management companies, from such a standard.

Yet the ideal owner is a long-term stockholder, perhaps even a permanent owner, whose goals are closely aligned with those of the corporation, The Economist of London expressed it well: “Everything now depends on financial institutions pressing even harder for reforms to make boards of directors behave more like overseers, and less like the chief executive’s collection of puppets . . . Financial institutions must also fight to restore their rights as shareholders and use their clout to elect directors, who would be obliged to represent only their collective interest as owners. Chief executives will still run their firms; but, like any other employee, they would also have a boss.” The giant institutions of investment America must take the lead in accomplishing these goals. Our money managers not only hold 75 percent of all shares, but they have the staff to pore over corporate financial statements and proxies; the professional expertise to evaluate CEO performance, pay, and perquisites; and, once full disclosure of all proxy votes (by pension funds as well as mutual funds) becomes mandatory, the incentive to vote in the manner that their beneficiaries have every right to expect. Their dereliction of duty in these areas also bears an important responsibility for what went wrong in our financial sector. (Who, for example, was analyzing those toxic balance sheets of our banks?)

Even more important, never forget Calvin Coolidge’s reminder that character counts. As the president told the National Council of Boy Scouts in 1926, “Character is what a person is; it represents the aggregate of distinctive mental and moral qualities belonging to an individual . . . good character means a mental and moral fiber of a high order, one which may be woven into the fabric of the community and state, going to make a great nation.” What’s more, especially in these days in which pessimism abounds, he’d likely advise us to hold on to our idealism. President Coolidge said, “We make no concealment of the fact that we want wealth, but there are many other things we want very much more. We want peace and honor, and that charity which is so strong an element of all civilization. The chief ideal of the American people is idealism. I cannot repeat too often that America is a nation of idealists.” (One of his predecessors, Woodrow Wilson, said, “Of course I’m an idealist. I am an American, and America is the most idealistic nation on earth.” Some ideas transcend politics!) We must also pay homage to our great American past, and resolve to honor more fully our nation’s founding principles. The Declaration of Independence assures us “that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.” I share those values, and indeed wrote about them in my recent book, Enough.

management, for example, is that a huge portion of the $400 billion that our financial system consumes each year is a dead-weight drag on the returns earned by investors as a group. After all, when we deduct from the gross returns produced in the stock market, the costs that we pay to our investment intermediaries, we investors actually receive only what remains. We investors dine, in fact, at the bottom of the financial food chain. It’s pretty simple, and it’s incontrovertible. To make this point, I rely on the words of Justice Louis D. Brandeis for the knockout punch, the wonderful phrase he gave us in his 1914 book Other People’s Money—“the relentless rules of humble arithmetic.” In The Battle, you’ll also find economists John Maynard Keynes, Paul Samuelson, and Alan Greenspan, and illustrious money manager Warren Buffett, along with the lesser-known but equally successful David Swensen and Jack Meyer, who have carried the Yale and Harvard endowment funds to such incredible heights. They share my concerns, and in pretty pungent language at that. Swensen describes the mutual fund industry as “a massive market failure,” and Meyer describes the investment business as “a giant scam.” But I don’t stop with today’s finest investors. One of my greatest joys in writing The Battle was incorporating some American history into my narrative.

giant manufacturers (think General Electric Capital, for example, or the auto financing arms of General Motors and Ford) to this total, financial earnings now likely exceed 33 percent of the earnings of the S&P 500. While, given the recent collapse of collateralized debt obligations that have already led to the demise of the careers of CEO’s of our nation’s largest bank and largest brokerage firms, that share may decline this year as it remains enormous. We’re moving, or so it seems, to a world where we’re no longer making anything in this country; we’re merely trading pieces of paper, swapping stocks and bonds back and forth with one another, and paying our financial croupiers a veritable fortune. We’re also adding even more costs by creating ever more complex financial derivatives in which huge and unfathomable risks—now beginning to emerge—are being built into our financial system. “When enterprise becomes a mere bubble on a whirlpool of speculation,” as the great British economist John Maynard Keynes warned us 70 years ago, the consequences may be dire. “When the capital development of a country becomes a by-product of the activities of a casino, the job of capitalism is likely to be ill-done.” Once a profession in which business was subservient, the field of money management and Wall Street has become a business in which the profession is subservient.

While equity funds themselves, as a group, are all too likely to deliver that net real return of 2 ½ percent, the dollar-weighted returns of fund investors have lagged the time-weighted returns of the funds themselves typically by at least 2 additional percentage points per year. (Investors appear to chase past performance, and are penalized both by counterproductive market timing and adverse fund selection.) If this pattern continues—and I see no reason that it will not continue—the average equity fund investor could earn a net real return of as little as ½ percent per year over the coming decade. (Chart 10C) Of course, our expectations for stock returns may be too low. On the other hand, I have ignored the impact of excess taxes forced on taxable fund investors by our hyperactive fund managers. While we have no ability to control the level of returns our businesses—and our stock markets—are generous enough to generate in the years ahead, we ought to be thinking about controlling what we can control, including investor costs and investment risks. (These same cautions, of course, apply to thinking about future bond returns. Since decade-long bond returns are established largely by today’s interest rates, we can forecast the nominal return on a portfolio of intermediate-term U.S.bonds

This interest-free ""loan'' from the government is at this moment working for Wesco shareholders and amounted to about $42 per Wesco share at yearend 2006. However, some day, parts of the interest-free ""loan'' may be removed as securities are sold. Therefore, Wesco's shareholders have no perpetual advantage creating value for them of $42 per Wesco share. Instead, the present value of Wesco's shareholders' advantage must logically be much lower than $42 per Wesco share. Business and human quality in place at Wesco continues to be not nearly as good, all factors considered, as that in place at Berkshire Hathaway. Wesco is not an equally- good-but-smaller version of Berkshire Hathaway, better because its small size makes growth easier. Instead, each dollar of book value at Wesco continues plainly to provide much less intrinsic value than a similar dollar of book value at Berkshire Hathaway. Moreover, the quality disparity in book value's intrinsic merits has, in recent years, continued to widen in favor of Berkshire Hathaway. All that said, we make no attempt to appraise relative attractiveness for investment of Wesco versus Berkshire Hathaway stock at present stock-market quotations. Wesco's consolidated balance sheet reÖects total assets of $3.0 billion as of yearend 2006. Of that amount, more than $1 billion has been invested in cash equivalents and Ñxed-maturity investments since early in 2003.

In it, I tell the story of how the wisdom of traditional long-term investment has come to be crowded out by today’s folly of speculation. Our financial markets today are largely driven by dens of speculators who focus on ephemeral stock prices, where they bet against one another with the outcome as certain as the night follows the day. One investor wins the bet, the other loses the bet.

focus on long term investing in business, not short term speculation in stocks. (My next book, to be published in February 2007, drives this message home: The Little Book of Index Investing— The Only Way to Guarantee Your Fair Share of Stock Market Returns.) The second path is what I call the “Societal Solution:” to create, out of our disappearing ownership society and our failed agency society, a new fiduciary society. Here, our agent/owners would be required by federal law to place the interest of their principals first—a consistently enforced public policy that places a clear requirement of fiduciary duty on our financial institutions to serve exclusively the interests of their beneficiaries, that duty would expressly require their effective and responsible participation in the governance of our publicly-owned corporations, and demand the return of our institutional agents to traditional standards of professional stewardship that is long overdue. The Impartial Spectator Together, these changes will compel—and perhaps even inspire—the principals of our corporations and our money managers to improve their own ethical principles. But we also need to raise our society’s expectations of the proper conduct of our leaders. So, in addition to Adam Smith’s almost universally-known Invisible Hand from The Wealth of Nations, we need to call on his almost universally-unknown Impartial Spectator, from Smith’s earlier Theory of Moral Sentiments.

In league with SEC-registered rating agencies (which were paid, as I understand it, some $400,000 for each issue on which they placed their imprimatur), an estimated one trillion dollars of new CDOs were created entirely out of subprime mortgages. While individually these mortgages were of dubious credit quality, the CDOs created various “tranches,” with about 75 percent rated top investment grade - AAA, on the assumption that any defaults would impair only the lower rated series. Alchemy? No, lead is still lead, not gold. How, I wonder (and I’m sure that you wonder too), could they have been so unmindful, so cavalier, so craven about the credit risks that so quickly came home to roost? And how much more is yet to be disclosed about the deteriorating market prices of these complex instruments? We’ll someday know. But we already know some sadly informative anecdotes. Charles Prince, chairman of the giant Citigroup, said it last summer as well as any friend—or foe—of the situation could have: “As long as the music is playing, you’ve got to get up and dance.still

The media are pretty good at publishing substantial information about CEO compensation and options. (Witness “The Perfect Payday” in The Wall Street Journal.) But it doesn’t seem to help. If we want to get serious about the scandal of executive compensation, the media need to tackle it as NBC tackled the profligate waste in federal spending a few years back. At the close of its “Nightly News” it presented a “Golden Fleece Award,” embarrassing the government bureaus involved. My dream is for a new Golden Fleece Award, a weekly naming of CEOs whose compensation is fleecing the company’s shareholders, right there in front of 10 million viewers on NBC. But it’s not going to happen, in part because the media are owned by corporations, those same corporations that are in turn controlled by CEOs, an obvious structural conflict that ought to raise some interesting discussions about where journalism the profession ends, and journalism the business begins. A Final Word In studying “Business and Its Publics,” you’ve chosen a fascinating subject that raises provocative issues about the relationships between business and the stock market and between business conduct and professional conduct, issues which for my nickel don’t get nearly enough attention in the press. So I’m happy that you’re being exposed to them here at NYU/Stern.

brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience, and usually also to give to speculation the deceptive guise of investment. Benjamin Graham, Right Again Graham was right (of course!) It is hardly news to this audience that the emphasis on future expectations noted by Graham continues to be pervasive today. The desire to quantify and model all aspects of our financial lives has carried the day. Even our learned financial journals are peppered with papers offering abstract models that purport to beat the market. But for me, I’m reminded of Albert Einstein’s famous observation: “Not everything that counts can be counted, and not everything that can be counted counts.” As investment professionals, money managers, and security analysts, we ought to focus primarily on investing based on long-term intrinsic corporate value rather than speculating on short-term, even momentary prices in the stock market. It is not the ephemeral perception of the price of a stock that varies from moment to moment that counts; it is the enduring reality of intrinsic value—however difficult to discern that counts. Make no mistake, the worth of a corporation is still neither more nor less than the discounted value of its future cash flows. So financial professionals need a new primary focus—on security analysis rather than market analysis.

therefore, business executives became increasingly attuned to short-term profits and the stock-market valuation of their firm. The growing role of institutional investors fostered continued financial-system evolution by providing a ready pool of buyers of securitized loans, structured finance products, and myriad other exotic innovations . . . something (is) basically wrong with the financial structure.” My own views of our flawed financial system closely parallel these views of Minsky and Keynes. Let me turn, then, to my own concerns about the current state of our commercial institutions—in particular, our giant publicly-held corporations—and our giant investment institutions—now largely owned by giant publicly-held financial conglomerates. Both corporate America and investment America represent a peculiar mix of business and profession, but they have moved a long way from the traditional values of capitalism. The origins of modern capitalism, beginning with the Industrial Revolution in Great Britain back in the late 18th century, had to do, yes, with entrepreneurship and risk-taking, with raising capital, with vigorous competition, with free markets, and with the returns on capital going to those who put up the capital. Central to these values of early capitalism was the fundamental principle of trusting and being trusted. But by the latter part of the 20th century, we were to witness the erosion of the very structure of capitalism.

the expectations of investors rise, not necessarily when sales, margins, or profits rise. But in the long-run, the ephemeral role of expectations and emotions—hope, fear, and greed—are washed away by the eternal (and transcendent) power of business reality. To this crucial distinction, I would add that the expectations market is not only a product of the expectations of active investors but the expectations of active speculators, trying to guess what these investors will expect, and how they will act as each new bit of information finds its way into the marketplace. The expectations market is about speculation. The real market is about investing. The only logical conclusion: the stock market is a giant distraction from the serious business of investing. The market causes investors to focus on transitory and volatile investment expectations rather than on what is really important—the gradual accumulation of the returns earned by corporate business. My advice to you is to ignore the short-term noise of our emotions reflected in our financial markets and focus on the productive long-term economics of our corporate businesses. Shakespeare could have been describing the inexplicable hourly and daily—sometimes even yearly or longer—fluctuations in the stock market when he wrote, “[It is] like a tale told by an idiot, full of sound and fury, signifying nothing.

between enterprise (“forecasting the prospective yield of the asset over its whole life”) and speculation (“forecasting the psychology of the markets”). Keynes was deeply concerned about the societal implications of the growing role of short-term speculation on stock prices. “A conventional valuation [of stocks] which is established [by] the mass psychology of a large number of ignorant individuals,” he wrote, “is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really matter much to the prospective yield . . . resulting in unreasoning waves of optimistic and pessimistic sentiment.” Then, prophetically, Lord Keynes predicted that this trend would intensify, as even “expert professionals, possessing judgment and knowledge beyond that of the average private investor would become concerned, not with making superior long-term forecasts of the probable yield on an investment over its entire life, but with forecasting changes in the conventional valuation a short time ahead of the general public.” As a result, Keynes warned, the stock market would become “a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.” In my thesis, I cited those very words, and then had the temerity to disagree with the great man.

There you’ll find our Declaration of Independence and our Constitution, along with Jefferson, Madison, Washington, Theodore Roosevelt, and Woodrow Wilson, all of whom represent the epitome of integrity-laden political leadership. By including them, I hope to inspire a return to the noble values of our past. The book closes with a wonderful quote from my favorite among our Founding Fathers, Alexander Hamilton: “Is it not time to awaken from the deceitful dream of a golden age, and to adopt as a practical maxim for the direction of our conduct that we are yet remote from the happy empire of perfect wisdom and perfect virtue?” Yes, it is time to awaken, and “to build the world anew.” The Joy of Writing Let me conclude with some reflections on the joy of writing. There are many delights in writing . . . if not for the world, surely for oneself. Even if your mind is light years from the genius category and sort of chaotic and unfocused, as mine is, active but undisciplined, and with the slightest interruption giving one a severe case of ADD (Attention Deficit Disorder), writing can bring order out of the chaos.about

And early in 2008, one fund manager (Federated Investors) called for “A New Paradigm for Federal Regulation of Financial Intermediaries,” suggesting that “all financial intermediaries that provide advice to individual customers should be fiduciaries.” A few weeks ago, Federated received what seemed to me surprising support from Paul Stevens, President of the Investment Company Institute, the principal lobbyist for fund management companies. The fiduciary standard, Stevens suggested, requires advisers to put their clients’ interests first, and “does provide a standard of responsibility and accountability.” He then asked the rhetorical question, “Isn’t that something that all of our recent experience suggests is important?” My answer: “Unequivocally yes.”

Not only had “trusting and being trusted” come to play a diminishing role, but the actual owners of our businesses were relegated to a secondary role in the functioning of the system, the result of two major developments. First, in our old “ownership society,” the shares of our corporations were held almost entirely by direct stockholders, but today it is giant financial institutions that call the tune. Since 1950, direct ownership of U.S. stocks by individual investors has plummeted from 92 percent of all shares to 30 percent, while indirect ownership by institutional investors has soared from 8 percent to 70 percent. Our old ownership society is gone, and it is not going to return. In its place we have a new “agency society” in which our financial intermediaries now hold effective control of American business. But these new agents haven’t behaved as agents should.the

While I’ve been around long enough to be roughly the age of your grandfathers, I hope I’ve stimulated your interest in these issues, and especially in the profound conflicts of interest so sharply delineated in the financial corner of the giant world of business and commerce. I hope, finally, that you’ll think about the message sent through me by Kurt Vonnegut in “Enough” and take up, as part of your career and your mission, to go out there and build a better world. And that’s what I tell my 12 grandchildren too.

In their cases, as in ours, it is hard to see what unique contribution public investors bring to the enterprise. They do not, as a rule, add capital; they do not add expertise; they do not contribute to the well-being of our clients. Indeed, it is possible to envision circumstances in which the pressure for earnings and earnings growth engendered by public ownership is antithetical to the responsible operation of a professional organization. Even though the field of money management has elements of both, there are, after all, differences between a business and a profession. My candor—Wellington Management was then owned largely by public investors—may well have played a supporting role in my dismissal as chief executive of Wellington Management Company in January 1974.gave

True Measures of Money, Business, and Life has ten chapters (called “the Ten Commandments” by management guru and author Tom Peters), each with a common cadence—too much cost, not enough value; too much speculation, not enough investment; too much complexity, not enough simplicity, too much counting, not enough trust; too much salesmanship, not enough stewardship, and so on. These trends clearly reflect the triumph of business standards over professional values. However, given the horrific events in the financial field during the past decade, I should have added an eleventh chapter (though that would have killed the Ten Commandments metaphor!) entitled “too much crime, and not enough punishment.” I’m not sure which bothers me more—the rampant spread of criminal conduct (that is, violations of law) during the recent era, or the disappointing lack of serious punishment of those individuals, the decision-making principals of the firms involved. The number of firms found in violation of securities laws is little short of staggering. I understand that in the academic community “Wikipedia” is not accepted as a valid source, but its “Timeline” on financial scandals covers seven full pages, with 42 separate cases.the

Combining these two sources, reasonable expectations suggest total stock market annual nominal returns in the range of 6 percent to 8 percent during the coming decade, call it a likely outcome of 7 percent. 2.0% 3.5% 0% 2% 4% 6% 8% Reasonable Expectations for the Future 7% Equity Returns, Next 10 Years 3.8%

” The way to investment success is to get out of the expectations market of stock prices and cast your lot with the real market of business. Simply heed the timeless distinction made by Benjamin Graham, legendary investor, author of The Intelligent Investor, and mentor to Warren Buffett. He was right on the money when he put his finger on the essential reality of investing: “In the short run the stock market is a voting machine . . . (but) in the long run it is a weighing machine.” 3. Who Earns the Stock Market’s Returns? But whatever returns the stock market is generous enough to deliver in the years ahead, please don't make the mistake of thinking that investors actually earn those returns. To explain why this is the case, we need only to return to that first relentless rule of humble arithmetic that explains the simple mathematics of investing: All investors as a group must necessarily earn precisely the market return, but only before the costs of investing are deducted.amount

values of capitalism, the virtuous circle of integrity and trust and trustworthiness that is its obligation to our society. In the era that lies ahead, the prudent fiduciary, the trusted businessman, and the honest steward must once again be our paradigms. For the fact is that, in the long run, good ethics is good business, part of that virtuous circle that builds our society. Enough. True Measures of Money, Business, and Life I wrote my new—7th—book largely because I care deeply about the issues I’ve discussed today. The crisis in capitalism, the failure of our agency system, the need to restore our traditional values that have been so severely eroded, not only in our communities but in our financial system, in our businesses, and even in our own lives. The story of ENOUGH. begins with a sort-of-poem by Kurt Vonnegut entitled “Joe Heller,” that appeared in The New Yorker in April 2005. It was a tribute to the late author of Catch 22—one of the seminal books of the post-World-War-II era, and one of its most successful. I can summarize the short poem in just a few words: At a party given by a billionaire on Shelter Island, Kurt Vonnegut tells Heller that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch - 22 over its whole history. Heller responds, “Yes, but I have something he will never have . . . enough.” Enough. I was stunned by the profound and simple elegance of that word. Think about it.

2% 0.2% -10% -5% 0% 5% 10% 15% ? 4.7% 2.0% 5.6% -5.6% 9.9% 3.9% 5.5% 9.9% 4.4% 7.4% 0.8% 4.8% 4.8% 3.5% 4.3% 5.9% 4.5% 5.0% 6.9% 3.1% 3.5% 5.2% 3.2% 1.2% 4.5% 2.2% -10% -5% 0% 5% 10% 15% 20% 8.2% 6.3% 11.5% -1.1% 14.9% 10.8% 8.6% 13.4% 9.6% 10.6% 2.0% 9.3% 7.0% Dividend Yields Have Accounted for Half of the Long-Term Returns on Stocks Market Return (S&P 500) 9.0% 2.9% 14.8% -0.8% 8.6% 20.1% 7.6% 5.9% 17.3% 17.8% -1.2% 9.5% 7.0% -5% 0% 5% 10% 15% 20% 25% 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s 1900 – 2011 Avg Investment Return: Dividend Yield and Earnings Growth Oct.decade

Unless those funds can be attractively reinvested in acquisitions, equity securities or other long-term instruments of the type that helped cause the long-term growth of Wesco's shareholders' equity, future returns on shareholders' equity will probably be less than those of the past. Due to the current size of Wesco and its parent, Berkshire Hathaway, Wesco's opportunities for growing shareholders' equity are unlikely to be as attractive as in the past.

My candor may well have played a supporting role in my dismissal as chief executive of Wellington Management Company in January 1974. While it’s a saga too complex to detail this evening, my firing gave me the chance of a lifetime—the opportunity to create a new fiduciary- focused structure for our funds. I proposed just such a structure to the directors of the Wellington funds.* Wellington Management Company, of course, vigorously opposed my efforts. Nonetheless, after months of study, the directors of the funds accepted my recommendation that we separate the activities of the funds themselves from their adviser and distributor, so that the funds could operate solely in the interests of our fund shareholders. Our new structure involved the creation of a new firm, The Vanguard Group of Investment * This lecture at Columbia University is essentially the third part of a trilogy that chronicles the development of the fund industry and of Vanguard itself. The first two parts of the trilogy were my speech at Boston University Law School on January 21, 2004 (“Re-Mutualizing the Mutual Fund Industry—The Alpha and the Omega”); and my speech at George Washington University on February 19, 2008 (“A New Order of Things: Bringing Mutuality to the ‘Mutual’ Fund”).

