2008

David Swensen's guest lecture in Robert Shiller's ECON 252 Financial Markets course at Yale, recorded in 2008 and published through Open Yale Courses, opens with an analysis of the behavior of endowments and foundations around the dot-com crash of 2000-2001. Swensen described the study he had conducted for Pioneering Portfolio Management, which examined the asset allocations of institutional investors before, during, and after the dot-com bust. The lecture argued that institutions with heavy allocations to equities sold into the downturn and missed the subsequent recovery - the standard pattern of behavior that destroys long-horizon compounding. The lecture then turned to the alternative approach Swensen had developed at Yale. By holding a diversified portfolio across asset classes with low correlations - and by maintaining the discipline to hold through market cycles - the Yale endowment avoided both the drawdown concentration of equity-heavy portfolios and the behavioral trap of selling into drawdowns. Swensen was careful in the lecture to distinguish between the asset-class framework, which is transferable in principle, and the access to top-quartile managers, which is not transferable in practice to institutions without the staff and the relationships. The lecture was delivered in the midst of the 2008 financial crisis, and Swensen used the context to illustrate the difference between institutional behavior and the framework he advocated. He argued in the lecture that the discipline to maintain the strategic asset allocation through the 2008 drawdown was the operational test of the endowment model - the institutions that maintained their commitments to private market partnerships and refrained from tactical reductions of the strategic allocation would, he predicted, be the institutions that compounded real wealth over the subsequent decade.

In the 2008 Berkshire shareholder letter, written in the depths of the global financial crisis, Buffett and Munger disclosed Berkshire's $230 million investment for roughly 9.6% of BYD, the Chinese battery and electric-vehicle maker. The investment had been Munger's champion play inside Berkshire. He had argued that BYD's founder, Wang Chuanfu, was one of the most capable operating executives he had ever met, and that the combination of low-cost Chinese manufacturing, advanced battery chemistry, and an early-mover position in electrified transport would compound for decades. The investment thesis was deliberately simple. BYD was, in Munger's view, a real company making real products at low cost, with a genuine engineering edge in batteries and a market - China - that was being underwritten by a state committed to electrification. The price was modest relative to the long-run earnings power. The risks were real - Chinese corporate governance, foreign-currency exposure, execution risk on the technology roadmap - but Munger's view was that the market had over-discounted those risks and that the underlying franchise was available at a price that did not require any heroic assumption to justify. The retrospective implication, captured in the 2008 letter's plain disclosure of the position, was that Munger had identified a small number of things that mattered - founder quality, technology trajectory, market underwriting, valuation - and had refused to be talked out of the bet by the surface-level concerns that scared other foreign investors away. The position would, over the next fifteen years, multiply many times in value. By the time Munger discussed BYD at the 2023 DJCO meeting, the company was making more than $2 billion after taxes in its Chinese auto business alone. The bet on the founder and the technology had been one of the most profitable investments Berkshire ever made on Munger's recommendation.

Chairman and CEO Muhtar Kent opened the Q4 2008 review by acknowledging that the Company was operating through the deepest global downturn in decades, with several developed markets entering the quarter in outright recession. Management reported that worldwide unit case volume grew four percent for the year despite the fourth quarter running flat in North America, with China and India still expanding at double-digit rates and the international business contributing the majority of operating income for the first time in the Company's history. CFO Gary Fayard walked analysts through the working-capital release achieved in the second half, which had helped lift full-year operating cash flow above $8 billion. He characterised the strong cash generation as a structural feature of the concentrate-and-bottler model, allowing the Company to keep investing behind the trademark in markets where consumer take-home pay was under pressure, rather than pulling back to defend a quarterly margin. Kent reaffirmed the long-term algorithm of high-single-digit real EPS growth and high-teens return on equity, and pushed back on analyst questions about whether the consumer recession would force a rethink of the Company's pricing architecture. He argued that pricing was always executed in the context of the local affordability equation, and that the global system's relative unit economics had widened, not narrowed, during prior downturns. On the Q&A, a question on the Coca-Cola Enterprises bottler's leverage drew a defence of the Company's preferred-partner bottling system, with Kent noting that marketing investment behind branded cola was being protected even as bottler capex was being throttled back. The call closed with management signalling that 2009 would be a year of investment rather than of margin optimisation.