Portfolio managers, in what I predicted—accurately, as it turned out—would become a far larger mutual fund industry, would “supply the market with a demand for securities that is steady, sophisticated, enlightened, and analytic [italics added], a demand that is based essentially on the [intrinsic] performance of a corporation [Keynes’s enterprise], rather than the public appraisal of the value of a share, that is, its price [Keynes’s speculation].” Alas, the steady sophisticated, enlightened, and analytic demand I had predicted from our expert professional investors is now nowhere to be seen. Quite the contrary! Our money managers, following Oscar Wilde’s definition of the cynic, seem to know “the price of everything but the value of nothing.” Portfolio turnover of equity mutual funds, then running steadily about 15 percent, year after year—has soared in recent years to more than 100 percent—an average holding period of less than one year. So, a half-century-plus after I wrote those words in my thesis, I must reluctantly concede the obvious: Keynes’ sophisticated cynicism was right, and Bogle’s callow idealism was wrong. But that doesn’t mean we should let that system prevail forever.

dancing.” (Rubin never heard of the “liquidity put.” Yet, as 2007 ended, Citigroup would write- down an astonishing $22 billion for expected future losses on CDOs and consumer loans). For Merrill Lynch, the write-down was $22 billion. Following a long age of cheap credit and rife credit availability and borrowers with high confidence and low collateral, we are beginning to pay the price, even as our economy itself faces a whole plethora of other risks created by our financial system. The key question is the extent to which these problems in our financial system will infect our economic system. The long boom in the real estate market has now turned down, with home prices in retreat, even as the same thing happened in the stock market early in 2000, and stock prices are now below the levels they reached eight long years ago. As I see it, our policy makers are running scared, with the Federal Reserve making credit available to banks (a good, and necessary step) and driving short-term interest rates down (great for borrowers but terrible for lenders and savers, and probably terrible for the dollar). I’m not at all sure that this is sound policy-making, for it increases the likelihood that inflation will rear its ugly head later on. Maybe, just maybe, we should not intervene and just let the markets clear.

Harvard Business School Professor Rakesh Khurana was right when he defined the conduct of 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. There’s another difficult reality here, for the financial economy. While my simple insight provides a solid framework for understanding stock market returns, however, I failed to consider the extent to which speculation in the financial economy (emotions) might influence changes in the business economy (enterprise). But when I learned of the work of the great American economist, Hyman Minsky (1919-1996), who dedicated his career largely to what he described as the “financial instability hypothesis,” I recognized that yet another element of risk—here, clearly, meaning uncertainty—existed.5 “In 1974, Minsky observed a fundamental characteristic of our economy that linked finance and economics: ‘The financial system swings between robustness and fragility, and these 5 In the following four paragraphs, I quote investment adviser Frank K. Martin, CFA, writing in the 2006 annual report of his firm, Martin Capital Management.

But the game is not symmetrical, for the Wall Street casino wins every time, meaning that for investors as a group, beating the stock market is—mathematically, tautologically—under all circumstances a zero-sum game. But because of those expensive croupiers, investing becomes a loser’s game because of the huge costs of running the casino. These momentary leaps and falls in stocks that we pay so much attention to each day are essentially meaningless—(if you like Shakespeare) “A tale told by an idiot, full of sound and fury, signifying nothing”. Or (if you like that formulation by all-time great investor Benjamin Graham, Warren Buffett’s mentor) “a huge laundry in which institutions take in large blocks of each other’s washing . . . without true rhyme or reason.” In today’s laundry, stocks change hands at enormous volume every day, every minute, every nanosecond. (When I joined this industry in 1951, stock exchange daily volume was less than 2 million shares a day; today 8 billion shares are traded on a typical day.) We use the stock market to invest, to be sure, because investing in stocks is the only realistic and broadly-available means in which we can be owners of capital, and obtain the benefits of the long-term growth of our major corporations, which in turn closely parallels the growth of our American economy.

But we also need more candor and involvement in understanding the process of valuing stocks. It is our corporations that create value, and the stock market is merely a derivative of that value. In my 2012 book The Clash of the Cultures: Investment vs. Speculation, I noted the failure of 10 sets of gatekeepers, each of which failed in its role to ensure that our corporate system works in the interests of investors. Three of those failed gatekeepers are especially relevant to all of us here this evening: corporate managers, money managers, and security analysts. Of course, the ultimate gatekeepers are the shareholders themselves. But in today’s agency society—with 70 percent of all U.S. corporate shares held by financial institutions—the manager/agents of those shareholders have been largely unwilling to stand up and be counted.

When they return—as they must—to their traditional focus on long-term investing, these institutional owners must fight for the access to the levers of control over the corporations they own that are both appropriate for their dominant ownership position and a reflection of their willingness to accept both the rights and responsibilities of corporate citizenship. And if these institutions do not soon return to traditional standards of prudent investment, we’ll have to institute a Federal stature of fiduciary duty, under which the interests of those whose capital is at stake comes first—a new ownership focus for our flawed agency-society. And this is one of the major reforms in the regulation we need in our emerging financial system. The task of returning capitalism to its owners will take time, true enough. But the new reality—increasingly visible with each passing day—is that proper corporate governance is not merely an ideal to be debated. It is a vital necessity to be practiced. The role of the owners, I underscore, is to do no more than ensure that the interests of directors and management are aligned with those of the shareholders in a substantive way. When there is a conflict of interest, it is the shareholders who should make the decision. It is in the national public interest and in the interest of investors that the owners—represented largely by investment America—come to realize that enlightened corporate governance is not merely a right of business ownership.

Just who is this impartial spectator, the force that arouses in us principles that are often so generous and so noble? It is the man within, shaped by the society in which he exists, even the soul, who gives us our highest calling. In Smith’s words, “It is reason, principle, conscience, the inhabitant of the breast, the man within, the great judge and arbiter of our conduct.” It is this impartial spectator, Smith tells us, “who calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it; and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from him only that we learn the real littleness of ourselves. It is this impartial spectator . . . who shows us the propriety of generosity and the deformity of injustice; the propriety of reining the greatest interests of our own, for the yet greater interests of others . . . in order to obtain the greatest benefit to ourselves.upon

True Measures of Money, Business, and Life. While we all may be created equal, however, we are born into a society where inequality—of family, of education, and, yes, even of opportunity—begins as soon as birth takes place. But our Constitution demands more. “We the People” are enjoined “to form a more perfect Union, establish Justice, insure domestic Tranquility . . . promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity.” These are not mere words; they represent the challenge of our age.

at about 4 ¾ percent, or about 2 ¼ percent after inflation—but before all-in bond fund costs of 1½ to 2 percent.) III. Innovation, Simplicity and Complexity To be sure, while all of us collectively are bound by the returns that are generated by the stock and bond markets, some of us will do better, some worse. Financial innovations designed to help us do better have been created all through history. But during the last decade, innovation has burgeoned to levels that are truly remarkable. Part of the reason is the expectation that stock and bond returns will lag behind historic norms—and far behind the halcyon norms of the 1980s and 1990s, when stock returns averaged 17 percent (!) and bond returns averaged 9 percent (!) (“We never had it so good.” Literally!) But if we know (within a fairly narrow tolerance) what returns to expect from broadly-diversified portfolios of stocks and bonds, what explains our expectations (or our hopes) that we can out-guess the markets and add additional returns by selecting strategies or managers that hold optimal subsets of the market portfolio? I fear that it is the triumph of hope over experience. The incredible rise—and fall—of so many derivative instruments in the present era should raise a red flag of caution regarding the value of financial innovation to investors. The flood of complexity—and its attendant high costs—seems to have overwhelmed simplicity—with its attendant low costs.

Investment returns (top line of figures) are generated by the initial (known) dividend yield on stocks (red bar), about 2 percent today, plus subsequent earnings growth (blue bar), averaging about 5 percent. A reasonable expectation for investment return in the coming decade is therefore around 7 percent, measured in today’s dollars. Such a return would be well below the historical norm of 9 percent (second column from the right)—creating a huge gap in appreciation of cumulative equity wealth during the coming decade. (Reminder: These are the market returns, before investment costs. Investors as a group do not—indeed cannot—earn these returns.) The second element, speculative return (green bar), depends entirely on investor expectations and investor behavior. Unlike investment return, speculative return is enormously variable. We can easily measure it by the number of dollars that investors are willing to pay for each dollar of future earnings on stocks. If valuations a decade hence prove to be materially higher or lower than today’s price-earnings multiple of about 16 times, speculative return would be an important factor in the stock market’s performance. For example, a valuation of 20 times could add about 2 percentage points per year, to returns raising that 7 percent investment return to a 9 percent total return. A drop to 12 times, on the other hand, would cost about 3 percentage points, dropping the 7 percent return to just 4 percent.

principals whom they are duty-bound to represent—those 100 million families who are the owners of our mutual funds and the beneficiaries of our pension plans. Some 200-plus years ago, Adam Smith described this “agency problem” in these simple terms: Managers of other people’s money (rarely) watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail. And so in the recent era, negligence and profusion have prevailed among our money manager/agents, even to the point of an almost complete disregard of their duty and responsibility to their principals. Too few managers seem to display the “anxious vigilance” over other people’s money that once defined the conduct of investment professionals. The second reason for the debasement of the values of traditional capitalism is that our new investor/agents not only seemed to ignore the interests of their principals, but also seemed to forget their own investment principles. In the latter part of the twentieth century, the predominant focus of institutional investment strategy turned from the wisdom of long-term investing to the folly of short-term speculation. During the recent era, we entered the age of expectations investing, where projected growth in corporate earnings—especially earnings guidance and its subsequent achievement, by fair means or foul—became the watchword of investors.

We live in wonderful and sad times—wonderful in that the blessings of democratic capitalism have never been more broadly distributed around the globe, sad in that the excesses of that same democratic capitalism have rarely been more on display. The rampant greed that has overwhelmed our financial system and our corporate world runs deeper than money. Not knowing what enough is subverts our society’s traditional values, as self-interest and greed replace community interest, and service to self takes priority over service to others. Unchecked, our failures ultimately result in the corruption of our character and our values. So in a broader sense, we all bear some of the responsibility for what has gone wrong in America.

It is a responsibility to the nation. In these days when we seem to like “stories” to explain complex issues, each of these men exemplify, respectively three short anecdotes centered on individuals whose names will be familiar to you—(1) Alan Greenspan, (2) Bernard Madoff, and (3) Barack Obama, an unlikely triumvirate if ever there were one—and their respective roles in: (1) how this financial crisis began, (2) how we fooled ourselves, and (3) what we must do to work out way through the incredibly intractable economic woes that now plague us. I’ll do this analysis by relating. Alan Greenspan and the Bubble First, former Federal Reserve Chairman Alan Greenspan. More than any other individual, he was central to the development of the financial bubble and the burst that inevitably followed.lenders

Where Were the Analysts? One might think that the professional security analysts of our giant financial institutions would have been the principal line of defense against the accounting scandals that we have witnessed over the past decade. But our sell-side analysts (i.e., advice-givers representing investment banking firms) are confronted with obvious conflicts of interest, and they largely failed to report the financial shenanigans that were taking place on the books of the companies whose stocks they were covering. Conflicts of interest were rife, especially when the firms employing them—for huge compensation—were engaged in public offerings of the very companies for whose stock coverage they held responsibility. Mike Mayo, a long-time banking and finance analyst, and author of Exile on Wall Street, candidly describes his observations of the analyst community. Here are some of his Mayo’s blunt and perceptive words: Analysts are supposed to be a check on the financial system—people who can wade through a company’s financials and tell investors what’s really going on. There are about 5,000 so-called sell-side analysts, watchdogs over U.S. companies. Unfortunately, some are little more than cheerleaders—afraid of rocking the boat at their firms, afraid of alienating the companies they cover and drawing the wrath of their superiors.

One example: Collateralized debt obligation (CDOs) have wreaked havoc among our commercial banks and our investment banks, and credit default swaps (CDS) now total an astonishing $600 trillion—speculative derivatives of credit instruments that themselves total less than $20 trillion—an amount of speculation 25 times (!) that modest amount of (risky) underlying investment. We know almost nothing about the counterparties to this boatload of CDS that embody the excesses of our financial system—innovation designed to benefit those who create these instruments rather than those who own them. There’s a wonderful story about an investment banker addressing his colleagues: “the bad news is that we’ve lost an enormous amount of money. The good news is that none of its ours.” The mutual fund industry, of course, is no stranger to financial innovation. Consider the new “products” we created during the recent Information Age bubble. As the stock market soared to new highs—and unprecedented P/E multiples—fund innovation focused on its hottest sectors. During the last three years of the decade alone, we formed nearly 500 new funds investing in technology, telecom, and Internet stocks, compared to only 87 such funds in the decade’s first three years. (Only one pure technology fund during the first three years; 116 in the last three.)aggressive

Wesco's shares were listed for many years on both the American Stock Exchange and, since 1963, on a regional exchange previously known as the PaciÑc Stock Exchange. Following the recent merger of various regional exchanges into the NYSE, the PaciÑc Exchange became the NYSE Arca exchange. We had happily paid a minimal annual listing fee of $1,000 for the privilege of having our shares listed on the PaciÑc Exchange. When notiÑed last December that NYSE Arca had decided to increase Wesco's annual listing fee to $30,000, Wesco voted with its feet. Its shares are now listed only on the American Exchange. The Board of Directors recently increased Wesco's regular dividend from /2 cents per share to 371 /2 cents per share, payable March 8, 2007, to shareholders of record as of the close of business on February 1, 2007. This annual report contains Form 10-K, a report Ñled with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited Ñnancial statements bearing extensive footnotes. As usual, your careful attention is sought with respect to these items. Shareholders can access much Wesco information, including printed annual reports, earnings releases, SEC Ñlings, and the websites of Wesco's subsidiaries and parent, Berkshire Hathaway, from Wesco's website: www.wescoÑnancial.com. Charles T. Munger Chairman of the Board and President February 27, 2007

Our political leaders, too, seem to have pressed some sort of panic button, enough (apparently) to unite a Democratic congress and a Republican administration in an election year. But I’m also concerned that the $150 billion fiscal stimulus plan—right out of Keynesianism— will not provide much in the way of stimulating the economy, even as it adds to an already staggering deficit in the Federal budget. (Yes, giving money to “the people” has a cost, even though I’ve yet to see an acknowledgement of that yet. It must be paid for, either by taxation or by borrowing, and ultimately with devalued dollars.) In short, it is by no means clear that this combined blast from our monetary masters and our fiscal authorities will make a large difference. Not only are our markets driven by the confidence of investors putting their dollars on the line, but our economy is driven by the confidence of consumers spending on their needs and wants, and corporations, spending to enhance the returns on their capital. The inherent risk in the stock prices—in the first instance based on speculation, emotions, and investor psychology—may well carry over to the performance of our economy, now approaching—if not already in—recession.off

These thoughts were echoed by Coolidge: “When people begin to cherish plans for everything save the common welfare, the decay of that country has begun.” It’s been a special delight for me to see so many parallels between my own humble work and the solid, traditional and conservative values of President Calvin Coolidge. Here’s how he summed them up, Material resources do not, and cannot, stand alone. They are the product of spiritual resources. It is because America, as a nation, has held fast to the higher things of life, because it has had a faith in mankind which it has dared to put to the test of self-government, because it has believed greatly in honor and truth and righteousness, that a great material prosperity has been added unto it. I too have spent most of my recent decades focused on character and values, the homespun elements that come down to moral conduct, integrity, and honor. Tonight, let’s pledge never to forget them. And, yes, let’s hold our persistence and determination high, more than ever in the challenging global environment which demands the active participation of our entire citizenry. In President Coolidge’s timeless words with which I opened these remarks: “The slogan ‘Press On’ has solved and always will solve the problems of the human race.” Thank you for your attention, ladies and gentlemen. And press on—Press On, Regardless.

precisely equal to the aggregate amount of those costs. In a market that returns 10 percent, we investors as a group earn 10 percent (Duh!), pay our financial intermediaries, and then pocket whatever remains. Two conclusions: 1) Beating the market before costs is a zero-sum game; 2) Beating the market after costs is a loser's game. The returns earned by investors in the aggregate inevitably fall well short of the returns that are realized in our financial markets. How much do those costs come to? In equity mutual funds, management fees and operating expenses—the "expense ratio"—average about 1.4 percent per year of fund assets. (Chart 3) Add another half of 1 percent to 1 percent in portfolio turnover costs—let’s call it 0.7 percent—and, say, another 0.5 percent to 1 percent in the annual impact of front-end sales loads; say, another 0.7 percent. Result: the total cost of equity fund ownership comes to roughly 2.8 percent per year. So yes, costs matter. The great irony of investing, then, is not only that you don't get what you pay for. The reality is quite the opposite: You get precisely what you don't pay for. So if you pay for nothing, you get everything. How much do costs matter? A ton! Indeed, fund costs have played the determinative role in explaining why, for example, during the quarter-century from 1980–2005, when the return on the stock market itself averaged 12.5 percent per year, the pre-tax return on the average mutual fund averaged just 10.0 percent. That 2.

sending a message and persuading others to accept it; and even about presenting facts and figures and logic to elevate the level of discourse. For me, the hardest job in writing is to begin. So I get out the lined yellow legal pad, and put pen to paper. If I can do it, you can do it too. Organize your thoughts, chapter by chapter. In each chapter, try and have an interesting beginning, perhaps a familiar quotation, or a quotation not so familiar but perfect for the theme. Then make sure that sentence A leads to sentence B, that paragraph 1 leads to paragraph 2, and so on. Follow that process chapter after chapter, and when you’ve gotten your message across, well, write a conclusion. Follow the old saw and “tell them what you told them.” I happen to favor idealistic, even spiritually uplifting conclusions, which is why I shamelessly call on the great figures of history—especially American history—to pull it all together, just as I did in The Battle. Of course, when your book is published, there’s no thrill quite like holding that first copy in your hand. It’s a book, and I wrote it! Then, if you’re lucky, come the reviews. I’ve been lucky. But one must have a thick skin, for there are both good and bad reviews. The bad stings for a moment; I’ll confess that. But only for a moment. Mostly it’s more like rain bouncing off a duck’s back, but it can be tough. Here’s a review from The New York Times of Character Counts: The Creating and Building of the Vanguard Group.

me the chance of a lifetime—the opportunity to create a new fiduciary-focused structure for our funds. I proposed just such a structure to the directors of the Wellington funds. Wellington Management Company, of course, vigorously opposed my efforts. Nonetheless, after months of study, the directors of the funds accepted my recommendation that we separate the activities of the funds themselves from their adviser and distributor, so that the funds could operate solely in the interests of our fund shareholders. Our new structure involved the creation of a new firm, incorporated on September 24, 1974, The Vanguard Group of Investment Companies, owned by the funds, employing their own officers and staff, and operated on an “at-cost” basis, would be unique in the field, a truly mutual mutual fund organization. While Vanguard began with a limited mandate—to provide only administrative services to the funds—I realized that, if we were to control our own destiny, we would also have to provide both investment advisory and marketing services to our funds. So, almost immediately after Vanguard’s operations commenced in May 1975, we began our move to gain substantial control over these two essential functions. By year’s end, we had created the world’s first index mutual fund, run by Vanguard.

Now to bond returns. Since the entire source of the fundamental return over the subsequent decade is the current interest rate, we can reasonably expect an annual investment return near today’s yield of 3 percent in a diversified portfolio of Treasury and investment-grade corporate bonds. If held for the full ten years, the final value of the bond portfolio is likely to center on its initial par value, assumed to be 100. So, with little or no significant speculative return (positive or negative) affecting the calculation, we can expect an annual total return on bonds in the range of 2 to 4 percent. Let’s assume a likely return of 3 percent. Over the coming decade, that difference between stocks and bonds matters. If stocks should return 7 percent, nominal capital would increase by about 100 percent. If bonds should return 3 percent, nominal capital would rise by about 35 percent. For a traditional 60/40 stock/bond portfolio, the expectation would be around 6 percent, or an 80 percent gain. CAUTION: these figures are merely my rational expectations. While I can guarantee an uneven path for both along the way, I can’t guarantee the final outcome. V.

nation’s largest financial and business firms—including Goldman Sachs, Merrill Lynch, American International Group, Citigroup, Xerox, KPMG, and Marsh and McLennan. Let me give just three examples: 1. The Fund Timing Scandals. The mutual fund market timing scandals were uncovered by New York attorney general Eliot Spitzer in 2003. A dozen or more major fund managers were involved in allowing scores of hedge funds to make what were essentially risk-free short-term trades, diluting the returns of the other investors in the funds. Putnam, Merrill Lynch, Massachusetts Financial Services. Alliance Capital, Janus, and Prudential only begin the list. What we had, simply put, was a conspiracy between hedge fund managers and mutual fund managers to defraud the long-term shareholders of the mutual funds involved. No individuals (as far as I know) were imprisoned for these crimes. And while many fines were assessed on the fund companies, most of the individual perpetrators paid little or nothing. (In a related case, Putnam president Lawrence Lasser was fined $25,000. Modest punishment indeed, when related to his compensation as Putnam chief, a total of more than $160 million during 1998-2002 alone.) 2. “Pay-to-Play.” Another mutual fund case was equally shocking. Capital Group of Los Angeles, manager of the giant American Funds complex, was regarded as one of the most ethical and professional firms in the industry.

In the ideal, our corporations represent the best way for us to build a growing family wealth base through ownership, rather than the, well, loanership of family savings earnings a fixed rate of return, and getting repaid at a certain future date. Owning Stocks vs. Owning Corporations Of course individual stocks are extremely risky. Capitalism assures us that with free and open markets and unfettered competition (we’re not there yet!), corporations have to fight each day for their right to exist.think

many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, the love of what is honourable and noble, the grandeur, and dignity, and superiority of our own characters.” With these powerful words, Adam Smith—yes, Adam Smith—touches on nearly all of those traditional ethical principles of which I spoke at the outset. And leave it to Bill George, former chief executive of Medtronic and one of our nation’s most respected business leaders, whom you honored last year with the very award with which you favor me this evening, to translate those societal principles into business principles. He describes them in his wonderful book, Authentic Leadership. Let me cite a few excerpts: “Authentic leaders genuinely desire to serve others through their leadership. They are more interested in empowering the people they lead to make a difference than they are in power, money, or prestige for themselves. They are as guided by qualities of the heart, by passion and compassion, as they are by qualities of the mind . . . Authentic leaders lead with purpose, meaning, and values. They build enduring relationships with people. They are consistent and self-disciplined. When their principles are tested, they refuse to compromise. “Their authentic companies create performance. [Dare I say real performance?] Values begin with telling the truth, internally and externally. Integrity must run deep in the fabric of an organization’s culture.