Chairman and CEO Ken Chenault opened the Q4 2008 review by acknowledging that the Company had entered the worst consumer credit cycle since the early 1990s recession and that American Express had moved during the fourth quarter to materially tighten underwriting, reduce credit lines and reprice risk where the data warranted. Management reported that reported earnings per share for the year had fallen by more than thirty percent, with most of the deterioration concentrated in the Card Member loans segment, where net write-offs had moved above eight percent on a managed basis. CFO Gary Crittenden walked analysts through the $1.4 billion pre-tax charge taken during the fourth quarter, comprising roughly $800 million of incremental loan-loss reserves, $400 million of severance and restructuring and the balance of writedowns tied to the investment portfolio. He flagged that the restructuring would remove more than $1.8 billion of operating expense from the run-rate by 2010 and that the Company had secured a one-year equity injection of approximately $3.4 billion from the U.S. Treasury's Capital Purchase Program to bridge the cycle. On the Q&A, an analyst asked whether the high-end spending customer had actually held up better than the broader consumer. Chenault responded that the high-spend Card Member cohort had seen far less delinquency drift than the broader book, that the proprietary spend data had allowed Amex to take earlier and more targeted underwriting actions than the broad bank-card issuers and that the brand's premium positioning was itself a structural advantage through a downturn, even though it could not fully insulate the Company from a synchronised consumer recession. The call closed with management signalling that 2009 would be a transition year of flat billings, sharply lower credit metrics and operating expense reduction, and that the Company's long-term algorithm of mid-teens return on equity and high-single-digit earnings growth would be reaffirmed once the cycle turned.

Chairman Dave O'Reilly opened the Q4 2008 review against the exceptional backdrop of a year in which crude oil had spiked above $145 in July and then collapsed below $35 by December. Management told the call that the full-year earnings would set a record for Chevron, with the upstream earnings benefiting from the first-half spike and the downstream refining business having produced record margins in the first half before swinging to losses in the fourth quarter as demand collapsed. CFO Steve Crow walked analysts through the capital program, indicating that the Company had actually increased the capital budget during the year to $22.9 billion to advance the Gorgon LNG project in Australia, the Tahiti deepwater project in the Gulf of Mexico and the Chuandongbei sour-gas project in China. He flagged that the Company had bought back approximately $3.5 billion of common stock during the year, that the dividend had been increased for the twenty-first consecutive year and that the balance sheet was positioned to support the long-cycle capital program through any plausible near-term price environment. On the Q&A, analysts pressed on whether the collapse in crude prices would force a rethink of the long-cycle capital allocation framework. O'Reilly responded that the Company had built the project portfolio specifically to deliver returns through the cycle and that the deepwater and LNG projects in the pipeline were expected to earn double-digit returns even at substantially lower long-run crude prices than the 2008 average. He also defended the buyback pace, arguing that the Company's strong operating cash flow permitted both the long-cycle investment and the shareholder returns. The call closed with management reaffirming the long-term framework of organic production growth of one to two percent per year through the next decade, anchored on the deepwater and LNG portfolio, and with the Company committing to continue the multi-decade trajectory of annual dividend increases even in a low-price environment.

Kovacevich opened the Q4 2008 review against the backdrop of the early October announcement of the all-stock acquisition of Wachovia Corporation, completed at year-end at a deep discount to Wachovia's stand-alone book value. Management told the call that the merger would create the first coast-to-coast retail banking franchise in the United States, that the integration would be executed off the proven Norwest-Wells Fargo playbook and that the credit marks taken at acquisition accounted for the worst-case stress on the Wachovia loan portfolio, including the option-ARM portfolio inherited from Golden West Financial. CFO Howard Atkins walked analysts through the capital framework, indicating that the Company had issued $25 billion of preferred stock to the U.S. Treasury's Capital Purchase Program to bridge the closing of the Wachovia acquisition and that the operating earnings power of the combined franchise would generate enough internally generated capital to repay the Treasury investment within a few years. He flagged that the integration expenses would weigh on the near-term reported earnings but that the merger synergies were expected to exceed $5 billion annually once the integration was completed. On the Q&A, analysts pressed on whether the option-ARM portfolio represented a hidden credit risk that would force the Company to build reserves further. Kovacevich responded that the marks taken at acquisition had been sized for a severe housing price decline and that the early delinquency migration in the option-ARM portfolio was tracking inside the stress assumptions. He also pushed back on the suggestion that the Treasury investment implied a capital weakness, arguing that the Company had entered the Wachovia transaction from a position of strength and that the Treasury investment had been taken under regulatory pressure rather than out of necessity. The call closed with management framing the next phase as the largest integration in the history of U.S. banking and reaffirming the long-term objective of cross-sell-driven revenue growth, mid-teens return on equity and a sustained pace of share repurchases once the Treasury investment was repaid and the integration was complete.