Yet both the Federated and the ICI comments seemed to gloss over the fact that there are two types of investment advisers, albeit similarly defined. In the 1940 Investment Company Act, the term “investment adviser” essentially means a management company that regularly furnishes advice to a mutual fund with respect to the selection and management of portfolio securities. In the Investment Advisers Act, the term “investment adviser” essentially means any firm that engages in the business of advising others and receives compensation for doing so, and excludes broker- dealers whose performance of such services is solely incidental to the conduct of his business as a broker-dealer. I totally support the efforts of FI360 to extend the standards of fiduciary duty that now apply to advisers registered under Investment Adviser Act to all financial advisers. While, the earliest financial planning group to operate under this standard is NAPFA, consisting of fee-only planning and advisory firms but that standard is now advocated by the Financial Planning Association (FPA), the Investment Adviser Association, the North American Securities Administration and the CFA Institute. But the fiduciary industry standard must be extended to other financial advisors, including broker-dealers who elect to act as advisors. Of course this idea generates considerable heat, but I am not sure why.

Why? Because our society is paying a high price for the shift that Keynes so accurately predicted. As professional institutional investors moved their focus from the wisdom of long-term investment to the folly of short-term speculation, “the capital development of the country [became] a by-product of the activities of a casino.” Just as he warned, “when enterprise becomes a mere bubble on a whirlpool of speculation, the job of capitalism is likely to be ill-done.” And that is one thing that we can’t allow to endure. A Princeton Education I freely confess that I am struck by the confluence of the simple arithmetic of investing and the simplistic virtue of ethical values that have shaped my long career. Both were inspired by my Princeton education and frequent encounters with remarkable Princetonians, beginning with my mentor Walter L. Morgan, ’20, and surely enhanced by my brother-in-law John J.F. (Jay) Sherrerd ’52, the late great Princeton Trustee. In my recent years especially, I’ve reflected on the relationship between these keystones of simple arithmetic and simple values, and how they paralleled my awakened interest in the culture of engineering and my long-standing love for the humanities. In retrospect, I fear that I was too narrow, too cautious in selecting my courses at Princeton.

Companies, owned by the funds, employing their own officers and staff, and operated on an “at- cost” basis, a truly mutual mutual fund firm. While Vanguard began with a limited mandate—to provide only administrative services to the funds—I realized that, if we were to control our own destiny, we would also have to provide both investment advisory and marketing services to our funds. So, almost immediately after Vanguard’s operations commenced in May 1975, we began our move to gain substantial control over these two essential functions. By year’s end, we had created the world’s first index mutual fund, run by Vanguard. Early in 1977, we abandoned the supply-driven broker-dealer distribution system that had been operated by Wellington since 1928, in favor of a buyer-driven “no-load” approach under our own direction. Later that year, we created the first-ever series of defined-maturity bond funds, segmented into short-, intermediate-, and long-term maturities all focused on high investment quality. Then, in 1981, Vanguard assumed responsibility for providing the investment advisory services to our new fixed-income funds as well as our established money market funds. (As you can imagine, none of these moves was without controversy!) Let me give you some sense of the importance of those changes. Since our formation in 1974, the assets of the Vanguard funds have grown from $1 billion-plus to some $1 trillion today.

swings are an integral part of the process that generates business cycles.’ Moreover, according to Minsky, the prevailing financial structure is a central determinant of the behavior of the capitalist economy. Likewise, the dynamism of profit-driven motives influence economic activity within the context of a given institutional structure in that the structure itself changes in response to profit seeking. Resonating with the ideas of economist Joseph A. Schumpeter, Minsky emphasized that: Financial markets will not only respond to profit-driven demands of business leaders and individual investors but also as a result of the profit- seeking entrepreneurialism of financial firms. Nowhere are evolution, change, and Schumpeterian entrepreneurship more evident than in banking and finance, and nowhere is the drive for profits more clearly the factor making for change. “The financial system takes on special significance in Minsky’s theory, not only because finance exerts a strong influence on business activity, but also because this system is particularly open—or, as some might claim, prone—to innovation, as is abundantly evident today. Continues Minsky: ‘Since finance and industrial development are in a symbiotic relationship, financial evolution plays a crucial role in the dynamic patterns of the economy.’ “The raison d’être for money managers, and basis by which they are held accountable, is the maximization of the value of the investments made by their clients.

of corporate earnings growth, followed by actual earnings declines. Thus the probabilities favor continued market turbulence—and some economic turbulence as well. These risks of investing in business and in the economy are well known. But there are other huge, seemingly unacknowledged risks out there in our society. The risks presented by the Social Security and Medicare payments committed to by our national government. For that matter, the staggering string of huge (and in fact understated) deficits in our Federal budget. Our enormous expenditures (soon to reach $1 trillion) on the wars in Iraq and Afghanistan, bleeding the resources of our empire. Terrorism; the threat of global warming and the cost of dealing with it. Unfettered global competition, our trade deficit, and the decline in the value of the U.S. dollar. There are other risks, too, more subtle in nature. Forgive me here for going where angels fear to tread but, a political system dominated by money and vested interests; a Congress and an administration seemingly focused entirely on the short-term, the long-term consequences be damned. The vast chasm between the very wealthiest among us (the top 1 percent of our citizenry holds more than a third of our total wealth) and those at the bottom of the economic ladder (some 20 percent of New York City residents earn less than $8,300 per year).

It guides the everyday actions of employees and is central to its business conduct. Transparency is an integral part of integrity. The truth, both successes and failures, must be shared openly with the outside world. Authentic companies [dare I say real companies?] value the importance of stewardship to the people they serve—customers, employees, shareholders, and communities. “Stock price,” Bill George continues, “is not the best measure (of shareholder value) because it is so heavily influenced by . . . investor expectations, market psychology, and the overall trend of the market. Sustained growth in revenues and earnings per share, cash flow, and return on investment are still the best measures of how well a company is performing. The best path to long-term growth in shareholder value comes from having a well-articulated mission that inspires employee commitment and the confidence and trust of clients.”

But those are fairly big moves for valuations, and I don’t personally see significant reasons either for multiples to rise much (and thus produce positive speculative returns) or to fall much (and thus produce negative speculative returns). So I expect that our possible 7 percent investment return (far right bar) will be neither materially enhanced nor materially depleted by speculative return during the coming decade. But even if stocks seem likely to provide adequate returns, nearly all prudent investors still need a balanced portfolio, including bonds, to reduce risk and contain volatility. The basic rule of asset allocation is age-based; less bonds when you are young, and more bonds as you age. Yet bonds today offer investors the lowest yields since I came into this field in 1951.Alas,

When I read Vonnegut’s poem in 2005, I felt like I’d been struck by a bolt of lightning. When I was invited to give the commencement address at Georgetown University’s business school two years later, in May 2007—as it happens, only a few short months before the burst came in the great bubble that had enveloped our stock market, our financial system, our real estate values, and our economy—I decided to use “Enough” as my theme, and began it with Vonnegut’s poem. Here’s what I then said to those newly-minted MBAs: “If you enter the financial 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.” “(But) no matter what career you choose, do your best to hold high its traditional professional values, now swiftly eroding, in which serving the client is always the highest priority. And don’t ignore the greater good of your community, your nation, and your world. As William Penn pointed out all those years ago, ‘We pass through this world but once, so do now any good you can do, and show now any kindness you can show, for we shall not pass this way again.

Early in 1977, we abandoned the supply-driven, commission-based, broker-dealer distribution system that had been operated by Wellington since 1928, in favor of a buyer-driven, “no-load” approach under our own direction. Later that year, we created the first-ever series of defined-maturity bond funds, segmented into short-, intermediate-, and long-term maturities, focused on high investment quality. Then, in 1981, Vanguard assumed responsibility for providing the investment advisory services to our new fixed-income funds as well as our established money market funds. (As you can imagine, none of these moves was without controversy!) Let me give you some sense of the importance of those changes. Since our formation, the assets of the Vanguard funds have grown from $1 billion-plus to some $1 trillion today. Some 82 percent of that trillion—$820 billion—is represented by our passively-managed index funds, bond funds, and money market funds that we at Vanguard manage, distribute, and advise.Wellington

5 percent differential is about what one might have expected, given our 2.8 percent rough estimate of fund costs. Simply put, fund managers have arrogated to themselves an excessive share of the financial markets' returns, and have left fund investors with too small a share. On first impression, that annual gap may not look large, but when compounded over 25 years it reaches really staggering proportions. (Chart 4a) In fact, $1000 invested in a simple S&P 500 Index Fund returned 12.3 percent per year during that period (the market return of 12.5 percent less costs of just 0.2 percent), growing by $17,080. By way of contrast, the average equity mutual fund’s return of 10.0 percent grew that original $1,000 by just $9,820, or little more than half as much (57 percent of the total). But it gets worse for the equity funds. With all of their frantic portfolio turnover— trading stocks, essentially with one another, at a rate of 100 percent per year—the average actively-managed fund surrendered 1.after-

“There is a compelling history to be written about the founding and evolution of the Vanguard Group: Unfortunately, Mr. Bogle’s latest book isn’t it…. (the book) feels like the leftovers from the files of one of investing’s great innovators.” While the 28 reader reviews of Bogle on Mutual Funds were also almost uniformly five- star on Amazon.com, the sole poor rating (three-stars) described it as having “useful ideas but poor conclusions. Like most MBAs, (Bogle) does not know how to use mathematics or empirical conclusions.” (For the record, I don’t even have an MBA.) Barron’s was also tough: “I liked this book the best, but reluctantly. Reluctantly because everyone from Warren Buffett to Money magazine loves it and it’s more fun to deflate the self-righteous than to encourage them.” And while the lion’s share of the 61 reader reviews on Amazon.com about Common Sense on Mutual Funds were also five-star, that didn’t keep one reader from writing “excellent but boring;” another, “Bogle is dead wrong;” and yet another, “save some cash and skip this book.”

AIG; and there are scores of others, companies that had the world at their fingertips, yet have fallen on hard times. But owning all of our nation’s corporations—including big winners like Apple as well as those losers like Eastman Kodak (unbelievable!)—carries only a fraction of the risk of owning individual companies. Such a totally diversified portfolio is an odds-on bet (but not a guarantee!) to grow over the long-term, simply because of its internal dynamics; putting vast sums of capital to work productively, earning a return on that capital, distributing part of that return to their owner/shareholders, and reinvesting the remainder of the cash flow in the business for future growth. But understand that the way the stock market values the shares of companies is very risky in the short-term; recessions subject our corporations to lower earnings; high—even speculative—valuations ebb and flow. But, bonds—the major alternative to stocks—despite their well-protected interest coupons and generally low default rates are, arguably, even riskier. Why? Because while the dollar value of our savings is fairly secure, the value of the dollar itself tends to shrink over time, as inflation takes its toll. Even at 3 percent per year, inflation would cut the purchasing power value (vs. nominal value) of today’s $1.00 to 74 cents over a decade and to 22 cents over a half-century. Many of you here tonight have witnessed just that in the past 50 years.

Some 82 percent of that trillion—$820 billion—is represented by the passively-managed index funds, the bond funds, and the money market funds that we at Vanguard manage, distribute, and advise. Some 25 external investment advisers serve our remaining (actively-managed) funds, with Wellington advising by far the largest portion of those assets. (Most of these funds have multiple advisers, the better to spread the risk of underperformance relative to their peers.) More than parenthetically, that long string of business decisions was made in a situation in which Vanguard’s very existence was in doubt. For the Securities and Exchange Commission had initially refused to approve Vanguard’s assumption of marketing and distribution responsibilities. But after a struggle lasting six (interminable!) years, the SEC reversed itself in February 1981. By unanimous vote, the Commission declared that: The Vanguard plan is consistent with the provisions, policies, and purposes of the (Investment Company Act of 1940). It actually furthers the Act’s objectives . . . enhances the funds’ independence . . . benefits each fund within a reasonable range of fairness . . .

Not surprisingly, therefore, business executives became increasingly attuned to short-term profits and the stock- market valuation of their firm. The growing role of institutional investors fostered continued financial-system evolution by providing a ready pool of buyers of securitized loans, structured finance products, and myriad other exotic innovations.” To drive this point home, think of investing as consisting of two different games. Here’s how Roger Martin, dean of the Rotman School of Management of the University of Toronto, describes them. One is “the real market, where giant publicly held companies compete. Where real companies spend real money to make and sell real products and services, and, if they play with skill, earn real profits. This game also requires real strategy, determination, and expertise; real innovation and real foresight.”

had been severed. His intellectual analysis and his market-moving power, it turns out, were based on a false premise. To his credit, in his testimony before Congress last October, Greenspan admitted his mistake. He acknowledged that the crisis had been prompted by “a once-in-a-century credit tsunami,” which had arisen from the collapse of a “whole intellectual edifice.” “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity—myself especially—are in a state of shocked disbelief,” he said. This failure of self-interest to provide self-regulation was, he said, “a flaw in the model that I perceived as the critical functioning structure that defines how the world works.” It’s worth dwelling on that phrase: “the critical functioning structure that defines how the world works.” As the New Yorker writer John Lanchester observed: “That’s a hell of a big thing to find a flaw in.” Here’s another way of describing that flaw, Lanchester continues: “the people in power thought they knew more than they did. The bankers evidently knew too much math and not enough history—or maybe they didn’t know enough of either.” To which I would add, enough indeed! Bernard Madoff and How We Fool Ourselves Next, let’s turn to issue number two, how we fooled ourselves in the financial markets, where investors—individual and institutional alike—seemed to lose all perspective.

-$60 -$40 -$20 $0 $20 $40 $60 $80 $100 $120 $140 $160 Q1'98 Q4'98 Q3'99 Q2'00 Q1'01 Q4'01 Q3'02 Q2'03 Q1'04 Q4'04 Q3'05 Q2'06 Q1'07 Q4'07 -1500 -500 1500 2500 3500 4500 5500 Growth Value Nasdaq Close Total Flow 98-00 01-08 Growth: $467b $(69b) Value: $(69)b $210b Source: Strategic Insight Net Flow (bil) Nasdaq Quarterly Flow into Growth and Value Funds, and the Nasdaq’s Close 1 1. growth and sector funds at a staggering rate—nearly $470 billion in 1998-2000 alone, in part funded by investor withdrawals of some $70 billion in capital from value funds (Chart 11), the very funds that were about to have their day. Since the inevitable fall, of course, disillusioned investors have withdrawn some $70 billion from the aggressive and growth funds—realizing huge losses—and poured $210 billion into value funds, the sort of “performance chasing” that this marketing-dominated industry fosters with the diverse menu of “products” we create to follow the trends of the day. (Unsurprisingly, the lag in investor returns in aggressive and sector funds relative to the stock market was far greater than the lag for investors holding diversified, middle-of-the-road fund offerings.) Today’s environment for mutual fund innovation is of course different.

Surely it should be made clear to clients whether they are relying on (1) trained investment professionals, paid solely through fully-disclosed fees to oversee their investments; or (2) sales representatives who sell the products and services of the companies that they represent, whether life insurance, annuities, mutual funds, or anything else. Simply put, the first group is representing its clients; the second group is representing its employers. And each firm’s advertising and promotion should make this distinction clear. But I believe that a federal standard of fiduciary duty should also apply to mutual fund advisers. That is the best way—perhaps the only way—for this industry to honor the lofty goal expressed in the preamble to the Investment Company Act of 1940: “the national public interest and the interest of investors” require that mutual funds be “organized, operated, and managed . . . in the best interests of their shareholders, rather than in the interests of advisers, underwriters or others.of

While the buy-side analysts employed by our financial institutions have fewer profound conflicts, there is little evidence that they delve deeply into the failure or our corporate system. But finally, of course, it is the stock owners who must be the ultimate gatekeepers. The very futures of the corporations whose shares they own are at stake. The greatest mystery of all is how and why our powerful institutional investors with such dominant ownership of all corporate shares—holding absolute voting control over virtually all of our nation’s public corporations— have remained largely silent. The record is clear that these institutions stand on the sidelines on proxy issues related to the governance of our corporations. What are these agent/owners thinking? Have they forgotten their fiduciary responsibilities?taking

Had I had time to do it all over (and could erase the limitations of time and space), I’d leap into Anthony Raubitschek’s classics courses; David Billington’s course on “Engineering in the Modern World”; Burt Malkiel’s finance course; Bob Hollander’s exploration of Dante; Uve Reinhardt’s accounting course (that in fact transcended mere accounting); one of Lionel Gossman’s courses in European literature; John McPhee’s creative writing seminar (though I doubt I’d get admitted!); and a survey course on the roots of Western Civilization. That I won’t get the opportunity to choose this broad-based curriculum is not really the point. Rather, I have come to believe that we need to better educate our college students in both of the traditionally-separate cultures of scientific inquiry and engineering and the precious values of our humanistic heritage—call it Western Civilization, if you will—by common understanding and respect. In fact, we seem to be losing sight of both, and our loss is our society’s loss. The work of two fellow Princetonians has reinforced my interest in both cultures.

In 2005, the National Association of Securities Dealers (NASD) brought an enforcement case against the firm. According to the NASD, the written record showed that the fund distributor had worked out a business plan with its leading broker-dealers that guaranteed these retailers financial support in the form of “revenue sharing” based on the sales volume in shares of Capital’s mutual funds. This so-called “pay to play” bargain was said to be a violation of the 1981 rule that prohibited NASD members from promising or arranging “a specific amount or percentage of brokerage commissions conditioned upon . . . [the] sales of [fund shares].” In its report, the hearing panel noted that the firm’s employees (including its president) “repeatedly testified that the damaging documents did not really mean what they plainly said,” and found this testimony “disingenuous, to say the least.” The NASD Enforcement Division calculated that the excess commissions paid by the funds totaled more than $98 million, and imposed a fine of that amount on the firm. An NASD Hearing Panel, however, reduced the penalty to $5 million, since such payments to the brokers were “consistent with practices that had arisen in the fund industry over a number of years.” In effect “if everyone else is getting away with it, I should be allowed to get away with it too.” Some reasoning!

The Elusive 8 Percent With reasonable expectations for a nominal annual return of roughly 7 percent on stocks over the coming decade, and, with somewhat more assurance, a return of roughly 3 percent on bonds, a traditional 60/40 stock/bond policy portfolio of a defined benefit pension plan might reasonably expect to earn a gross annual return averaging about 5.4 percent (Chart 6). Given the cost efficiencies in managing and administering portfolios with substantial assets, I might have assumed an annual cost of 0.5 percent, bringing the return to 4.9 percent. But if the pension fund adopts an index strategy, the cost could easily be as low as 10 basis points or less, bringing the net annual return to 5.3 percent, within one-tenth percent of the market return.2 (Note: Even an inflation rate as low as 2 percent would result in a real return of only about 3 percent per year.) 2 This example is a clear affirmation that investors as a group not only don’t get what they pay for, they get precisely what they don’t pay for. Therefore, if they pay nothing, they get everything (i.e., the markets’ gross returns).

Never mind that the reported earnings were too often a product of financial engineering that served the short- term interest of corporate managers and Wall Street security analysts alike. But when long-term owners of stocks become short-term renters of stocks, and when the momentary precision of the price of the stock takes precedence over the eternal vagueness of the intrinsic value of the corporation itself, concern about corporate governance is the first casualty. The single most important job of the corporate director is to assure that management is creating value for shareholders; yet when that goal became secondary, our new investors seemed not to care. While their 70 percent ownership position gives our institutional agents absolute voting control of corporate America, all we hear from these money managers is the sound of silence. Not only because they are more likely to be short-term speculators than long-term investors, but also because they are managing the pension and thrift plans of the corporations whose stocks they hold, and thus face a serious conflict of interest where controversial proxy issues are concerned.

But I see little in it that persuades me that the complexity that is being offered will serve the interests of fund investors—as distinct from the interests of fund marketers—nearly as effectively as the simplicity that combines sensible asset allocation, broad diversification, and low costs, a strategy that has demonstrably served investors so effectively in the past. Let me be clear: I favor innovation when it serves fund investors. And I’m pleased that I’ve been lucky enough to have played a key role in such innovations in the past: the stock index fund; the bond index fund; the defined-maturity bond fund; the tax-managed fund; even the first fund-of-funds, absent an additional level of expense ratios. (I’ve also been involved in some innovations that haven’t worked for investors as I’ve hoped. We’ll save them for the question and answer period!)

Our self-centered “bottom-line” society, focused on money over achievement, charisma over character, and the ephemeral over the eternal. And finally, the paucity of leaders who are willing to, well, lead—to defy the conventional wisdom of the day and to stand up for what is right and noble and true. So the risks are high; the uncertainties rife. Yet perhaps we’ll muddle through. After all, throughout our 230-year history, America has always done exactly that. Perhaps, once again, our society and our economy will continue to reflect the resilience that they have demonstrated in the past, often against all odds. And perhaps we’ll come to our collective senses and develop the courage to take arms against this sea of troubles I’ve described and by opposing, end them. If we do, the stock market will undoubtedly respond and resume the upward course that is based on the intrinsic economic value of business growth. Let me close by acknowledging that I’m conservative and, I’m well, getting on in years, I’ve followed my own advice and am about 68 percent in bonds and 32 percent in stocks—all Vanguard and overwhelmingly in index funds. But each of us is different. So even if risks are high and uncertainties abound, we must consider not only the probabilities of our investment decisions, but the consequences that we face if we are wrong.famous

Loosely linked to this game is another game, the expectations market. Here, “prices are not set by real things like sales margins or profits. In the short-term, stock prices go up only when the expectations of investors rise, not necessarily when sales, margins, or profits rise.” To this crucial distinction, I would add that the expectations market is not only a product of the expectations of active investors but the expectations of active speculators, trying to guess what these investors will expect, and how they will act as each new bit of information finds its way into the marketplace. The expectations market is about speculation. The real market is about investing. The only logical conclusion: the stock market is a giant distraction that causes investors to focus on transitory and volatile investment expectations rather than on what is really important—the gradual accumulation of the returns earned by corporate business. My advice to investors is to ignore the short-term noise of our emotions reflected in our financial markets and focus on the productive long-term economics of our corporate businesses. Shakespeare could have been describing the inexplicable hourly and daily—sometimes even yearly or longer—fluctuations in the stock market when he wrote, “[It is] like a tale told by an idiot, full of sound and fury, signifying nothing.” The way to investment success is to get out of the expectations market of stock prices and cast your lot with the real market of business.

And the $5 million penalty was but small potatoes relative to the $15 billion in management fees received by Capital Group and its affiliates during 2001- 2007 alone. Some punishment! 3. The New York State Pension Plan. The final outcome of my third example— another “pay to play” scandal, this time in New York State’s pension plan—has yet to be determined. The disgraceful crimes that were uncovered at the highest levels of state government began with former state controller Alan G. Hevesi, and include noted political consultant Hank Morris and financier Steven L. Rattner. According to court documents, one-half of the state pension fund’s $10 billion of assets reserved for hedge funds would be handled by firms that paid off Mr. Morris and his associates; firms that refused to pay these intermediaries were typically rejected by the pension fund. Mr.

So the most productive strategy for equity investors (my opinion) is to own the entire stock market, own it at the lowest possible cost, and hold it forever, come what may. Then capitalize on the wisdom of investing, and free yourself from the folly of speculation, with Benjamin Graham’s simple but profound observation: “In the short-run, the stock market is a voting machine; in the long-run it is a weighing machine.” Alas, in the recent era, we’ve forgotten that wisdom.

The critics for The New York Times and The Wall Street Journal were quite generous to The Battle for the Soul of Capitalism, albeit often kinder to the author than to the message. On Amazon, the sole poor review described it as “pop capitalism for bone-headed businessmen (or women) worried about nonsense . . . i.e., it is not about capitalism at all.” Take that, you dumb author! But overall, the book’s critical reception was terrific—lots of reviews, all largely positive. The Good Overwhelms the Bad I acknowledge these pans to justify mentioning some of the pats. And the good— wow!—has vastly outweighed the bad. How about this note from Pulitzer-Prize-winning author John McPhee (who’s penned a mere 30 books himself!) “Your words in Bogle on Mutual Funds are spoken like every ink-stained wretch who is not self-deluded. It is easier to shinny up a mile- high pole than to complete a piece of writing, or so it seems. You got there, though.” And consider for a moment how you would feel if you got a note like this one just a week ago from a young college professor. (He happens to be a Princeton alumnus, class of 1991.) “In my Artistic Entrepreneurship and Technology Class at Pepperdine University your classic book The Battle for the Soul of Capitalism is required reading along with Homer’s The Odyssey . . . Both are great books about long-term investing—about forgoing short-term temptations . . .

advising by far the largest portion of those assets. (Most of these funds have multiple advisers, the better to mitigate the risk of underperformance relative to their peers.) More than parenthetically, that long string of business decisions was made during a long period in which Vanguard’s very existence was in doubt. For the Securities and Exchange Commission had initially refused to approve Vanguard’s assumption of marketing and distribution responsibilities. Only after a struggle lasting six (interminable!) years did the SEC reverse itself. In February 1981, by unanimous vote, the Commission declared that: The Vanguard plan is consistent with the provisions, policies, and purposes of the (Investment Company Act of 1940). It actually furthers the Act’s objectives . . . enhances the funds’ independence . . . benefits each fund within a reasonable range of fairness . . . . . . (provides) substantial savings from advisory fee reductions (and) economies of scale . . . and promotes a healthy and viable mutual fund complex in which each fund can better prosper. A Prescient SEC? Indeed! The SEC’s words now seem prescient. In fact, “can best (rather than better) prosper” would have been more accurate. Measured by Morningstar’s peer-based rating system— comparing each fund with other funds having distinctly comparable policies and objectives— Vanguard ranked first in performance among the 40 largest fund complexes.

tax return to 8.2 percent and reducing the compound cumulative profit to $6,170. (Chart 4b) If that sounds like a pretty good profit, just compare it with the after-tax profit with our 500 Index Fund, which has virtually no turnover. Its owners were subjected to income taxes of only 0.6 percent per year (largely on the divided income generated by the fund), with a net after-tax return of 11.7 percent. Result: a net profit of $14,820, or nearly two-and-one-half times the profit on the average managed fund. And now a cold shower of financial reality. Let’s make one final adjustment to our returns. So far, we’ve done all our measurements in nominal dollars, ignoring the fact that it is only real dollars—dollars that are adjusted to take inflation into account—that are available for us to spend. During the past 25 years, inflation averaged 3.3 percent, reducing the real after-tax return of the index fund to 8.4 percent, and the average fund to but 4.9 percent. (Chart 4c) Cumulative real profit after compounding on the original $1,000 investment: just $2,270 for the average actively-managed equity fund; $6,450 for the passively-managed index fund. The average fund produced only about one-third of the profit earned by the market itself through the simple index fund, which was there for the taking. Dare I remind you yet again, fund expenses and taxes matter! Indeed, they make the difference between investment success and investment failure.

1. 2. 3. 4. 5. 6. (2+3) (2 + 3 – 5) Asset Class Allocation Projected Annual Return Value Added by Managers Adjusted Annual Return Less Investment Costs Net Return Traditional Policy Portfolio Equities 60% 7.0% 0.0% 7.0% -0.06% 6.9% Bonds 40 3.0 0.0 3.0 -0.10 2.9 Total 100% 5.4% 0.0% 5.4% -0.08% 5.3% Policy Portfolio with 30% Allocated to Alternatives Equities 40% 7.0% +2.5% 9.5% -1.0% 8.5% Bonds 30 3.0 +1.0 4.0 -0.5 3.5 Venture Capital 10 12.0 +3.0 15.0 -3.0 12.0 Hedge Funds 20 12.0 +3.0 15.0 -3.0 12.0 Total 100% 7.3% +2.2% 9.5% -1.5% 8.0% The Elusive 8% A Template for DB Plan Returns Over the Coming Decade Chart 6 So is 5.3 percent the nominal return that our DB plans—corporate and government alike—are projecting? No, it is not. The typical return projection is 8 percent, with precious few plans much lower or higher. Where does this estimate come from? Well, here is what one large corporation tells us: “We consider current and expected asset allocations, as well as historical and expected returns on various categories of plan assets . . . evaluating general market trends as well as key elements of asset class returns such as expected earnings growth, yields and spreads. Based on our analysis of future expectations of asset performance, past return results, and our current and expected asset allocations, we have assumed an 8.0 percent long-term expected return on those assets.” (Note the reliance on historical returns.)

First, the Culture of the Engineer In engineering, while I’ve come to be skeptical about the rise of financial engineering— which in the aggregate, by definition, subtracts value from society4—I find myself almost transfixed by the beauty of mechanical engineering, civil engineering, aeronautical engineering, chemical engineering, and a host of related subjects, all of which add value to our lives. During the years after Princeton, I have come to deeply respect the precision and rationality of the engineer’s mind. Yes, as Professor David Billington, legendary teacher and member of the Class of 1950, points out in his remarkable book, Power, Speed, and Form,5 the engineering profession has been isolated from society. We think of engineering as complex beyond comprehension, but in fact, as Dr. Billington points out, most radical innovations in engineering thought have been based, not on complexity, but on “the simplicity of the basic ideas.” In his book, Dr. Billington calls attention to the fact that the ideas of many of our greatest engineers—including Alexander Graham Bell, Thomas Edison, and Henry Ford—were “immersed in established technologies and ways of doing things.” The best engineers, he notes, have sought the economical over the costly, the efficient over the less efficient, and, where possible, the elegant over the ugly.

This conflict is pervasive, for it is said that money managers have only two types of client they don’t want to offend: actual, and potential. And so in corporate America we have witnessed staggering increases in executive compensation not only unjustified by corporate performance, but also grotesquely disproportionate to the pathetically small increase in real (inflation-adjusted) compensation of the average worker; financial engineering that dishonors the idea of financial statement integrity; and the failure of the traditional gatekeepers we rely on to oversee corporate management—our regulators, our legislators, our auditors, our attorneys, our directors. It’s high time for our now- empowered institutional agents to fight for the rights of their investor principals, honoring their agency responsibilities of corporate ownership and exercising their rights in overseeing governance. Building A Fiduciary Society So, out of the ashes of our old ownership society and our failed agency society we must develop a new fiduciary society, one that guarantees that our last-line owners—those mutual fund shareholders and pension fund beneficiaries whose savings are at stake—have their rights as investment principals protected. These rights must include: 1. The right to have money manager/agents act solely on their principals’ behalf. The client, in short, must be king. 2.

How do we develop such authentic leaders, ethical principals who honor ethical principles? Legendary law professor Tamar Frankel, who will speak to us tomorrow, agrees the answer lies in the hands of a caring and ethical society. In her impassioned recent book Trust and Honesty: America’s Business Culture at a Crossroads, she writes: “The real test for an honest and productive society is not what a society has achieved, but what it aims to achieve. It can put honest people on a pedestal even if they do not maximize their personal benefits and preferences . . . and discard and shun as models of failure dishonest people who achieve their highest ambitions by fraud and abuse of trust.” It’s all up to society, then, simply another reflection of Adam Smith’s Impartial Spectator who calls on each of us to be “honorable and noble, to live up to the grandeur and dignity and superiority of our own character.” No, this goal will never be totally achieved. I know that. But if we all strive for a more perfect system of capitalism that honors society as a whole, even as it holds as its highest priority serving the interests of the stock owners who invest and risk their own capital, we can make meaningful progress toward achieving these noble ideals for our citizens and our nation.

’” As it turned out, the warning I set forth in that speech—the need to recognize “that any endeavor that extracts value from its clients (and indeed subtracts value from our society) may, in times more troubled than these, find that it has been hoist by its own petard”—proved not only eerily prophetic, but surprisingly timely. For the financial sector was indeed about to be blown up by its own dynamite. Soon after the speech to those Georgetown University MBAs, I expanded it into the book, published last November. It is a short book (250 pages) with ten impassioned chapters, each highly opinionated, each linked by a consistent theme that you’ll recognize by the time I reach about the third iteration: In our Money system— ∑ Too much cost, not enough value.

today’s yields are excellent predictors of the total returns you’ll earn on bonds over the coming decade. Worst case: the (so-called) risk-free rate—based on the 10-year Treasury bond—is now 1.6 percent, down from a high of 11.6 percent in the early 1980s. (We could call them “the good old days.”) Two more shocking mathematical facts: a 1.6 percent return would increase capital by just 17 percent during the next 10 years; an 11.6 percent return for the same length of time would have multiplied capital three times over. So, yes, holding a balanced stock-and-bond allocation is essential today, but it will not likely provide the kinds of handsome returns we were lucky enough to experience during the 1980s and 1990s, albeit much better than we have seen thus far during the 21st century. (During the past 12 years, when a 60/40 stock/bond index portfolio earned 4.3 percent, it was bonds that did the heavy lifting. In the coming decade; it is stocks that will have to do that job.) Of course, investors are not limited to U.S. Treasury 10-year bonds. Owning an investment-grade corporate bond index fund with a somewhat longer maturity should produce a yield of perhaps 3 percent. So it seems it is reasonable to own a mix of Treasurys and corporates, which might earn about 2 ½ percent. The Total Bond Market Index Fund—70 percent in Treasuries and other governments—now yields only 1.7 percent. But a Total Corporate Bond Index Fund would generate a yield about 3.2 percent.

Short-term speculation—more than at any time in the entire history of our nation—was the star of this show, and long-term investment barely played even a supporting role. Too many of us were too greedy, too willing to believe that there were managers who could roundly beat the returns generated in our markets; almost childlike in our eagerness to pay the substantial costs to capture these returns (which proved non-existent); and more or less unaware of the powerful marketing system that greases the machinery of Wall Street. All of these baneful forces converged in the enormous Ponzi scheme directed by Bernard Madoff. Unlike Greenspan, Madoff was only a marginal contributor to the present crisis, but he surely is its exemplar.its

. . (provides) substantial savings from advisory fee reductions (and) economies of scale . . . and promotes a healthy and viable mutual fund complex in which each fund can better prosper. A Prescient SEC? Indeed. The SEC’s words now seem prescient. In fact, “can best prosper” would have been more accurate. Measured by Morningstar’s peer-based rating system (comparing each of our funds with other funds having distinctly comparable policies and objectives), Vanguard ranked first in performance among the 50 largest fund complexes.* Advisory fee reductions and economies of scale? Once again, indeed. Vanguard’s low- costs are legendary, by far the lowest in the field. Last year, over all, our operating expense ratio came to 0.20 percent of average assets, compared to 1.30 percent for the average mutual fund. That 1.1 percentage point saving, applied to one trillion of assets, now gives our shareholders an average savings of $11 billion annually. Do low costs matter? Of course they do! As the world of investing is at last beginning to understand, low costs are the single most reliable indicator of superior fund performance. Yes, as we read in Homer’s The Odyssey, “fair dealing yields more profit in the end.

investors,” but they permitted, as we now know, a governance structure that would later fly directly in the face of the national public interest and the interest of investors. 2 It is only to state the obvious that a once-small mutual fund industry, managed by firms whose owners were the investment professionals who managed the money is now a giant industry in which the vast majority of firms—26 of the largest 30 firms are either publicly-owned (7 firms) or, more likely (19 firms), owned by financial conglomerates—face a conflict of interest, with a duty owed to two parties with opposing interests, a situation that would be precluded by a fiduciary duty standard. These owners are in business to maximize the returns on their capital, not to maximize the returns of the capital of their mutual fund investors. (Although they do their best to do so, but of course without even the remotest incentive to reduce their fees. Au contraire!) Most of the private firms of yore have vanished, although it is significant that those that yet remain rank among the very largest firms in the industry. Success in the fund field, then, is largely measured by gathering the largest possible base of assets under management, the surest route to maximizing advisory fees.

precedence over the interests of their shareholders? Do they exercise their rights and responsibilities of ownership to demand corporate governance in the interest of the shareholders whom these institutional managers represent? Executive Compensation and Political Contributions The failure of our gatekeepers has lead to massive failures of corporate governance in cases such as Enron and WorldCom in 2001-02. (Don’t forget them!) But other important failures remain. Today, two of the most significant corporate governance transgressions relate to executive compensation and corporate political contributions. In the case of executive compensation, our stockowner/gatekeepers seem particularly reluctant to take on this issue. By failing to do so, they must assume at least partial responsibility for the ridiculously high salaries, bonuses, deferred compensation, stock options, and other compensation paid to corporate CEOs, numbers that have been driven to amounts beyond reason—aided and abetted by the executive compensation consultants. Yet how many of the highly paid CEOs of these large institutional investors have dared to cast the first stone? Yet one more agency conflict. Another major emerging issue on corporate affairs relates to political contributions. The Supreme Court’s decision in the 2011 Citizens United case opened the door to virtually unlimited political contributions by our corporations.

What would a plan’s manager have to do to earn an 8 percent nominal return? (Chart 6 lower section) Let’s make some assumptions that are arbitrary but not absurd. The chart shows one version of how various markets and asset-class managers must perform in order for a pension plan to reach that elusive goal. Now let’s consider how realistic the data in the table might be. First, the stock and bond returns are fully consistent with the reasonable expectations cited earlier. The 12 percent return required for venture capital is aggressive but perhaps not unreasonable. But the 12 percent required return for hedge funds is far above historical norms.to

Pascal wager, conceived as a bet on whether or not God exists. (Pascal concluded that, considering the consequences, the safer bet was that He existed.) As Peter Bernstein explained the wager, “considering the consequences of being wrong is essential in decision-making under uncertainty.” So I urge you all not only to weigh the probabilities of where our markets and our economy are headed in this age of turbulence and uncertainty, but also weigh the consequences to your own portfolios if you are wrong. If you follow these rules, you’ll be able to ride out today’s risks and uncertainties with favorable consequences.

In investing, then the relentless rules of humble arithmetic—the subtraction of the logical, inevitable, and unyielding penalty assessed by investment costs, excessive taxes, and rising living costs—devastates the returns that investors in mutual funds earn over time. Using Justice Brandeis’s formulation, the mutual fund industry is obsessed with the delusion—and is foisting that delusion on investors—that a nominal gross return of 12 ½ percent per year in the stock market, minus fund expenses of 2.5 percent, minus taxes of 1.8 percent, and minus inflation of 3.3 percent, still equals a real net return of 12 ½ percent. Well, to state the obvious, it doesn’t! And unless the fund industry changes, it will falter and finally fail, a victim, yes, of the relentless rules of humble arithmetic. Were he here in your class this evening, Justice Brandeis surely would have warned, “Remember, NYU students, that arithmetic is the first of the sciences and the mother of safety.” 4.Economy

When Odysseus gets on home, he has to reclaim it from all the imposters who have been living off his estate while he was off fighting for his country. So it’s a story about property rights, about the risk takers getting their just reward, about valuing the higher ideals over the bottom line, about faith and family, and serving one’s customers and employees.” (“Clients” and “crew” in my Vanguard lexicon. Who says we can’t always find better words to convey our true meaning?) “(My) students” the professor adds, “are just beginning a great journey, and eternity’s principles will serve them well in all their intellectual and entrepreneurial endeavors . . . we must call on the muse to help us find the right words to inspire (and) I’m grateful that Homer and Bogle did such a great job, as they’ll be great companions on this voyage on out, during this Fellowship of Humble Heroes, where the students are invited to journey alongside those two everlasting leaders who exalted all in their humility before higher ideals.” Maybe that’s a bit over the top, but it’s surely nice!

Simply heed the timeless distinction made by Benjamin Graham, legendary investor, author of The Intelligent Investor, and mentor to Warren Buffett. He was right on the money when he put his finger on the essential reality of investing: “In the short run the stock market is a voting machine . . . (but) in the long run it is a weighing machine.” 5. Rebuilding the Financial Systems – a Framework I’ve described a financial system that has grown to enormous and excessive proportions. The root causes of this change are deep, and the remedies that are required to cure it will not be easy to come by. What we have witnessed, in the words of journalist William Pfaff, is “a pathological mutation in capitalism.” The classic system—owners’ capitalism—had been based on a dedication to serving the interests of the corporation’s owners, maximizing the return on their capital investment.with

∑ Too much speculation, not enough investment. ∑ Too much complexity, not enough simplicity. In Business— ∑ Too much counting, not enough trust. ∑ Too much business conduct, not enough professional conduct. ∑ Too much salesmanship, not enough stewardship. ∑ Too much management, not enough leadership. In our Lives— ∑ Too much focus on things, not enough focus on commitment. ∑ Too many twenty-first-century values, not enough eighteenth-century values. ∑ Too much “success,” not enough character. This is a book, as it has been said, laced with both searing criticism and soaring idealism, one might even say Adam Smithian (if only I had his gifts for the well-turned phrase.) And I believe that both TRF and Vanguard continue to share my basic values. We are as one, I think, in our belief that—if they are to benefit our society—economic markets must, finally, have a public purpose. You at TRF are an exemplar of one approach to implementing this concept, and I salute you for your commitment. We at Vanguard are an exemplar of a very different approach, but an approach in which acceptance in the marketplace of ideas (and investment strategies) are quite literally growing by the day. Let us both “Press on, Regardless.”

Investing Today But no matter how flawed the nature of our financial system has become, invest we must. It is our responsibility to put our money to work but to stay out of the casino—that casino where the money changers and croupiers sit in the driver’s seat and get rich . . . to the tune of $362,950 each in the last year alone (the average salary reported this very day). “Is this a great country, or what?” Of course, I believe that a strategy focused largely on low-cost equity index funds is the optimal strategy—simply because it focuses on the long-term, and guarantees you of your fair share of whatever positive returns the stock markets are generous enough to deliver—or, for that matter your fair share of whatever negative returns our markets are mean-spirited enough to inflict on us. (The same factors apply to owning the bond market through a low-cost bond index fund.) As investment strategy that is as simple as it is profound. “The majesty of simplicity in an empire of parsimony.” If you favor actively-managed funds, you should know that picking winning managers over the long term is not easy. Even if you wish never to liquidate one of your fund holdings, your fund portfolio will inevitably roll over again and again. In the years ahead, you’re sure to run through scores of funds and fund managers. History suggests that about 3,500 of today’s 7,000 active funds will go out of business during the coming decade.

This issue could well be of great importance to our country’s already unbalanced political system. So far, money talks! Disclosure of political contributions seems to be developing, but we need more than voluntary corporate disclosure. The institutional investor community ought to act even more forcefully. Before we even consider appropriate standards for disclosure, we must insist that shareholders have the right to decide whether they should allow corporations to make any political contributions whatsoever. It is the shareholders, after all, who own the company, and it is their right to decide company policy on political spending. Wrapping Up Let me close by summing up my message. I’ve given you a lot of interlinked history— much of which I’ve observed first hand—the story of my investment career; my frequent interfaces with your Philadelphia Society; and my support for the CFA Institute.who

This strategy has led to aggressive marketing, over-the-top advertising of the fund performance, creation of exotic new fund products—yes, capitalize on products—to meet the investment fads of the day, and quantitative approaches to investment management based on historical investment returns that are, truth told, virtually meaningless. So it is small wonder that the huge economies of scale in mutual fund management have benefited fund managers far more than fund shareholders. Small wonder that the industry’s focus has moved from management to marketing. Small wonder that in all the rush to salesmanship in the fund industry, stewardship seems to have been left in the dust. To return stewardship to the preeminent position it deserves in money management, establishing a federal fiduciary standard for all money managers is essential. Quoting ICI leader Stevens again, “isn’t that something that all of our recent experience suggests is important?” Again, of course it is important! 2 I recognize that in the 1960 amendments to the Investment Company Act, the fund adviser “is deemed to have a fiduciary duty with respect to the receipt of compensation.” But that provision has been largely eliminated by the courts. It now seems likely to receive further review in the U.S. Supreme Courts.

The right to rely on due diligence and high professional standards on the part of money managers and securities analysts who appraise securities for principals’ portfolios. 3. The assurance that agents will act as responsible corporate citizens, restoring to their principals the neglected rights of ownership of stocks, and demanding that corporate directors and managers meet their fiduciary duty to their own shareholders. 4. The right to demand some sort of discipline and integrity in the mutual funds and financial products that they offer. 5. The establishment of advisory fee structures that meet a “reasonableness” standard based not only on rates but dollar amounts, and their relationship to the fees and structures available to other clients of the manager. 6. The elimination of all conflicts of interest that could preclude the achievement of these goals.