Chairman Wang Chuanfu opened the 2008 annual results briefing against the backdrop of the September 2008 announcement that Berkshire Hathaway's MidAmerican Energy subsidiary had subscribed for 225 million new BYD H-shares at HK$8 each, raising approximately HK$1.8 billion and giving MidAmerican a 9.9 percent stake in the Company. Wang told analysts that the transaction was structured as a long-term strategic partnership rather than as a financial investment, that MidAmerican's interest in BYD's battery and electric vehicle technology had been the strategic motivation and that the Berkshire relationship would provide BYD with access to global capital markets, technology validation and the standing to recruit international senior management. Wang walked analysts through the 2008 results, indicating that net profit had grown to approximately RMB 1.02 billion on revenue of approximately RMB 26.7 billion, with the rechargeable battery business contributing the majority of operating profit and the automotive business contributing the majority of revenue growth. He flagged that the F3 sedan had become one of the best-selling single models in the Chinese market, that the battery technology had been validated through the supplier relationship with Nokia and other global handset manufacturers and that the Company was preparing to launch the F3DM, the world's first mass-produced plug-in hybrid electric vehicle, during 2009. On the Q&A, analysts pressed on whether the electric vehicle ambition was a credible near-term business or a long-term option. Wang responded that the underlying battery technology had been developed over a decade of consumer electronics scale, that the iron-phosphate battery chemistry being deployed in the F3DM was inherently safer than the cobalt-based chemistry used in many competitor products and that the Company intended to deploy the technology across the full model range within the next several years. He also defended the choice of the iron-phosphate chemistry as reflecting the long-term safety and cost trajectory rather than the short-term energy density. The briefing closed with management reiterating the long-term ambition of being the world's largest manufacturer of rechargeable batteries, the largest manufacturer of electric vehicles in China and the leading manufacturer of new energy solutions for the global market, anchored on the vertically integrated battery, automotive and energy storage franchises.

In his work on the seventh edition of Security Analysis, Klarman argued that the discipline Graham and Dodd articulated in the 1930s remained the only durable foundation for investment. He framed the book's endurance as evidence that the basic logic of buying assets below conservative value does not decay with the arrival of new asset classes, derivatives, or algorithmic trading. He observed that each generation of investors believes its own era to be categorically different - that the new instruments, new markets, or new technologies have changed the rules. The lesson of the prior cycles, he argued, is that the rules change in surface detail but not in underlying logic. A bond bought at a deep discount to recovery value still behaves as Graham and Dodd described, even if the bond is now a synthetic collateralized debt obligation tranche rather than a railroad debenture. The implication Klarman drew was that the right way to read Graham and Dodd is as a discipline of skepticism, not as a museum piece. The specific examples age, but the method - distrust of reported earnings, insistence on conservative asset coverage, awareness of the difference between recurring and non-recurring results - is universal. He saw his editorial role as preserving that method against the recurrent temptation to believe it had been surpassed.

Institutional Investor's interview with Seth Klarman accompanied the 2008 publication of the sixth edition of Graham and Dodd's Security Analysis, which Klarman co-edited and to which he contributed a substantial introduction that has itself become a frequently cited text in the value-investing literature. The interview probed Klarman's view of what makes a value investor in a moment when the discipline was being widely pronounced obsolete and when the financial crisis had intensified the criticism that value investors had missed the signals that the prior decade of speculative excess had produced. He argued that the financial crisis had vindicated rather than disproven the framework, since the losses of the prior decade had been concentrated in securities whose prices had been allowed to detach from underlying value and in strategies that had abandoned the discipline of demanding a margin of safety in favor of strategies that depended on perpetual accommodation. The interview pressed Klarman on what he meant by describing the new edition as, in his own words, an act of sacrilege in places where modern finance had drifted from the original text and where the institutional practices of the asset-management industry had diverged from the principles that Graham and Dodd had originally articulated. He explained that the revisions were intended to acknowledge the legitimate advances in finance theory while preserving the core conviction that markets are imperfect processors of information and that price and value routinely diverge in ways that the disciplined analyst can detect and exploit. He argued that the institutional drift toward indexing, while defensible for many investors and while appropriate for those who lack the time or the temperament for active analysis, had created pockets of mispricing that disciplined analysts could still exploit profitably over time, and that the case for active security analysis remained intact even as the case for indexing had grown in the wake of the crisis. The conversation also touched on Klarman's view of the role of the value investor in a market increasingly dominated by quantitative strategies and by the rise of passive vehicles that had absorbed an unprecedented share of equity flows and that had altered the composition of the marginal buyer in ways that the prior generation of value investors had not had to consider. He argued that the rise of passive and systematic investing had not eliminated the case for active security analysis, but had rather shifted it toward the extremes, where patience and capital structure flexibility could still produce advantages that algorithms could not replicate and where the structural rigidities of systematic strategies themselves created exploitable patterns. The interview closes with Klarman's insistence that the discipline of value investing is best understood not as a strategy but as a philosophy, one that demands a particular posture toward uncertainty and toward one's own fallibility, and that the institutional form of the practice is inseparable from the substance of the philosophy it is meant to advance.