It’s probably just one more crazy coincidence in my Princeton life, but I’m struck by the realization that in my thesis I used an almost identical formulation. I called for mutual funds to be operated in “the most economical, most efficient, and most honest way possible. The first two words are the same in David Billington’s mantra. His third was elegance, applied to engineering design. Perhaps it is not far-fetched to see the elegance in investing as represented by the beauty represented in the all-too-rare simple honesty of the best financial “products” yet created. Perhaps immodestly, I’d include the world’s first index mutual fund in that category, the simplest basic idea in financial history. In yet one more coincidence, the seed for that idea was planted right here in Princeton in my senior thesis. Just own the entire stock market and hold it 4 See “A Question So Important That It Should Be Hard To Think About Anything Else,” John C. Bogle, Journal of Portfolio Management, Spring 2008. 5 Subtitled Engineers and the Making of the Twentieth Century. Published by Princeton University Press in 2006.

So, let’s put these projections together. If it’s reasonable to expect stocks to return around 7 percent annually during the coming decade, and bonds to return as much as 3 percent (before costs), a traditional balanced index portfolio with 60 percent stocks and 40 percent bonds should provide a return of about 5 percent, not so different from the past twelve years (although, as I noted earlier, it was bonds, not stocks that led the way). This return is far below the 7 percent historical return on such a portfolio. And those are nominal dollars, not real dollars. If we are lucky enough to hold the inflation rate to 2 ½ percent, that 5 percent market portfolio return drops to a real return of 2 ½ percent. That figure, of course, is before the costs of investing—say, very conservatively, at least 1 ½ percent—and perhaps another 1 percent in taxes for taxable investors—a real, after-cost, after-tax return of, well, zero. (It’s frightening to do the math!) As we meet today, however, that is the investment reality. Seeking Income that Is “Enough” Considering income generation alone, such a portfolio could yield up to 2 ½ percent, before costs, in nominal dollars.moderate

Yes, all of us here tonight at the Center for Corporate Excellence must work toward “changing the game,” striving to hold high the ethical principles that must be the foundation of any business worthy of our trust, and then demand that they be honored by ethical principals who are authentic leaders.

own dynamite. While investors seemed surprised by the collapse of the Madoff fund and astounded by its magnitude, however, we should not have been. In fact, the investment returns he claimed were preposterous. In my long career, I’ve seen some money managers who have earned high returns, and others who have succeeded in earning consistent returns—in each case, whether by skill or luck. But any seasoned investor knows that a pairing of returns that are both high and consistent is truly oxymoronic. Yet Madoff attracted wealthy investors who thought of themselves as part of the “smart money” crowd, or sought to join that crowd. Too often these investors entrusted their fortunes to managers who knew “the secret” of making lots of money, a secret that would enrich those who had, well, enough, but wanted still more. Alas, however, the secret of beating the markets is that there is no secret. As his reputation for having the “smart money secret” was burnished by individual investors, institutional managers who should have known better also joined the “high-and- consistent-returns” throng. Madoff’s scheme was fostered by marketers who recommended him to their own substantial clients—hedge-fund-of-hedge-funds managers who were taken in by Madoff’s scam, even as they were grossly enriched by it. In just four years, for example, a single firm received $500 million of fees, simply by investing their clients’ money in Madoff’s fund.

Hevesi has pleaded guilty and awaits sentencing; Mr. Morris is said to have agreed to a guilty plea to a single felony. Mr. Rattner has not yet settled with New York or Federal regulators, but it can’t help his case that his former advisory firm, Quadrangle, has described his actions as “inappropriate, wrong and unethical.” His punishment, if any, remains to be seen. I’ve chosen these three examples out of scores—even hundreds—of examples, reluctantly leaving out that pillar of probity, Bernard Madoff. While his long jail sentence for his crimes surely is fair punishment, the hedge fund managers whose clients paid them some $500 million for the privilege of having Mr. Madoff defraud them remain scot-free. But the fact is that a disturbingly high percentage of the violations of law and of traditional ethics have occurred in the financial field, where the financial rewards are simply too tempting to ignore. The traditional emphasis on professional standards and fiduciary behavior focused on preserving and enhancing the wealth of clients has given way to business standards aimed at acquiring and accumulating wealth for agents, ethical principles be dammed. III. Vanguard – Structure, Strategy, and Values There is a better way. So in this third and final section of my remarks this afternoon, let me turn to some reflections on Vanguard and the structure, strategies, and values that have brought us to the pinnacle of the mutual fund industry—the largest fund manager in the world.

” If you are willing to accept—based on that solid data—that Vanguard has achieved both commercial success (asset growth and market share) and artistic success (superior performance and low costs), you must wonder why, after nearly 35 years of existence, no other firm has elected to emulate our shareholder-oriented structure. (A particularly ironic outcome, since I chose the name Vanguard in part because of its conventional definition as “leader in a new trend.”) The answer, I think, can be expressed succinctly: under our at-cost structure, all of the darned profits go to the fund shareholders, not to the managers, resolving the transcendent conflict of interest of the mutual fund industry. In any event, the leader, as it were, has yet to find its first follower. * John Bogle speech at George Washington University on February 19, 2008 (“A New Order of Things: Bringing Mutuality to the ‘Mutual’ Fund”).

In recent years, there have been other investor-friendly innovations, including target retirement funds and life strategy funds. Properly used (and properly costed!) these funds can easily serve as an investor’s complete investment program for the long run. But in today’s wave of fund innovation, I see little else that seems likely to serve investors effectively. Let me give a brief thumbnail sketch of the “products” that have been created in recent years, and offer my own perspectives. ETFs. Exchange traded funds are clearly the most widely accepted innovation of this era. Of course I admire their endorsement of the index fund concept—and (more often than not) their low costs. And how could I not admire the use of broad-market index ETFs that are held for the long term, and even broad-market-segment ETFs that are used in limited amounts to accomplish specific goals? But I have serious questions about the negative impact of brokerage commissions when ETFs are rapidly-traded. Further, I wonder why there are only 15 ETFs broadly-diversified in stocks and bonds; but 675 in market sectors that range from the reasonable to the absurd. In this latter category I’d include sectors as narrow as “Emerging Cancer,” and leveraged funds that now promise to double the market’s returns in either up or down markets. Not to be outdone, a few ETFs now offer the opportunity to triple those swings. Could quadruple be next?

Largely because of the competitive returns that we’ve delivered to our fund shareholders, our market share of the assets of long-term funds (stock and bond funds) has risen from 4 percent of industry assets in our early years to 15 percent today. Advisory fee reductions and economies of scale? Once again, indeed. Vanguard’s low- costs are legendary, by far the lowest in the field. Last year, over all, our operating expense ratio came to 0.20 percent of average assets, compared to 1.30 percent for the average mutual fund. That 1.1 percentage point saving, applied to one trillion of assets, now gives our shareholders an average savings of $11 billion annually. Do low costs matter? Of course they do! As the world of investing is at last beginning to understand, low costs are the single most reliable indicator of superior fund performance. Yes, as we read in Homer’s The Odyssey, “fair dealing yields more profit in the end.”

My all-time favorite review is this one, from a reader of The First 50 Years: “Given the din and cacophony of the financial press, it is not ludicrous to liken old Bogle to Moses bringing the law down off Sinai amidst thunder, lightning, and a thick cloud . . . I’m sure Bogle is a hard man to work for. People like that always are. I know, we have one in our family and the fact that he’s been dead for 53 years hasn’t lessened his influence much . . . But people like this strike a chord in the public because they are starved for something good and pure and true.” And, yes, it remains my career-long goal to give it to them. These positive comments give me something that every writer must need—the strength to carry on. My near-50-year career as an active businessman, CEO, entrepreneur, and innovator now seems a long time ago. In recent years, I’ve had the great joy of the quest to become, inch by inch, step by step, what passes for a writer. As my real writer friend Peter Bernstein jokes of his inability to stop writing, “it’s a disease.” And so it is for me. Need proof? I’ve just completed the manuscript for my sixth book. The Little Book of Common Sense Investing will be published by John Wiley & Sons in February 2007. It will drive home the powerful message of its subtitle, The Only Way to Guarantee Your Fair Share of Stock Market Returns. Harking back to the quotation that I cited at the outset: the new book will be, well, an enchiridion, a handy manual for index investing.

More than parenthetically, I should note that this final provision would seem to preclude the ownership of money management firms by financial conglomerates, now the dominant form of organization in the mutual fund industry. Painful as such a separation might be, conglomerate ownership of money managers is the single most blatant violation of the biblical principle that “no man can serve two masters.” Grounds for Hope Had I not found agreement with this harsh indictment of present-day capitalism from some of the most respected names in investing and in academia, I might be a little less certain of my ground. But leaders of great repute in both communities have stood up and spoken out, and their wisdom will ultimately make a positive difference. In his remarkable 2000 book On Money and Markets, the eminent financier, economist, and historian Henry Kaufman put it this way: Unfettered financial entrepreneurship can become excessive—and damaging as well— leading to serious abuses and the trampling of the basic laws and morals of the financial system. Such abuses weaken a nation’s financial structure and undermine public confidence in the financial community . . . When financial buccaneers and negligent executives step over the line, the damage is inflicted on all market participants . . . and the notion of financial trusteeship too frequently lost in the shuffle.

Put another way, ETFs used for investment are perfectly sound, but using them for speculation is apt to end badly for your clients. “Fundamental” Indexing. While this method of value investing has been presented as some sort of Copernican Revolution, the idea behind the methodology is many decades old. But offering such funds in ETF form suggests that they are useful for short-term trading—a dubious proposition on the face of it. And bringing them out only after the sharp upsurge in value fund relative returns during the 2000-2002 stock market collapse suggests the kind of marketing motivation and performance chasing that, as I’ve noted earlier, has ill-served investors. Of course, we’ve been assured that “value investing wins” (not “has won in the past”), especially in troubled markets. But the troubled markets of the last twelve months the leading “fundamental index” fund is down nearly 12 percent, almost double the 6 percent decline in a standard S&P 500 Index fund. Mark me down (Surprise!) as a market-cap-weighted indexer. As for value-weighted versus dividend-weighted strategies, I’m interested to read that they’re now arguing with each other! “Absolute Return” Funds.equity/venture

amounts of your capital—but an investor can’t do that forever; (4) Reach for higher yields by using junk bonds—with their far higher credit risk—or shift some of the bond portion into high dividend stocks—with much more volatility risk. But in general, make only moderate changes in your asset allocations; avoid box-car changes in favor of marginal changes. For in the real world, as you see above, for every pro, there’s a con. As it is said, there’s no such thing as a free lunch. . . . Or is there? In fact, there is one remarkably easy way to increase your clients’ income returns while leaving risk absolutely unchanged. And this brings me full circle in my discussion. The simple mathematical fact is that, because of high mutual fund expenses, the passively- managed all-stock-market index fund typically holds the same composite portfolio as the average actively-managed fund, and generates about the same gross dividend yield, say, 2.1 percent for stocks and 2.9 percent for taxable bonds. (Chart 6) But active stock funds (the managed funds are in red) subtract expenses averaging about 1.2 percent, leaving less than 90 basis points for the investor. Active taxable bond funds generate gross income of about 3 percent, but subtract about 0.9 percent in expenses on average, consuming more than 30 percent of the yield and leaving just 2.0 percent to distribute.

To Build the Financial World Anew Vanguard represented my best effort to align the interests of fund investors and fund managers under established principles of fiduciary duty. I leave it to wiser—and surely more objective—heads than mine to evaluate whether or not I overstate or hyperbolize what we have accomplished, even as I freely acknowledge that we owe our accomplishments to the three simple principles: the firm is (1) structurally correct (since we are owned by our fund investors); (2) mathematically correct (since it is a tautology that the lower the costs incurred in investing, the higher the returns); and (3) ethically correct (since we exist only by earning far greater trust and loyalty from our shareholders than any of our peers. There’s simply no close rival for our #1 position.) Please be appropriately skeptical of that self-serving claim, but look at the data. In a 2007 survey, an independent research group concluded, “Vanguard Group generates far more loyalty than any other company.”* As you have just learned, restructuring the firm was no easy task. Without determination, expertise, luck, timing, and the key roles played by just a handful of individuals, it never could have happened. So when I suggest to this forum that we must now go beyond restructuring the nature and values of a single firm to restructuring the nature and values of the entire money management business, I am well aware of how difficult as task it will be to accomplish that sweeping task.

add lots of excess value—on average 2.2 percent per year. To state an obvious truism, managers as a group are bound to achieve the market return. No more, no less, and only before costs. As to the value added by the alternatives managers, my long experience tells me that only a microscopic percentage of the managers—if any!—can deliver the 3 percentage points of excess return they must deliver for the total plan to meet its 8 percent target. Good luck finding even one in advance! Competing with one another, DB plan managers as a group will produce zero Alpha before costs. With the typical costs that I’ve assumed, pension managers will, in the aggregate, produce significant negative Alpha. So mark your calendars for June 2022, ten years hence, and see who’s made the best estimate. For me, subjectively, even the 5.3 percent net return likely to be earned on a “plain vanilla” 60/40 traditional policy portfolio is a fairly ambitious goal. And even if that return is in fact achieved, the financial implications of the cumulative funding deficit resulting from the 8 percent assumption would be staggering, particularly when today’s cumulative deficit of our corporate DB plans alone already exceeds $500 billion. After reaching the record funding ratio of 120 percent in 2000, our corporate plans are now only 80 percent funded.

Conclusion Let me close with this warning: “I venture to assert that when the history of the financial era which has just drawn to a close comes to be written, most of the mistakes and its major faults will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that ‘a man cannot serve two masters’ . . . the development of the corporate structure so as to vest in small groups control over the resources of great numbers of small and uninformed investors, make imperative a fresh and active devotion to that principle if the modern world of business is to perform its proper function. Yet, those who serve nominally as trustees, but relieved, by clever legal devices, from the obligation to protect those who interests they purport to represent . . . [and] consider only last the interests of those whose funds they command, suggest how far we have ignored the necessary implications of that principle.” I wish that those were my words. But they are not. They are the words of Supreme Court Justice Harlan Fiske Stone, and they were written in 1934. “The more things change, the more they remain the same.

forever; and own it through a company with a truly mutual structure, a company where serving two masters is anathema, and where the rewards of investing go to the investors rather than to the managers. In a sense, most of the funds Vanguard offers are products of simple arithmetic, a reflection of these words of Sophocles’: “Remember, O Stranger, that arithmetic is the first of the sciences, and the mother of safety.” Yes, arithmetic and engineering. So Next Let’s Consider the Culture of the Humanist Even as Princetonian David Billington became one of my guiding spirits on the culture of the engineer, so Elliot McGucken, Princeton Class of 1992, has lifted my spirits on the culture of the humanist. Dr. McGucken received a B.A. in Physics from Princeton, and earned a Ph.D. in physics at University North Carolina in Chapel Hill. Now teaching at Pepperdine University, he has created a business school course entitled “Artistic Entrepreneurship and Technology,” linking today’s Information Age to the great values of Western Civilization. His required reading list includes Homer’s Odyssey, and Dante’s Inferno. Believe it or not, “Dr. E.” discovered my 2005 book, The Battle for the Soul of Capitalism when he was browsing in a bookstore. It formed one of three foundations for reading in his course. When he told me that, of course I was thrilled. (Heck, truth told, astonished!)

Apparently ignorant of the time-honored rule “trust, but verify,” these managers flunked the due- diligence test. Paid such huge revenues for so little effort, they are a vivid example of one of Upton Sinclair’s timeless warnings, which I paraphrase here: “It’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it.” President Obama, Leadership, and Confidence My third and final subject is “where do we go from here?” We are facing the worst economic crisis of my adult lifetime (I was born just before the Great Depression, so I don’t remember it!), a financial mess that is enormous beyond imagination, and complex beyond the intellectual capacity of most (perhaps all!) of us. What’s more, the solutions that we are considering are without precedent—and therefore uncertain of success. Resolving the crisis and reforming the system will take patience and sacrifice—two traits that at the moment seem far from being the defining elements of our national character.

accountants and the managers of other corporations.” Why did it happen? “Because,” in Mr. Pfaff’s words, “the markets had so diffused corporate ownership that no responsible owner exists. This is morally unacceptable, but also a corruption of capitalism itself.” When most owners either don’t or won’t or can’t stand up for their rights, and when corporate directors lose sight of whom they represent, the resulting power vacuum quickly gets filled by corporate managers, living proof that Spinoza was right when he told us, “nature abhors a vacuum.” Little good is likely to result when the CEO becomes not only boss of the business but boss of the board, erasing the “bright line” that common sense tells us ought to exist between management and governance. Put more harshly, in a quote that I came across last spring, “when we have strong managers, weak directors, and passive owners, don’t be surprised when the looting begins.” There were two major forces behind this baneful change: First, the “ownership society”—in which the shares of our corporations were held almost entirely by direct stockholders—gradually lost its heft and its effectiveness. Since 1950, direct ownership of U.S. stocks by individual investors has plummeted from 92 percent to 30 percent, while indirect ownership by institutional investors has soared from 8 percent to 70 percent. Our old ownership society is now gone, and it is not going to return.

If you are willing to accept—based on that solid data—that Vanguard has achieved both commercial success (asset growth and market share) and artistic success (superior performance and low costs), you must wonder why, after nearly 35 years of existence, no other firm has elected to emulate our shareholder-oriented structure. (A particularly ironic outcome since I chose the name Vanguard in part because of its conventional definition as “leader in a new trend.”) The answer, I think, can be expressed succinctly: under our at-cost structure, all of the darned profits go not to the managers, but to the fund shareholders, resolving the transcendent conflict of interest that besets the mutual fund industry. In any event, the leader, as it were, has yet to find its first follower. To Build the Financial World Anew Vanguard represented my best effort to align the interests of fund investors and fund managers under established principles of fiduciary duty.

The mutual fund industry is hardly unique in the oppressive level of its costs. In fact, it is a sort of poster child for the escalating costs that investors incur all across our nation’s system of financial intermediation. The direct costs of the mutual fund system (largely management fees and operating and marketing expenses) are currently running at an annual rate of almost $100 billion, but funds are also generating transaction fees to our brokerage firms and investment bankers, and to their lawyers and all those other facilitators. Mutual fund expenses, plus fees paid to hedge fund and pension fund managers, plus advisor fees and trading costs and investment banking fees and all the other costs of the system will total about $528 billion this year. (Chart 5) But don’t forget that these costs recur year after year. If the present level holds for the next decade (I’m guessing that it will grow), total intermediation costs would come to a staggering $5 trillion. (Think about these cumulative costs relative to the $16 trillion value of the U.S. stock market and the $26 trillion value of our bond market.) Does this explosion in intermediation costs create an opportunity for money managers? You better believe it does! Does it create a problem for investors? You better recognize that too.

And even if a fund that you own endures, it is apt to have about five different managers in the next 25 years. If you own, say, four mutual funds and—defying the odds—all survive, your money will have been run by 20 different managers. You must realize that, given their higher costs, the chances of their outpacing the index fund are insuperable, if not inconceivable. Only the index fund is a fund for a lifetime.

The fact is that the Vanguard is simply different from our peers, unique in our field. We are in fact a group of truly mutual mutual funds, structured so that our management company is owned directly by our funds and their shareholders, operating on an at-cost basis for the benefit of our owners. Our rivals are not “mutual” in any sense of the word. (That is why in my recently published book Don’t Count On It!, the section on “What’s Wrong with ‘Mutual’ Funds” includes quotation marks around the word mutual.) They are operated for the benefit of profit- making corporations, in business to earn a profit on their own capital. Of course, they also want to earn profits for the shareholders of their funds. But in the long run, these managers as a group are destined to produce market-like performance before costs.and

have set demanding standards for those of us who follow in their footsteps, lest history forget that even a handful of dedicated idealists can move the world forward. I’ve also offered some provocative ideas on improving corporate governance, a mission in which true professionals must lead the way in bringing about needed reform. Today, the CFA Institute has an enlightened mission—providing “the highest standards of ethics, education, and professional excellence for the ultimate benefit of society.” We’re reaching for those stars, but our reach inevitably will exceed our grasp. (That’s the way the world works.) But tonight, on the 70th Anniversary of the CFA Society of Philadelphia, I ask you for something more than ethics, and education, and excellence. As essential as those goals are, I ask each of you to develop a keener awareness of the “big picture” of our financial system; a profound introspection into how we can make it better, a sense of our long and proud history, and a deep involvement in giving our profession the high character it requires if it is to serve investors effectively and honestly in the years ahead. Yes, these are idealistic goals. But what would our profession be without a healthy dose of idealism? Indeed, a bright future for finance— in Philadelphia and across our nation— depends upon it.

In its place we have a new “agency society” in which our financial intermediaries now hold effective control of American business. But these new agents haven’t behaved as agents should. Our corporations, pension managers, and mutual fund managers have too often put their own financial interests ahead of the interests of the principals whom they are duty-bound to represent, those 100-million families who are the owners of our mutual funds and the beneficiaries of our pension plans. As Adam Smith wisely put it 200-plus years ago, “managers of other people’s money (rarely) watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail.” And so negligence and profusion among our corporate directors and money managers have prevailed in present-day America. The second reason for the debasement of the values of our capitalistic system is that our new investor/agents not only seemed to ignore the interests of the investor principals whom they are duty-bound to serve, but they also seemed to forget their own investment principles.the

Investing Today In a New York Times piece in August, I was quoted (correctly) as saying “this is the worst time for investing that I’ve ever seen.” It is. Because while the prospects for future returns on stocks are highly likely to be positive, albeit below long-term norms, based on the methodology I developed for realistic return expectations a quarter century ago that has met the test of time. In it, I separate stock returns into two components: investment return, and speculative return. (This is the math part of the talk!) I show that future investment returns—the current dividend yield (about 2 percent today) plus subsequent earnings growth (probably about 5 percent) would likely be around 7 percent, measured in nominal dollars, well below the historical norm of 9 percent—a huge gap over the long-term. Consider that each dollar invested at 7 percent over a quarter century would grow by 5.4 times; at 9 percent, by 8.6 times. The second element, speculative return, depends entirely on investor opinion and investor behavior, and we can easily measure it by the number of dollars that investors are willing to pay for future earnings on stocks. If valuations a decade hence were materially higher or lower than today’s price-earnings multiple of about 16 times, speculative return could be an important factor in the stock market’s performance. For example, a valuation of 20 times could add almost 2 percentage points per year, raising that 7 percent to 9 percent.

capital proxies, etc. My advice: look before you leap, and don’t leap until the fund has a ten-year track record. And above all, remember (courtesy of Warren Buffett), “What the wise man does in the beginning, the fool does in the end.” Commodity Funds. First principles: the prices of stocks and bonds are ultimately supported by their internal rate of return—respectively, dividends and earnings growth, and interest coupons. That is why stocks and bonds are considered investments. Commodities have no internal rate of return; their prices are based entirely on supply and demand. That is why they are considered speculations. I freely concede that the huge rise in the prices of most commodities in recent years doesn’t guarantee that speculation on future price increases will not be rewarded. But that may well be the odds-on bet. Managed Payout Funds. The fund industry apparently only recently discovered that growing millions of investors are moving from the accumulation phase of investing to the distribution phase. (Although, that demographic handwriting has been on the wall for decades). So we have new funds that, in effect, guarantee the exhaustion of your assets in whatever time period you choose (something that has always been all too easy to accomplish!) We also have funds designed to distribute 3 percent, 5 percent, or 7 percent of your assets without necessarily invading principal. Only time will tell if that will happen.

so on—the performance of their funds falls, as it must, well behind the returns provided in the stock market. In his foreword to my 1999 book Common Sense on Mutual Funds (updated and republished last year), the late eminent economist and prolific author Peter Bernstein made this pungent observation: What happens to the wealth of individual investors cannot be separated from the structure of the industry that manages those assets . . . [and] investment managers go right on earning a return on their own capital that most other industries can only envy. In the present manager-dominant structure of institutional investing, managers garner huge rewards and their clients get second shrift. If you doubt that, just compare the huge returns earned on the stocks of publicly-held management companies with the far more modest returns earned by even the best-performing of their funds. While we don’t know the exact profitability of the management companies that are owned by giant U.S. and international banks and financial conglomerates—now the dominant structure in the fund industry—aggregate profits must run to many billions. (In 2006-2009 alone, for example, Sun Life Financial reported operating profits of $1.5 billion from its mutual fund subsidiary MFS.) I suspect that the returns are even higher for the few large management companies that remain privately-held. (Example: Fidelity Management and Research reported net operating income of $2.5 billion for 2009 alone.)

By then, I hope, our corporations will be required to report the actual returns of their DB plans over the prior ten years, disclosure that, absurdly, has never been mandated. VI. The Challenges We Face To sum up, in mid-2012, economic and market conditions together constitute as challenging a combination as I have seen at any time during my 61 years in finance (a milestone I will reach on July 5). Economic conditions in the U.S. and around the globe are, bluntly put, threatening. The battle has been joined between Keynesians demanding that governments borrow and spend to increase aggregate demand for goods and services, and Hayek-ites (disciples of the Austrian School of Economics) calling for fiscal austerity. It’s premature to guess how a compromise might be reached. For the political will to save both the Euro from fragmentating and the dollar from inflation by taking strong action to reduce our nation’s massive overlay of debt seems stymied by partisan interests. Our economic future depends on resolving these seemingly intractable issues—and there are many others!

Only by improving the balance between entrepreneurial innovation and more traditional values—prudence, stability, safety, soundness—can we improve the ratio of benefits to costs in our economic system . . . And just a few weeks ago, Daedalus, the Journal of the American Academy of Arts and Sciences, devoted its entire Fall 2010 issue to “the financial crisis and economic policy.” Its lead essay by Harvard professor and acclaimed author Benjamin M. Friedman asks the question, “Is our Financial System Serving Us Well?” Dr. Friedman expresses grave concerns about the shortcomings of our financial system in allocating scarce investment capital, and the high—and growing—costs of its operations. He concludes that the “breakdown in the financial system (has) inflicted serious damage on the real economy, damage that may last for years . . . ” Solving these problems goes far beyond the tinkering with the system that characterized much of the recent Dodd-Frank financial reform legislation.the

For as long as our financial system delivers to our investors in the aggregate whatever returns our stock and bond markets are generous enough to deliver, but only after the costs of financial intermediation are deducted, these enormous costs seriously undermine the odds in favor of success for our citizens who are accumulating savings for retirement. Alas, the investor feeds at the bottom of the costly food chain of investing. This is not to say that our financial system creates only costs. It creates substantial value for our society. It facilitates the optimal allocation of capital among a variety of users; it enables buyers and sellers to meet efficiently; it provides remarkable liquidity; it enhances the ability of investors who wish to capitalize on the discounted value of future cash flows, and other investors who wish to acquire the right to those cash flows; it creates financial instruments (so-called “derivatives,” albeit often of mind-boggling complexity) that enable investors to divest themselves of a variety of risks by transferring those risks to others. No, it is not that the system fails to create benefits. The question is whether, on the whole, the costs of obtaining those benefits have reached a level that overwhelms those benefits.

I leave it to wiser—and surely more objective—heads than mine to evaluate whether or not I overstate or hyperbolize what we have accomplished, even as I freely acknowledge that we owe our accomplishments to the three simple principles: the firm is (1) structurally correct (since we are owned by our fund investors); (2) mathematically correct (since it is a tautology that the lower the costs incurred in investing, the higher the returns); and (3) ethically correct (since we exist only by earning far greater trust and loyalty from our shareholders than any of our peers). Measured by repeated evaluations of loyalty by independent research firms, there’s simply no close rival for our #1 position. Please be appropriately skeptical of that self-serving claim, but look at the data. In a 2007 survey, one such group concluded, “Vanguard Group generates far more loyalty than any other company.”* Creating and restructuring Vanguard was no easy task. Without determination, expertise, luck, timing, and the key roles played by just a handful of individuals, it never could have happened. So when I suggest that we must now go beyond restructuring the nature and values of a single firm to restructuring the nature and values of the entire money management business, I am well aware of how difficult it will be to accomplish that sweeping task. *Cogent Research data, as reported in The Wall Street Journal, date March 15, 2007.

And yet we dare not stand still. For we meet at a time when, as never before in the history of the country, our most cherished ideals and traditions are being subjected to searching criticism. The towering edifice of business and industry, which had become the dominating feature of the American social structure, has been shaken to its foundations by forces, the full significance of which we still can see but dimly. What had seemed the impregnable fortress of a boasted civilization has developed unsuspected weaknesses, and in consequence we are now engaged in the altogether wholesome task of critical re-examination of what our hands have reared. * Cogent Research data, as reported in The Wall Street Journal, date March 15, 2007. Our loyalty score (percentage of strong supporters minus strong detractors) was plus 44. The fund industry scored a pathetic minus 12.

Here is where Barak Obama comes in. For while resolution and reform will come neither easily nor quickly, both require strong leadership. And without strong leadership, we are lost. I speak not as a partisan but as a citizen when I express my belief that President Obama can—and will—give us the kind of leadership we urgently require. Clearly, he understands the challenge. Recall with me these words from his Inaugural Address: “That we are in the midst of crisis is now well understood . . . Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age . . . The question before us (is not) whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control—and that a nation cannot prosper long when it favors only the prosperous. The success of our economy has always depended not just on the size of our gross domestic product, but on the reach of our prosperity; on our ability to extend opportunity to every willing heart . . . the surest route to our common good.” “Those values upon which our success depends—hard work and honesty, courage and fair play, tolerance and curiosity, loyalty and patriotism—these things are old. These things are true. What is demanded then is a return to these truths.

The Impact of Investment Costs on Fund Yields, October 2012 Net Percent of Yield Gross Yield Expense Ratio SEC Yield Consumed by ER LARGE-CAP STOCK FUNDS 2.09 1.22 0.87 58% Vanguard Total Stock Market Index Admiral 2.10 0.06 2.04 3% BALANCED FUNDS 1.91 1.29 0.59 68% Vanguard Balanced Index Admiral 1.93 0.10 1.83 5% INTERMEDIATE-TERM BOND FUNDS 1.74 0.65 1.09 37% Vanguard Total Bond Market Index Admiral 1.76 0.10 1.66 6% INTERMEDIATE-TERM MUNICIPAL BOND FUNDS 1.73 0.78 0.95 45% Vanguard Intermediate-Term Tax Exempt Admiral 1.74 0.12 1.62 7% Notes: Sales loads not included.2012

But hear the concern McGucken expresses as he explains what is happening to Humanistic education, in words far better than my own: When I first embarked on this venture four years ago, I had thought that common sense would be a bit more common, and that Homer and Bogle would naturally and immediately prevail in the academy with nary a battle. Well, amongst the students a vast market exists for the words that speak to the immortal sensibilities of their souls (and thus time is on our side!), but the modern university's bureaucracy has evolved to oppose classical wisdom, as has Wall Street and our government, which all too often see more profit in trying to purchase virtue and enduring wealth via mere money; rather than focusing first on virtue and ‘doing the right thing,’ reminding us of Socrates belief that we should ‘care about the greatest improvement of the soul . . .

Like my other books, it’s designed to be protected by our librarians and by our libraries—including this one—for generations, protected always against rodents, the elements, and clumsy hands, and against nature, and fighting a war against the forces of oblivion.

” What’s more, I endorsed them to my partners at Wellington Management Company way back in 1971, three years before Vanguard was founded, with a structure—the management company owned by the funds and operated on an “at cost” basis—which represented my best effort to eliminate, or at least mitigate to the maximum extent possible, the many conflicts of interest in money management that I’ve described to you today. So I am hardly a newcomer to the idea of reforming our financial sector. I’ve done my best, and the record is clear that it has worked in the interest of Vanguard fund shareholders. But 1971 was a long time ago, and 1934 even longer. So let’s take advantage of this crisis so that we won’t have to hear a latter-day Justice Stone render that analysis all over again. Let’s take this opportunity to do big things. Whether we are, like most of you in this audience, serving as investment advisers to the human beings who need your help, or, as I am, part of the giant mutual fund industry that dominates our financial sector, we owe no less to our clients. We cannot fail again to honor this trust.

Financial market conditions, too, are unusually difficult. While the U.S. stock market seems reasonably valued, its long-term performance—let us never forget—is ultimately dependent on the course of our own economy and the global economy. In many earlier eras of challenge, bonds provided not only a haven against stock market risk, but solid yields while you waited. Today, bond yields are, well, awful. The yield on ten-year U.S. Treasury notes is just 1.6 percent, and the yield on the Treasury dominated total bond market index is just 2.03 percent, only slightly above the stock yield of 1.95 percent. My unvarying advice has been to accept the yield environment as it exists (no matter how painful). Most investors should avoid reaching out on the risky limb for higher-yielding junk bonds and stocks. With U.S. Treasury yields so low relative to investment-grade corporates, however, a holder of the total bond market index (72 percent in government-backed issues), might seek some increased exposure to corporate bonds, as I suggested a few paragraphs earlier. Happily for my peace of mind, I’m not alone in my view that future returns in the financial markets will fall well short of historical norms. Two of the best in the business—Cliff Asness, managing principal of hedge fund manager AQR Capital Management, and PIMCO’s Bill Gross—share my concerns. In his Investment Outlook for June 2012, Bill Gross actually has a more cautious—even negative—view than my own.

wisdom and objectivity of dedicated academics, combined with the intelligence and experience and independence of the most integrity-laden leaders of corporate America and investment America alike. Further, democracy being democracy, even the most promising solutions for restoring our powerful but flawed financial system will ultimately require the perspective and understanding of our elected representatives. We need such academics, private sector leaders, and political leaders with the courage and character to fix what has been broken. Of course there are never enough such extraordinary citizens to allow us to envision an easy road ahead. But surely understanding the issues, which I have tried to help you with this evening, will enable an informed citizenry to begin to tackle the monumental task that lies before us.

virtue is not given by money, but from virtue comes money and every other good of man.’ During each faculty meeting, he continues, I need to justify why I am teaching Homer and Socrates in a business class of all things. I have been tempted to ask the question, ‘Well, can you find anything of greater and more-enduring value?’ But I have refrained . . . despite the daily news which screams at us regarding the epic failures of the current system and all that the soulless MBA curriculum hath wrought, the contemporary academy yet refuses to see, because the MBA is a license to partake in the $500 billion of innovation-free, annual wealth-transfer [to the financial sector] that compromises, erodes, and opposes capitalism's moral premises. The risk- taker ought to get the reward, and the primary purpose of an institution ought to be to serve—not to tempt and take. Quoting from Who Killed Homer, McGucken notes that “This ignorance of Greek wisdom should be of crucial interest to every American. The Greeks bequeathed us constitutional government, individual rights, freedom of expression, an open economy, civilian control of the military, separation of religious and political authority, private property, free scientific inquiry and open dissent. But it is foolish—and dangerous—to embrace these conventions . . .

On the other hand, for an equity index fund with a cost of a mere 0.1 percent, the net yield on the stock index fund comes to slightly above 2.0 percent, the Intermediate-Term Bond Index Fund to 2.1 percent. The yield enhancements are 120(!) percent for stock funds and about equal for the bond funds (with higher quality and shorter maturity)—are there for the taking, without any increase whatsoever in risk exposure. (The same arithmetic applies to annuities, with annuities invested in index funds available at costs as low as 0.25 percent, compared to more than 2 percent per year for their highest cost cousins.) The Dominance of the Index Fund In recent years, with sharply lower income yields now available, and the demonstrated importance of low costs as the major factor in producing optimal total returns in stock funds and bond funds alike, the move toward index funds has come into its own. During the past six years, fund investors have moved almost $300 billion out of relatively high-cost, actively-managed equity funds and poured more than $650 billion into low-cost, passively managed equity index funds, a swing of almost $1 trillion. (Chart 7) In today’s low yield environment, with clients starving for income, indexing is even more attractive than ever before, and intelligent investors are voting for it with hundreds of billions of dollars.billions

When one considers the ancient Biblical precept, “No man can serve two masters,” it is clear that the master who manages the funds—by definition—feeds at the top of the food chain of investing, paid before whatever profits remain are shared by the shareholders of the funds, who feeds at the bottom of the food chain. Under Vanguard’s mutual structure, our idea was to make the fund shareholder the master. It must be clear that the benefits of this mutual structure to shareholders, in financial terms, are not only larger, but mathematically certain. “The less the managers take, the more the shareholders make.” When I founded Vanguard in September 1974, it followed the idealistic principles that I outlined in my senior thesis at Princeton University, written in 1951 (when I was only a bit younger than most of you students here in this room today).Company:”

latter part of the twentieth century, the predominant focus of institutional investment strategy turned from the wisdom of long-term investing to the folly of short-term speculation. During the recent era, we entered the age of expectations investing, where projected growth in corporate earnings—especially earnings guidance and its subsequent achievement, by fair means or foul— became the watchword of investors. Never mind that the reported earnings were too often a product of financial engineering that served the short-term interest of corporate managers and Wall Street security analysts alike. But when long-term owners of stocks become short-term renters of stocks, and when the momentary precision of the price of the stock takes precedence over the eternal vagueness of the intrinsic value of the corporation itself, concern about corporate governance is the first casualty. The single most important job of the corporate director is to assure that management is creating value for shareholders; yet our new agent/investors seemed not to care when that goal became secondary. While these institutional agents now hold absolute voting control over corporate America, all we hear from these money managers is the sound of silence.

As you may have suspected, I’ve once again cited a section of Justice Stone’s 1934 speech, and it’s high time we take it seriously. For the fact is that there has been a radical change in our investment system from the ownership society of a half-century ago—which is gone, never to return—to our agency society of today—in which our agents have failed to serve their principals—mutual fund shareholders, pension beneficiaries, and long-term investors. Rather the new system has served the agents themselves—our institutional managers. Further, by their forbearance on governance issues, our money managers have also served the managers of corporate America. To make matters even worse, by turning to short-term speculation at the expense of long-term investment, the industry has also damaged the interests of the greater society. Hear Lord Keynes on this point: When enterprise becomes a mere bubble on a whirlpool of speculation, the consequences may be dire . . . when the capital development of a country becomes a by- product of the activities of a casino . . . the job (of capitalism) will be ill-done. Yet despite these changes in the very nature of corporate ownership we have failed to change the rules if the game. Indeed, in the financial sector we have rolled back most of the historic rules regulating our securities issuers, our exchanges, and our investment advisers.

Whatever the benefits, the tremendous drain on investment returns represented by the costs of our investment system raises serious questions about the efficient functioning not only of that investment system, but of our entire society. Over the past two centuries, our nation has moved from being an agricultural economy, to a manufacturing economy, to a service economy, and now to what is predominantly a financial economy. But the costs that we incur in our financial economy, by definition, subtract from the value created by our productive businesses. Think about it. When investors—individual and institutional alike—engage in far more trading—inevitably with one another—than is necessary for market efficiency and ample liquidity, they become, collectively, their own worst enemies. To reiterate: while the owners of business enjoy the dividend yields and earnings growth that our capitalistic system creates, those who play in the financial markets capture those investment gains only after the costs of financial intermediation are deducted. Thus, while investing in American business is a winner’s game, beating the stock market before those costs—for all of us as a group—is a zero-sum game. And after intermediation costs are deducted, beating the market becomes a loser’s game. The rise of the financial sector is one of the seldom-told tales of the recent era.

What seems to be ignored by the fund industry, for obvious reasons: Serving retired investors by increasing fund investment income, the forgotten man of the fund industry. The only way to increase payouts from fund income—while holding risk constant (something some deeply trouble short-term bond funds obviously forgot)—is to slash expense ratios. Aren’t equity fund shareholders ill-served when 75 percent (!) of investment income of the average equity fund is confiscated by costs? (And that’s precisely what happens when the gross yield on stocks is 2 percent, and the fund’s expense ratio is 1.5 percent.) Similarly, the all-in costs of the typical bond fund, including amortized sales loads, consume about 50 percent of the yield on the average bond fund. (As investors in some deeply-troubled short-term bond funds have learned, increasing the net return by holding higher-yielding CDOs wasn’t a good idea.) BRIC Funds and International Funds. No doubt about it. With returns in Brazil, Russia, India, and China soaring in recent years, fund sponsors were quick to market them. Perhaps their recent declines will squash investor appetites for them, but my experience is that it’s all too easy to jump on the bandwagon of superior past performance. Just consider the ebb and flow of equity fund capital flows into international markets, consistently declining as U.S. stocks lead and then soaring as non-U.S. issues lead.

What is required of us now is a new era of responsibility—a recognition, on the part of every American, that we have duties to ourselves, our nation, and the world, duties that we do not grudgingly accept but rather seize gladly, firm in the knowledge that there is nothing so satisfying to the spirit, so defining of our character, than giving our all to a difficult task. This is the price and the promise of citizenship.” As I listened to the president’s Inaugural Address, I was impressed with his obvious gift of oratory. And when I read the text in the next day’s newspaper, I was even more struck by the power, the clarity, and the realism that resounded throughout his cadences. While he didn’t use the phrase “America, we have had enough” (as he did—of course, to my delight—in his speech accepting his party’s nomination), I was struck by how his words and values paralleled what I had written months earlier for my own ENOUGH.. In the section in which I ask, “Enough for America?president:

And a drop to 12 times would cost about 3 percentage points, dropping the 7 percent return to just 4 percent. But those are fairly big moves for valuations, and I don’t see much reason either for multiples to rise much (and thus produce positive speculative returns) or to fall much (and thus produce negative speculative returns). So I expect that possible 7 percent investment return to be neither materially enhanced nor materially depleted by speculative return during the coming decade.

What we must do is develop a new fiduciary society which guarantees that our last-line owners—those mutual fund shareholders and pension fund beneficiaries whose savings are at stake—their rights as investment principals. These rights must include: (1) The right to have their money-manager/agents act solely in their behalf. The client, in short, must be king. (2) The right to rely on due diligence and high professional standards on the part of our money managers and securities analysts who appraise securities for our portfolios. (3) The assurance that our agents will act as responsible corporate citizens, restoring to their principals the neglected rights of ownership of stocks, and demanding that corporate directors and managers meet their fiduciary duty to their own shareholders. (4) The right to demand some sort of discipline and integrity in the mutual funds and financial “products” that we offer. (5) The establishment of advisory fee structures that meet a “reasonableness” standard based not only on rates but dollar amounts, and their relationship to the fees and structures available to other clients of the manager. (6) In all, measuring up to the 1940 Act standard that funds are in fact “organized, operated, and managed in the interest of their shareholders,” by eliminating of all conflicts of interest that could preclude the achievement of these goals.

As my newest book, The Clash of the Cultures, makes clear, I am dissatisfied, disappointed, and angry about how our financial system is working today. But I am pleased with how those remarkably simple ideas that I expressed at Princeton all those years ago have proven themselves. Index equity fund assets are rapidly approaching one-half of the assets of active equity mutual funds, and growing apace. In these days of low market yields and high mutual fund expenses, I expect that growth to accelerate. A journalist recently reported that I take “almost childlike delight” in seeing my idealistic dreams come true, as the low-cost mutual model of mutual fund structure and the dominance of index funds have come into their own, reflecting two vital ingredients of fiduciary duty that our clients expect of their investment advisers and of their mutual fund providers. (He was accurate, I think, except for the almost!) But I’ve long since realized that what passes for success in this funny world of ours is really a journey, not a destination. My long journey continues, and I thank you for being in the, well, vanguard of the coming new order of fiduciary duty in the investment advisor field and the field of mutual fund management.

[Mutual funds] should be operated in the most efficient, honest, and economical way possible . . . Future growth can be maximized by reducing sales charges and management fees . . . Funds can make no claim to superiority over the market averages . . . the principal function of investment companies is the management of [their] investment portfolios. Everything else is incidental . . . The principal role of the mutual fund should be to serve its shareholders. What should one make of these words? The idealistic ruminations of an immature college senior? An intelligent design for a new fund management structure? Something in between? I’ll let you decide. Strategy Follows Structure Before you do decide about Vanguard’s origins (and don’t forget luck and determination!), let’s consider the far-reaching consequences that our unique structure—simply designed to minimize the costs of investing—has on the strategies followed by such a mutually- operated firm to maximize that compelling advantage. Here they are, and how they differ from our peers. 1. Profit. Higher profits for investors, rather than awesome profits for managers. 2. Pricing. On an at-cost basis, rather than whatever traffic will bear. 3. Service. Treating the client as an owner, rather than as a customer. 4. Risk. Limiting risk without sacrificing return, an option available because of the cost advantage. 5. “Products.

Hear his blunt words: The developing credit cancer may be metastasized, and the global monetary system fatally flawed by increasingly risky and unacceptably low yields, produced by the debt crisis and policy responses to it. The great white whale lies waiting on the horizon. Investors should sail carefully and the Wall Street 1% should put on their life vests if they expect to weather the inevitable storm that may threaten the first-class cabins they have come to enjoy. Deleveraging [has] produced narrower yield margins, asset price exhaustion, and a reluctance on the part of lenders to lend (and in many cases – borrowers to borrow). Combined with now negative real interest rates of 200-300 basis points on the front end of the lending curve, the ability to successfully lever financial market returns has been jeopardized. Bond, equity and all financial assets which are structurally bound together by this dynamic must lower return expectations. Maintain a vigilant watch matey! Cliff Asness, writing in the May issue of Institutional Investor, is equally unequivocal: Institutional investors are in a quandary. They commonly target 5 percent real annual returns, or 7 to 8 percent nominal returns. Starting from today’s prices for stocks and bonds, the likelihood of actually achieving those returns is low. . .have

“While we seem to have quite enough things in the United States, our traditional values seem to be eroding, and soon we’ll not have nearly enough of them. So let’s never forget that over the long term it is not things, nor power, nor money that form the heart of any nation. Rather, it is values, the very values, applied to our society that I have described here for us as individuals: the persistence, resilience, moral standards, and virtue that have made this nation great. The question, in short, is not whether the United States has enough money—enough productive wealth—to maintain and enhance its global presence and power, but whether we have enough character, values, and virtue to do so.” And that’s really what ENOUGH. is all about . . . and that’s surely enough words to inflict on you on this busy morning, during this long winter of our discontent. These are truly “the times that try men’s souls,” but please remember the eternal wisdom of these words: “This too shall pass away.” And so today’s crisis shall pass away, as time and the resilience of our system—and important changes in the way we manage American capitalism—heal our wounded economy. It can’t pass away too soon for me!

But even if stocks seem apt to provide adequate returns, nearly all prudent investors still need a balanced portfolio, including bonds to reduce risk and contain volatility. The basic rule of asset allocation is age-based; less bonds when you are young, and more bonds as you age. Yet bonds today offer the lowest yields since I came into this field in 1951. Alas, today’s yields are excellent predictors of the total returns you’ll earn on bonds over the coming decade. Worst case: the (so-called) risk-free rate—based on the 10-year Treasury bond—is now 1.6 percent, down from a high of 11.6 percent in 1980. Two more mathematical facts: a 1.6 percent return would increase your capital by just 17 percent during the next 10 years; in the same length of time with an 11.6 percent return would multiply capital three times over. So, yes, holding a balanced stock-and-bond allocation is essential, but it will not likely provide the kinds of handsome returns we were lucky enough to experience during the 1980s and 1990s, albeit better than we have seen thus far during the 21st century. (During the past 12 years, bonds were the driver. In the coming decade; it is stocks that will have to do the heavy lifting.) Of course, investors are not limited to U.S. Treasury 10-year bonds. Owning an investment grade corporate bond with a somewhat longer maturity should produce a yield of perhaps 3 percent. So it seems it is reasonable to own a mix of Treasurys and corporates, and earn about 2 ½ percent.

without understanding that the Greeks also insisted that such energy was to be monitored and restrained by a host of cultural protocols that have nearly disappeared: civic responsibility, philanthropy, a world view that is rather absolute, a brief that life is not nice, but tragic and ephemeral . . . an entire way of looking at the world, a way diametrically opposite to the new gods that now drive America: therapeutics, moral relativism, blind allegiance to progress and the glorification of material culture.” So you can see why Dr. E and I get along so well! We have reached common ground in loving the classics and in seeking the triumph of virtue and ethics—and even fiduciary duty!— over the vanishing values of the day. It is time to accept our responsibility to reverse the recent triumph of unfettered business conduct, and fight to restore the professional conduct that once permeated our society.

-$50,0 00 $0 $50,0 00 $ 100,0 00 $ 150,0 00 $ 200,0 00 $ 250,0 00 1990 1991 1992 1993 1994 1995 1996 1997 1998 199 9 2000 2001 2 00 2 2003 200 4 2 00 5 2006 2 00 7 0 .0 0 .2 0 .4 0 .6 0 .8 1 .0 1 .2 Dom Eq Net Flow Int'l Eq Net Flo w EAFE / S&P Net Flow into Domestic and International Equity Funds, versus Relative Performance of S&P 500 and EAFE Indexes mil S&P outperfor ming EAFE outperforming 1 2. Total Flows 90-00 01-07 Dom Eq: $1,281b $610b Int’l Eq: 309b $711b 1990-2000, when U.S. stocks vastly outpaced foreign issues. Nor is it surprising that since then, with U.S. stock returns averaging 6 percent per year and foreign stocks averaging 14 percent, that the tables were turned—last year, $1.1 billion into foreign; only about $200 million into U.S. Now there’s a red flag! (Alas, of course, it could be a false warning!) (Chart 12) But risk in the hottest sectors of the international markets is high, so be careful. (Also note that, even including the recent boom in non-U.S. stocks, the returns since 1990 have been dwarfed by the returns on U.S. equities—6 percent annually versus 10 percent.) No objective industry veteran can look at this blunderbuss of innovation with other than a jaundiced eye.

I should note that this final provision would seem to preclude the ownership of money management firms by financial conglomerates, now the dominant form of organization in the mutual fund industry. Among today’s 40 largest fund complexes, only six remain privately-held. The remaining 34 include 13 firms whose shares are held directly by the public, and an astonishing total of 21 fund managers owned or controlled by U.S. and international financial conglomerates—including Goldman Sachs, Bank of America, Deutsche Bank, ING, John Hancock, and Sun Life of Canada. Painful as such a separation might be, conglomerate ownership of money managers is the single most blatant violation of the principle that “no man can serve two masters.” Of course it will take federal government action to foster the creation of this new fiduciary society that I envision.their

Not only because they are more likely to be short-term speculators than long-term investors, but also because they are managing the pension and thrift plans of the corporations whose stocks they hold, and thus face a serious conflict of interest when controversial proxy issues are concerned. This conflict is pervasive, for, as it is said, money managers have only two types of client they don’t want to offend: actual, and potential. Had I not found agreement with this harsh indictment of the present-day capitalism from some of the most respected names in investing, I might be a little less certain of my ground. But leaders of great repute in the business community and the investment community have stood up and spoken out, making a positive difference. Consider, for example, the eminent financier, economist, and historian Henry Kaufman. In his remarkable 2000 book On Money and Markets, here’s what he said: “Unfettered financial entrepreneurship can become excessive—and damaging as well—leading to serious abuses and the trampling of the basic laws and morals of the financial system. Such abuses weaken a nation’s financial structure and undermine public confidence in the financial community . . . Only by improving the balance between entrepreneurial innovation and more traditional values—prudence, stability, safety, soundness—can we improve the ratio of benefits to costs in our economic system . . .

While we should have been improving regulatory oversight and administering existing regulations with increasing toughness, both have been relaxed, ignoring the new environment and therefore bearing much of the responsibility for today’s crisis. Of course American society is in a constant state of flux. It always has been, and it always will be. I’ve often pointed out that our nation began as an agricultural economy, then became largely a manufacturing economy, then largely a service economy, and most recently an economy in which the financial services sector had become its dominant element. Such secular changes are not new, but they are always different, so enlightened responses are never easy to come by. Justice Stone, once again, recognized that new forces demand new responses: It was in 1809 when Jefferson wrote: “We are a rural farming people; we have little business and few manufactures among us, and I pray God it will be a long time before we have much of either.” Profound changes have come into American life since that sentence was penned.have

(Chart 6) Twenty–five years ago, financials accounted for only about 5 percent of the earnings of the 500 giant corporations that compose the Standard & Poor’s 500 Stock Index. Fifteen years ago, the financial sector share had risen to 10 percent, then to 20 percent in 1997, and to a near-peak level of 27 percent in 2007. If we add to this total the earnings of the financial affiliates of our giant manufacturers (think General Electric Capital, for example, or the auto financing arms of General Motors and Ford) financial earnings now likely exceed one-third of the annual earnings of the S&P 500. In fact, (Chart 7) the finance sector is now by far our nation’s largest generator of corporate profits, larger even than the combined profits of our huge energy and health care sectors, and almost three times as much as either industrials or information technology.1 To some degree, of course, the growth of the financial sector reflects not just the rise in demand for financial services (the mutual fund industry is a good example). It also reflects the fact that many privately-owned firms have become publicly-owned, including investment banking firms, mutual fund managers, once-mutual insurance companies, even our stock 1 Standard & Poor’s Corporation.

exchanges. For example, there were 56 stocks in the S&P financial sector in 1989, including 28 banks; today there are 92 stocks, but only 26 banks. The combination of public ownership and earnings growth has been dramatic. For example, earnings of fund manager T. Rowe Price rose from $4 million in 1981 to $582 million in the twelve months ended June 30, 2007. In any event, we’re moving, or so it seems, toward becoming a country where we’re no longer making anything. We’re merely trading pieces of paper, swapping stocks and bonds back and forth with one another, and paying our financial croupiers a veritable fortune. We’re also adding even more costs by creating ever more complex financial derivatives in which huge and unfathomable risks are being built into our financial system. “When enterprise becomes the bubble on a whirlpool of speculation,” as the great British economist John Maynard Keynes warned us 70 years ago, the consequences may be dire. “When the capital development of a country becomes a by-product of the activities of a casino, the job (of capitalism) is likely to be ill-done” (1936). 5. Lower Equity Returns in Prospect? The burdensome costs of financial intermediation are all too likely to occur in an era of falling returns on equities, and the arithmetic is not good. Briefly put, the 100-year return of 9 ½ percent annually on stocks included a 4 ½ percent dividend yield. (Chart 8) Today’s 1.8 percent yield represents a dead-weight loss of 2.

” Shunning faddish new strategies focused on short-term fashions, in favor of simplicity and winning on the long-term arithmetic (gross return, minus cost, equals net return). 6. Indexing. Focusing on index funds, unattractive to active managers because of the minuscule fees they generate, but guaranteeing investors their fair share of whatever returns our markets generate. (As I suggested in that 1951 thesis, passive index funds must ultimately demonstrate performance superiority over their actively-managed peers.) 7. Bonds. Focusing on fixed-income securities, whose long-term returns are derived entirely from interest coupons, where the yield advantage will be obvious, narrowly define the maturity range for each fund.

beneficiaries—largely the owners of mutual fund shares and the beneficiaries of our pension plans. If, as corporate reformer Robert Monks accurately points out, “capitalism without owners will fail,” it’s high time we began the task of reform. The Role of Government The accomplishment of that task cannot be left to the fainthearted, and will likely require the appointment of a national commission composed of our wisest, most respected, and best- informed citizens. The federal government will likely need to preempt, at least in part, the multiple state laws under which our corporations have been chartered ever since our nation’s founders granted that power to the individual states. While most of us cherish the belief that the separation of the economy from the state is as essential for capitalism as it is for liberty, we also understand that from time to time the people’s government must step in and work to solve novel and complex problems. This is one of those times. Traditionally, America’s political parties have been philosophically divided between a so-called liberal tradition favoring the use of the national government to foster equality and social justice, and a so-called conservative tradition favoring limited national government in the name of protecting liberty, freedom, and personal responsibility.

created, their relationship to the lives of individuals in widely separated communities engaged in widely differing activities, and the adaptation to those forces of old conceptions developed in a different environment to meet different needs.* To deal with the new and complex economic forces our failed agency society has created, of course we need a new paradigm: a fiduciary society in which the interest of investors come first, and ethical behavior by our business and financial leaders represents the highest value. Building a Fiduciary Society While challenges of today are inevitably different from those of the past, the principles are age-old. Consider this warning from Adam Smith way back in the 18th century: Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which . . . they watch over their own . . . they very easily give themselves a dispensation. Negligence and profusion must always prevail. And so in the recent era, negligence and profusion have prevailed among our money manager/agents, even to the point of an almost complete disregard of their duty and responsibility to their principals. Too few managers seem to display the “anxious vigilance” over other people’s money that once defined the conduct of investment professionals.

“A Moral History of U.S. Business” I close by coming full circle from my Princeton education that began all those years ago; through my career, my battles, and my mission to establish new standards of investment strategy; my ever-growing confidence that the unbending rules of engineering combined with the unbending standards of ethical conduct will come and will benefit our society. So I now move, finally, to one more Princeton coincidence that has remained with me even 60 years after my thesis research began. In that same December 1949 issue of FORTUNE magazine, when a chance reading of the article that led me to the mutual fund industry and to my thesis, there was another essay, long forgotten, but now at the front of my mind. It was lengthy (nine pages), and was entitled “The Moral History of U.S. Business.” The article reviews how six generations of businessmen have sought to harmonize their business success with moral purpose. It asks executives, “What are the moral credentials for the social position [and political power] they wield.” When the article described the extra-pecuniary motives that lay behind their labors, it mentioned “love of power and prestige, altruism, pugnacity, patriotism, and the hope of being remembered through a product or institution.” Those words, for better or worse, seemed to aptly describe my own career, and I could feel the author gazing at me with a disapproving stare.

The problem is not only that future returns earned or untried and often costly strategies are unpredictable and rarely live up to their hyperbolic promises; the problem is that the industry focus on salesmanship over stewardship leads to the proliferation of idiosyncratic funds that inevitably results in a fund failure rate that, however rarely publicized, is little short of astonishing. In my Little Book, I wrote that of 355 funds that existed in 1970, only 132 made it through the next 35 years. In the recent era, of the 6126 mutual funds that existed at the start of 2001, 2797 have already been consigned to the dustbin of history. (You know what I mean!) How, I ask, can a planner or adviser implement a long-term strategy of investing in mutual funds if only half of the funds can make it through a period as short as seven years—and seven pretty good years at that! * * * In any event, please forgive the bluntness of this aging mutual fund Luddite who finds himself uninspired—and unimpressed—by the rise of complexity (and excess cost) at the expense of simplicity (and minimum cost).the

The Total Bond Market Index Fund—70 percent in Treasuries and other governments—now yields only 1.7 percent. But a Total Corporate Bond Index Fund would generate a yield about 3.2 percent. So, much as I love the total bond market index fund, it needs to be more heavily seeded with corporates. So, let’s put these projections together.a

gingerly lowered their long-run targets but few institutions outwardly expect less than a 4 percent real return or 6 to 7 percent nominal return on their overall portfolios. Over the past decade and a half, such expectations have generally not been fulfilled, and most investors will likely be disappointed yet again over the coming decade. In fact, those with simple, traditional portfolios like 60-40 U.S. stocks and bonds are even more likely to be disappointed going forward. Currently the prospective real yield on the 60-40 portfolio is 2.4 percent, its lowest level in 112 years. Roughly speaking, the ex-ante real yield on stocks is 4 percent and bonds is zero percent—both below their long-run average levels, with bonds well below.3 The prospectively low-return environment underscores the importance of cost-effectiveness, whatever returns investors are harvesting. When it comes to external management, it is essential to not pay alpha prices when it’s not really alpha. Fair fees depend on the return source. Today is relatively unique in that both stocks and bonds are expensive at the same time. In conclusion, traditional, simple asset-class allocations—say, 60-40 stocks and bonds— are likely not going to make 5 percent real returns from here given that forward-looking real returns are at half this level. The standard universe of “alternative asset classes” is not likely to fill the gap, as it tends to repeat the problem of concentration in equity risk, just at a higher fee.

Dr. Kaufman is not alone. Felix Rohatyn, the widely-respected former managing director of Lazard Freres, is another of the wise men of Wall Street who have spoken out. Here’s what he wrote in The Wall Street Journal a few years ago: “I am an American and a capitalist and believe that market capitalism is the best economic system ever invented. But it must be fair, it must be regulated, and it must be ethical. The last few years have shown that excesses can come about when finance capitalism and modern technology are abused in the service of naked greed. Only capitalists can kill capitalism, but our system cannot stand much more abuse of the type we have witnessed recently, nor can it stand much more of the financial and social polarization we are seeing today.” The fact is that, in some important respects, the Invisible Hand of capitalism has failed us. Here are the familiar sentences that Adam Smith wrote in The Wealth of Nations. “It is not from the benevolence of the butcher, the baker, or the brewer that we expect our dinner, but from their regard to their own self-interest. By directing (our own) industry in such a manner as its produce may be of the greatest value, (we) intend only our own gain, and (we are) led by an invisible hand to promote an end which was no part of (our) intention.” So what’s to be done?

Who Actually Earns the Market’s Returns? In my view, then, we are looking ahead to a decade of returns in the financial markets that are well below historical norms (9 percent for stocks, 5 percent for bonds), albeit a decade in which equities seem highly likely to provide a significant return premium over bonds. But please remember this: the returns I have projected are not of the real world. They are the theoretical returns delivered by the stock and bond markets, before the deduction of investment costs. That raises this crucial question: Just who is it that earns the returns generated in our financial markets? Answer: Very few investors. So whatever returns the financial markets are generous enough—or stingy enough—to deliver, please don’t make the mistake of thinking you will actually earn those returns. Of course all investors as a group must necessarily earn precisely the market return. But they do so only before the costs of investing are deducted. After these costs are taken into account—all of the advisory 3 My own 5.4 percent expectation for nominal returns entails an assumed 2.5 percent inflation rate for a real return of 2.9 percent, virtually identical with Cliff’s figure.

While the quest to restore those non-economic but transcendently vital values of trust, loyalty and honesty is hardly for the faint of heart, it’s easy to conceptualize the path we need to follow. If each individual investor out there—not only that minority who hold their stocks directly, but those millions who hold their stocks through mutual funds—would only look after their own economic self-interest, then great progress would be made in restoring the vanishing values of capitalism. Here, I think, Adam Smith’s Invisible Hand would in fact be helpful. For if intelligent investors would only move away from the costly folly of short-term speculation to the priceless (and price-less!) wisdom of long-term investing—abandoning both the emotions that betray sound investment strategy and the expenses that turn beating the market into a loser’s game—will they achieve their financial goals. When they do—and they will—our financial intermediaries will be forced to respond with a focus on long term investing in businesses, not short term speculation in stocks. But we need more.need

traditional balanced portfolio with 60 percent stocks and 40 percent bonds should provide a return of 5 ½ percent, not so different from the past decade. (Although, as I noted earlier, it was bonds, not stocks that led the way.) This return is far below the 7 ½ percent historical return on such a portfolio. And those are nominal dollars, not real dollars. If we have inflation of 2 ½ percent, that 5 ½ percent return drops to 3 percent. As we meet tonight, that’s the investment reality. Seeking Returns that are “Enough” If that’s not, in some sense, “enough” of a return for you, the options to earn income that will cover your living costs are simple, but not easy: reduce your household expenses (no matter how painful); leverage your portfolio by borrowing at today’s low interest rates (a very risky strategy); spend moderate amounts of your capital (but you can’t do that forever); reach for higher yields by owning junk bonds (with their far higher credit risk); or increase your position in high dividend stocks (which have considerable volatility risk). But in general, make only moderate changes in your asset allocations; avoid box-car changes in favor of marginal changes. In the real world, as you see, for every pro, there’s a con. As it is said, there’s no such thing as a free lunch. Or is there? In fact, there is one remarkably easy way to increase your income return and leave risk absolutely unchanged. And this brings me full circle in my discussion this evening.

positions I’ve set forth in these remarks have been endorsed by the group that includes the most successful investors of the modern era (try Warren Buffett and Yale’s David Swensen) and by the most informed and respected academics (for example, Nobel Laureates Bill Sharpe and Paul Samuelson—now with 95 years of wisdom under his belt). I understand, I think, the pressure that you financial planners face in assuming the awesome responsibilities of serving your clients, even as you endeavor to build firms that will prosper and endure. I understand the pressure you face from concerned clients who want to follow the traditional response of “don’t just stand there. Do something,” especially in these turbulent markets. But I suspect that your instincts suggest, as mine do, that far more often, the best strategy is likely to be “don’t do something. Just stand there.” Of course, this is not a digital field—positive/negative; either/or—in which we find ourselves. A stand-there, steady-asset-allocation; very broadly-diversified; extremely-low-cost strategy can easily be seasoned with a do-something—heck, a do-anything—strategy focused on shifting short-term opportunities, however difficult such a strategy may be to implement successfully.

7 percentage points in future investment returns. By the same token, the glorious 12 ½ percent return of the past 25 years included not only a 3.4 percent dividend yield, but a speculative return averaging 1.7 percent per year, borne of a price-earnings ratio that doubled on balance, from 9 times to 18 times. The sharp drop in yields, and the likelihood (in my view) that today’s price-earnings ratio of 18 will not only not redouble, but, in my judgment, is likely to decline by a few points in the coming decade, means that we are likely to experience a future return on stocks of about 7 percent. Shamelessly, I persist in reducing that nominal annual return of 7 percent by the estimated 2.3 percent expected rate of inflation, slashing it to a real return of just 4.7 percent. (Chart 9) If annual mutual fund costs—sales loads, expense ratios, and hidden turnover costs— continue to run at about 2.5 percent, those costs will reduce the real return of the average fund by more than half, to a humble 2.2 percent. (And I have even deducted those excessive taxes.) Clearly, reducing investment costs is at the crux of the ability of our nation’s families—the very backbone of our savings base—to earn the wealth to which they aspire.

But a later quotation, believe it or not, seemed even more focused on the likes of me. Quoting William Parsons, a mid-19th century New Yorker of probity the essay continued, “The good merchant, though an enterprising man and willing to run some risks, yet is not willing to risk everything, nor put all on the hazard of a single throw . . . Above all, he makes it a matter of conscience not to risk in hazardous enterprises the property of others entrusted to his keeping . . . He is careful to indulge in no extravagance, and to live within his means . . . Simple in his manner and unostentatious in his habits of life, he abstains from all frivolities and foolish expenditures . . . He recollects that he is not merely a merchant, but a man, and that he has a mind to improve, a heart to cultivate, a character to form.” So here we are. All these years after my Princeton graduation, and all those years in which Princeton returned to my mind and my life through one connecting coincidence after another, to this very evening, I look at those words as if they were my own. A mind to improve?this

So what we must do is develop a new fiduciary society which guarantees that our last- line owners—those mutual fund shareholders and pension fund beneficiaries whose savings are at stake—their rights as investment principals. These rights must include: (1) The right to have their money-manager/agents act solely in their behalf. The client, in short, must be king. (2) The right to rely on due diligence and high professional standards on the part of our money managers and securities analysts who appraise securities for our portfolios. (3) The right to demand some sort of discipline and integrity in the mutual funds and financial products that they offer. * Again, words from Justice Stone’s article.

According to David Brooks of The New York Times, however: Through much of American history there has always been a third tradition, now dormant, which believed in limited but energetic government in the name of social mobility and national union. This third tradition was founded by Alexander Hamilton, embraced by Henry Clay, taken up by Abraham Lincoln and brought into the 20th century by Theodore Roosevelt. . . . Hamilton came from nothing and spent his political career trying to create a world in which as many people as possible could replicate his amazing success. [He] looked around after independence and saw a country destined to become the greatest empire of the earth, and sought to liberate and stir Americans to exploit the full range of their capacities. Hamilton believed in using government to enhance market dynamism by fostering more equitable competition. He believed government could usefully promote social revolutions . . .for

8. Marketing. Instead of vainly shouting-out implied promises based on evanescent short-term performance, spend as little as possible on this activity, which inevitably subtracts from fund returns. Yes, strategy follows structure, not only for Vanguard but for our rivals, whose vastly different structures demand very different strategies. I don’t need to turn this talk into a Vanguard commercial, but the fact is that those simple strategies are the very strategies that Vanguard has followed since its inception 36 years ago. They have served us well, not because of magic or genius, but because the “relentless rules of humble arithmetic” (Supreme Court Justice Louis Brandeis’s phrase) are eternal. So I look at Vanguard as an artistic success. Not just because our fund performance has, with considerable consistency, outpaced our peers (largely by reason of our low costs), in virtually every sector of fund investing—money markets, bonds, and equities, ranging from large-cap growth, to small- cap value, to international, and so on. This steady performance has earned us the industry’s highest scores in investor trust. Without going into the mechanics of a recent independent study, we have earned a “loyalty” rating of +44, with the #2 firm at +26, and the industry average at -12 (hardly a message that suggests that fund investors are satisfied.) The lowest-ranking firms had scores of -54, -48, and -47.

evening do not belie my claim. A heart to cultivate? Of course. But not the heart that finally expired in 1996 after almost 67 years of wear and tear. A new heart—now but 39 years old—that demands that my energies be used for a worthwhile cause. A character to form? Surely that, but as I reach the age of 80 a week from tomorrow, it’s likely to be difficult to alter my now-deeply- imbedded character very much. So I guess I’ll just have to drive to raise the character of our financial sector and our society to a higher standard, yes, returning to my title, as I “aspire to build a better financial world.”

to create, out of our disappearing ownership society and our failed agency society, a new “fiduciary society.” Here, our agent /owners would be required by federal law to place the interest of their principals first—a consistently enforced public policy that places a clear requirement of fiduciary duty on our financial institutions to serve exclusively the interests of their beneficiaries. That duty would expressly require their effective and responsible participation in the governance of our publicly-owned corporations, and demand the return of our institutional agents to the traditional values of professional stewardship tat are so long overdue.

The simple mathematical fact is that, because of high mutual fund expenses, the passively- managed all-stock-market index fund typically holds the same composite portfolio as the average actively-managed fund, and generates about the same gross dividend yield, say, 2.1 percent for stocks and 2.7 percent for bonds. But active stock funds subtract expenses of about 1.3 percent, leaving just 0.8 percent for you. Active bond funds subtract about 0.8 percent in expenses, leaving just 1.9 percent for you. On the other hand, for an index fund with a cost of a mere 0.1 percent, the net yield on the stock index fund comes to 2.0 percent, bonds to 2.6 percent. The respective yield enhancements—120(!) percent higher for stock funds and almost 40 percent higher for bond funds—are there for the taking, without any increase in risk exposure.

(4) The assurance that our agents will act as responsible corporate citizens, restoring to their principals the neglected rights of ownership of stocks, and demanding that corporate directors and managers meet their fiduciary duty to their own shareholders. (5) The establishment of advisory fee structures that meet a “reasonableness” standard based not only on rates but dollar amounts, and their relationship to the fees and structures available to other clients of the manager. (6) The elimination of all conflicts of interest that could preclude the achievement of these goals. More than parenthetically, I should note that this final provision would seem to preclude the ownership of money management firms by financial conglomerates, now the dominant form of organization in the mutual fund industry. Among today’s 40 largest fund complexes, only six remain privately-held. The remaining 34 include 13 firms whose shares are held directly by the public, and an astonishing total of 21 fund managers owned or controlled by U.S. and international financial conglomerates—including Goldman Sachs, Bank of America, Deutsche Bank, ING, John Hancock, and Sun Life of Canada. Painful as this separation might be, it is the single most blatant violation of the principle that “no man can serve two masters.” Of course it will take federal government action to foster the creation of this new fiduciary society that I envision.

government or for the market, but not for both. He saw entrepreneurial freedom, limited but energetic federal power, and national greatness as qualities that were inextricably linked. It was always the cause America represents—universal freedom—that was uppermost in Hamilton’s mind, spurring individual initiative, but also gathering the fruits of that energy in the cause of national greatness. Were Alexander Hamilton alive today, I simply cannot imagine that he would not agree with the notion that it’s high time to restore the integrity of our system of capitalism, and high time to rethink the nation’s investment process. In today’s wrongheaded version of capitalism, corporate managers are in charge of our business wealth, almost unchecked by traditional gatekeepers; and the investment community is too heavily focused on short-term stock prices and too lightly focused on long-term intrinsic corporate values to challenge their domain. I believe that a federal standard of fiduciary duty would play a major role in reversing that focus. Given the vicious circle in which corporations, in important degree, act as if they own themselves, our investment intermediaries have proven reluctant to use their latent power. Further, even for those intermediaries who have the motivation to exercise it, hopelessly archaic proxy rules serve to handcuff the exercise of that power.

fees, the transaction costs, the consultants’ costs, the operating costs, and the hidden costs of financial intermediation—the returns of investors must—and will—fall short of the market return by an amount precisely equal to the aggregate amount of those costs. Beating the market before costs is a zero-sum game; beating the market after costs is a loser’s game. The great paradox of investing is that the very costs incurred by those managers who strive to help investors to beat the market, themselves constitute the reason that the managers as a group are destined to fail at the task. Do costs matter? You bet they do! And they matter most of all in diversified investment portfolios. Why? Because while much of the value of most consumer goods is measured by intangibles such as taste and tone and prestige and image, both the returns and the costs of an investment account are measured entirely by that most measurable of all assets, dollars. For investors, costs matter most when they are (1) easily calculable, (2) directly related to returns, and (3) compounded over time. So pension funds, endowment funds, and foundations, all institutions with notably long-term—in a sense, perpetual—investment horizons can hardly fail to consider the role of costs.

Yet most economists have been indifferent to the issue of costs in our financial sector. Even the seminal paper on transaction costs, “The Nature of the Firm,” by Ronald H. Coase (1937), only became broadly accepted after he received the Nobel Prize in economics in 1991. A paper by economists at Harvard University and the University of Chicago in that same year argued that when excessive rewards go to “rent-seekers” whose returns come from the redistribution of wealth rather than the creation of wealth—they single out government, law, and financial services (including stock traders and money managers)—the economy suffers. Despite the obvious importance of this issue, I know of not a single academic study that has systematically attempted to calculate the value extracted by our financial system from the returns earned by investors, nor (as far as I know) has a single article on the subject ever appeared in the Journal of Portfolio Management or the Financial Analysts Journal. It is high time for our profession to join with academia and at long last tackle this vital issue of investment costs and how they relate to the benefits of an efficient system of capital formation. We must not only think about it, but study it in depth, and ultimately to demand that our nation’s system of financial intermediation function far more effectively in the national public interest and in the interest of investors than it does today. 6.

As consumers seek out better goods and services at ever lower costs, sometimes the competitive free market system works pretty well. In Vanguard’s case, our solid returns, our low costs, and our shareholder loyalty (that’s the artistic success) have resulted in commercial success. Our market share of industry assets has risen from 1.8 percent in 1981 to 13 percent currently, and we have become the world’s largest fund manager. (Happily, our passive management strategies don’t leave us muscle-bound and Gulliver-like, a challenge that our giant peers must deal with on a daily basis.) Since we are structurally sound, mathematically sound, and (I believe) ethically sound, and our strategies have followed our structure, it’s easy for me to make the case that “good ethics is good business.” Getting those simple ethical values across to a rapidly growing company is much easier when it’s part of the firm’s ethic since the day we began in September 1974, with $1.4 billion of fund assets (now at $1.4 trillion, 1000 times larger) and 28 crew members (now 12,000 in number, 400 times larger). Changing a firm’s character and value system is infinitely more difficult than embedding the character and values established at the outset.the

If that is the dual course you choose to follow, however, dare I recommend that the lion’s share of your clients’ assets be committed to the former stay-the-course approach that has worked so well for me over, yes, now 57 years of investing in the mutual funds whose investors I’ve done my best to serve. But whatever course you choose to follow, I wish you every success. Less than a month from now, those who hold the CFP designation will be required to honor an explicit standard of fiduciary duty that I’ve talked about for more than a decade. I’m sure that the overwhelming majority of financial planners have observed such a standard throughout their careers, and I’m equally sure that such an approach has served your clients and your careers alike. If my thoughts today have increased your focus on investment rather than speculation; on setting your expectations for future stock and bond returns, not on history but on their known sources; and on demanding that the firms whose mutual funds you offer to your clients focus less on innovation and more on substance, then, I’ve achieved what I’ve attempted to achieve in these remarks. Thanks for your patience, and for your attention.

And the prospects seem increasingly dim for opening even a tiny crack in the rigid regulatory doorway that precludes owners from their rights of ownership by denying them reasonable access to corporate proxy statements. With mutual fund managers firmly ensconced in the driver’s seat of the governance of the funds themselves, we are captives of a system in which both corporate directors and fund directors seem not only unwilling but unable to take on the role and responsibility of the gatekeeper as a steward, one who holds the interests of the shareholder as his highest priority. Summing Up So I await—with no great patience!—the return of the standard so beautifully described by Justice Cardozo all those years ago, excerpts from his words: Those bound by fiduciary ties . . . (are) held to something stricter than the morals of the marketplace . . . a tradition unbending and inveterate . . . not honesty alone but the punctilio of an honor the most sensitive . . . a level of conduct . . . higher than that trodden by the crowd.

Above all else, it must be unmistakable that government intends, and is capable of enforcing, standards of trusteeship and fiduciary duty under which money managers operate with the sole purpose and in the exclusive benefit of the interests of their beneficiaries—largely the owners of mutual fund shares and the beneficiaries of our pension plans. While the government action is essential, however, the new system should be developed in concert with the private investment sector, an Alexander-Hamilton-like sharing of the responsibilities. The task of returning capitalism to its ultimate owners will take time, true enough. But the new reality—increasingly visible with each passing day—is that the concept of fiduciary duty is no longer merely an ideal to be debated. It is a vital necessity to be practiced. So a lot is at stake in reforming the very nature of our financial system itself, which in turn is designed to force reform in our failed system of governance of our business corporations.colleagues

Old Guard – Part II Some men wrest a living from nature; this is called work. Some men wrest a living from those who wrest a living from nature; this is called trade. Some men wrest a living from those who wrest a living from those who wrest a living from nature; this is called finance. In that one long career, I’ve done my best to make the world of finance work effectively for those scores of millions of our citizens who wrest their livings from nature and from trade. But, the more I observe of finance, the more I wonder about the grotesque distortions it periodically creates in our markets, in our business enterprises, and in our society.

leaders not merely “talking the talk,” but “walking the walk,” every step of the way. It means communicating these values, over and over again, ad infinitum, in the simplest possible terms— Put the shareholder in the driver’s seat . . . Do what’s right. If you’re not sure, ask your boss . . . Keep Vanguard a place where judgment has at least a fighting chance to triumph over process . . . a company that stands for something—stewardship . . . Character counts. If we can build a crew that holds high those values, and focuses not on a job, but on a lifetime career, those veterans will pass the values along to those who follow them, and the firm’s character should endure for a long, long time, and with it—if we don’t lose our way— our industry preeminence. Food for Thought Summing up: One, we still seem to have plenty of ethical principles out there, but not nearly enough ethical principals. Two, business standards (such as they may be) have, in less than a half-century, come to supersede traditional professional ethics, at great cost to society. Three, a promising new structure in money management, focused on the positive ethics of placing shareholders rather than managers at the top of the food chain of investing, has carved out a now- dominant niche in money management. At some point, if only in order to survive, other firms will have to emulate the Vanguard model. But the task remains: to elevate the ethical behavior of we all-too-human beings.

Conclusion While my entire career has been in our financial sector, I’m also a critic who has come to believe—with only the relentless rules of humble arithmetic to support my position that investors are ill-served by today’s financial system. Its participants garner excessive rewards, inevitably at t he expense of the investors who risk their capital. This issue is well-defined by this 19th century quotation from “across the pond.” Some men wrest a living from nature; this is called work. Some men wrest a living from those who wrest a living from nature; this is called trade. Some men wrest a living from those who wrest a living from those who wrest a living from nature; this is called finance.

The Dominance of the Index Fund In recent years, the move toward index funds has come into its own. During the past five and one-half years, fund investors have moved some $300 billion out of relatively high-cost, actively-managed equity funds and poured over $600 billion into low-cost, passively managed equity index funds. In today’s low yield environment, indexing is even more attractive than ever before, and wise investors are voting for it with their hundreds of billions of dollars. So am I satisfied with how our financial system is working today? No I am not! But I am pleased with how those remarkably simple ideas that I expressed at Princeton all those years ago have began to work. Index equity funds are rapidly approaching 50 percent of the assets of active equity mutual funds, and growing apace. In these days of low market yields and high mutual fund expenses, I expect that growth to accelerate. A journalist recently reported that I take “almost childlike delight” in seeing my idealistic dreams come true. (He was accurate, I think, except for the almost!) But I’ve long since realized that what passes for success in this funny world of ours is really a journey, not a destination. My long journey, one that arguably began some 65 years ago right across the street, on that dark, bitterly cold, and snowy early morning hike down Montgomery Avenue to the Ardmore Post Office, continues. Perhaps it will never end . . .

Just as the magic of compounding returns over, say, a quarter-century, carries investment values to almost unimaginable heights, so the tyranny of compounding costs results in an almost equally unimaginable deterioration in these returns. If the market return—before costs—averages 7 percent over 50 years but only 5 percent after costs, the final value an initial investment of $10,000 tumbles from $295,000 to $115,000, fully 60 percent less. So, yes, these are tough times for investors who assume that the past is prologue and who ignore the impact of costs, in a shaky financial system in which a short-term speculation has crowded out long- term investment. It is up to professional analysts—exemplified by the CFAs in this audience—to help investors cut through the fog of today’s investment climate, to allocate their assets with care, and to avoid joining the crowd of traders and speculators. Whatever we do, invest we must, however, for not investing is an iron-clad formula for failure.

and peers. But soon, perhaps, many others will ultimately see the light. Only last week the idea of governance reform got encouraging support from Professor Andrew W. Lo of M.I.T., one of today’s most respected financial economists: . . . the single most important implication of the financial crisis is about the current state of corporate governance . . . a major wake-up call that we need to change (the rules). There’s something fundamentally wrong with current corporate governance structures, (and) the kinds of risks that typical corporations face today. In sum, the change in the rules that I advocate—applying a federal standard of fiduciary duty to their clients for institutional money managers—would be designed in turn to force these managers to use their own ownership position to demand that the managers and directors of the corporations in whose shares they invest honor their own fiduciary duty to the holders of their shares. Finally, it is these two groups that share the responsibility for the prudent stewardship over corporate assets and investment securities alike that have been entrusted to their care, not only reforming today’s flawed and conflict-ridden model, but developing a new model that, at best, will restore traditional ethical mores. And so I await—with no great patience!—the return of the standard so beautifully described by Justice Cardozo all those years ago, excerpts from his words cited earlier in my remarks: Those bound by fiduciary ties . . .

The change in the rules of the game that I advocate—applying to institutional money managers a federal standard of fiduciary duty to their clients—would be designed in turn to force these managers to use their own ownership position to demand that the managers and directors of the business corporations in whose shares they invest also honor their own fiduciary duty to the holders of their shares. Finally, it is these two groups that share the responsibility for the prudent stewardship over corporate assets and investment securities alike that have been entrusted to their care, not only reforming today’s flawed and conflict-ridden model, but developing a new model that, at best, will restore traditional ethical mores. I close with a Biblical quotation (John 10: 11-13): I am the good shepherd: the good shepherd giveth his life for the sheep. But he that is a hireling, and not the shepherd, whose own the sheep are not, seeth the wolf coming, and leaveth the sheep, and fleeth: and the wolf catcheth them, and scattereth the sheep. The hireling fleeth, because he is an hireling, and careth not for the sheep.” This parable reminds us that our financial hirelings didn’t protect us sheep from the wolves that created this financial crisis, either because they didn’t see them coming, or saw them and decided to flee the pastures of capitalism.

It will be no easy task, but perhaps we can find some of that hope in a new book by Princeton professor Kwame Anthony Appiah, The Honor Code: How Moral Revolutions Happen. He points out that honor—the respect of one’s peers and one’s community—is, ultimately, more important than money as a moral motivator. Whatever the case, we need to raise society’s expectations of the conduct and the character of the leaders of our businesses and financial institutions. Professor Appiah notes that his ideas echo the words in our Declaration of Independence—“a decent respect for the opinions of mankind.” Knowingly or not, he is also echoing Adam Smith’s philosophy of life. In his first book, The Theory of Moral Sentiments, written in 1773 but now more relevant than ever, Smith developed the concept of the Impartial Spectator—“the force that arouses in us values that are so often generous and noble, the inner man, shaped by the society in which he exists, who gives us our highest calling. It is reason, principle, conscience, the inhabitant of the beast, the man within, the great judge and arbiter of our conduct.us,

ENOUGH True story, Word of Honor: Joseph Heller, an important and funny writer now dead, and I were at a party given by a billionaire on Shelter Island. I said, “Joe, how does it make you feel to know that our host only yesterday may have made more money than your novel ‘Catch-22’ has earned in its entire history?” And Joe said, “I’ve got something he can never have.” And I said, “What on earth could that be, Joe?” And Joe said, “The knowledge that I’ve got enough.” Not bad! Rest in Peace!

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.

” In one sense this explosion is wonderful, suggesting that our professional designation is highly valued. But it also raises serious concerns that the field will get more and more crowded, causing the costs of financial intermediation will to rise to even higher levels. This is not to say that bright individuals from today’s remarkable younger generation should not enter the profession of money management. Rather, it is to say that those who enter this field should do so with their 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. While it is said on Wall Street that “money has no conscience,” the future leaders of this profession must not let that truism cause them to ignore their own consciences, nor to alter their own conduct and character. Indeed, I expect you future leaders to bring to the operation of our system of financial intermediation a level of honest introspection that I find too often lacking among today’s leaders, and a return to our traditional focus on fiduciary duty, and on service to others before service to self.

(are) held to something stricter than the morals of the marketplace . . . a tradition unbending and inveterate . . . not honesty alone but the punctilio of an honor the most sensitive . . . a level of conduct . . . higher than that trodden by the crowd.good

. . calls to us, with a voice capable of astonishing the most presumptuous of our passions, that we are but one of the multitude, in no respect better than any other in it, and that when we prefer ourselves so shamefully and so blindly to others, we become the proper objects of resentment, abhorrence, and execration. It is from [this Impartial Spectator] only that we learn the real littleness of ourselves . . . who shows us the propriety of generosity and the deformity of injustice; the propriety of resigning the greatest interests of our own, for the yet greater interests of others . . . It is not the love of our neighbour, it is not the love of mankind, which upon many occasions prompts us to the practice of those divine virtues. It is a stronger love, a more powerful affection, the love of what is honourable and noble, the grandeur, and dignity, and superiority of our own characters . . . in order to obtain the greatest benefit to ourselves [Italics added.] With these powerful words, Adam Smith—yes, Adam Smith—touches on nearly all of those traditional ethical principles of which I spoke at the outset. We need to be reading him again today. Yes, our corporate values and virtues have been greatly eroded. But there remain scores of examples—although never nearly enough—of corporations and financial institutions that have held to their traditional bearings, staunchly resisting the powerful forces that are driving our society away from them.

citizenship . . . Yet we know that unless the urge to individual advantage has other curbs, and unless the more influential elements in society conduct themselves with a disposition to promote the common good, society cannot function . . . especially a society which has largely measured its rewards in terms of material gains . . . We must (square) our own ethical conceptions with the traditional ethics and ideals of the community at large . (There is) nothing more vital to our own day than that those who act as fiduciaries in the strategic positions of our business civilization, should be held to those standards of scrupulous fidelity which (our) society has the right to demand. This Columbia Leadership and Ethics Week of 2009 gives us all the opportunity to strengthen our resolve to meet that test.

Again, quoting from The Honor Code, “honor is, for us, what it has always been, an engine fueled by the dialogue between our self-conception and the regard of others that can drive us to take seriously our responsibilities in a world we share.” I close my remarks this afternoon by urging you favored members of the next generation to begin to assume responsibility for our great nation’s future, and to join me in the quest to demand ethical principals in all the avenues of American life, principals who are eager to implement ethical principles. Take heart, and remember these words of the anthropologist Margaret Mead: Never doubt that a small group of thoughtful committed citizens can change the world. Indeed, it is the only thing that ever has.

Decision — Studied Pool Corp for 14 years; never bought. Context: Gold Medal error — the marquee errors-of-omission case study. Outcome (known): ~800%+ foregone; documented annually.