Beginning in 2007 Icahn accumulated Motorola shares and pushed hard for the company to separate its declining handset business from its infrastructure and public-safety operations, arguing the conglomerate structure hid the value of the parts and dulled accountability. After years of pressure, including board representation he eventually won, Motorola split in 2011 into Motorola Mobility and Motorola Solutions.

Investopedia's reference article George Soros and Black Wednesday documents the September 1992 trade in which the Quantum Fund, then run jointly by George Soros and Stanley Druckenmiller, bet that the British pound could not be defended at its Exchange Rate Mechanism peg. The article frames the episode as the most famous macro trade of the modern era and reports that Soros and his team sold roughly ten billion pounds short, buying back the position after the currency was forced out of the mechanism on what became known as Black Wednesday. The realised profit for the fund was on the order of one billion dollars, and the trade has been used ever since as a teaching case for how policy pegs create asymmetric payoffs for the speculator willing to take the other side. The article is one of the few extended on-record discussions of the topic at the time of its publication and is used as a reference document by writers covering the broader institutional investment industry. The Investopedia piece stresses that the trade was not a gamble on a random outcome but a position taken against a policy configuration that was clearly broken. German reunification had pushed Bundesbank rates to levels that Britain could not match without tanking its own economy, and the market correctly read the Bank of England's hesitation as a signal that the peg was politically unsustainable. The article notes that the size of the short was the variable that mattered: a smaller trade would have been right but uninteresting, while the scale that Soros and Druckenmiller built, financed by leverage and by selling other European currencies, turned the trade into one of the defining returns of the decade and a permanent reference point in the macro literature. The piece is widely cited in the literature on the topic as a case study in how the principles at stake interact with the broader institutional context and the operational architecture of the office. The piece closes with the longer-term consequences of the trade for both the pound and for hedge fund reputation. The article notes that Black Wednesday became a political reference point in the United Kingdom, that subsequent British chancellors treated defence of sterling as a lesson in what not to do, and that the macro hedge fund model that Quantum epitomised became both admired and feared. Investopedia also notes the role of Druckenmiller in sizing the trade, since Soros's published remarks credit his then-deputy with the original conviction and Soros himself with the push to take the position to its full size. The article is the standard reference entry for readers looking for the basic facts of the episode and for a clean teaching summary. The article is regularly updated as new information becomes available and is one of the most frequently consulted references on the subject for general-audience readers and for institutional practitioners.

A February 2008 piece on CBS News framed David Swensen as the finance guru out front of the rocketing growth of the Yale endowment, then at roughly twenty-two billion dollars and on its way to its pre-crisis peak. The piece noted that his last raise had brought his salary up to roughly two and a half million dollars a year and that, by many measures, he was still grossly underpaid relative to what he could have earned running money on Wall Street. The coverage used the salary comparison to make a larger point about Swensen's commitment to the institution and to the public-service conception of his role that he had articulated since taking over the office in 1985 and that had been a consistent theme of his public remarks. The article is widely used as a teaching document in business-school courses on the subject and in wealth-management training programmes that draw on the published record of the investor. The article walked through the office's track record, noting that the endowment had produced a string of strong returns in the years preceding the piece and that the office had been particularly disciplined during the late-1990s equity bubble, when many institutional peers had been tempted to chase the returns of the public market. The CBS coverage stressed that the office's published returns had been a major channel by which the Yale model had been propagated, and that the network of Swensen's protégés had been a major channel by which the model had been adopted by other institutions. The piece also noted that the office had been a major contributor to the university's operating budget throughout Swensen's tenure and a major source of financial aid for undergraduate education at the university. The piece is paired in the secondary literature with the original source documents and with the broader coverage of the subject in the financial press and the academic literature that followed. The piece closed with a section on Swensen's argument, articulated in his two books, that the individual investor should not try to replicate the institutional model but should instead use low-cost index funds to build a diversified portfolio. The CBS coverage is paired in the office's public bibliography with the longer-form interviews Swensen gave to the Yale School of Management and to the broader financial press, and it remains a reference for general-audience readers looking for an accessible introduction to his contribution. The article is widely cited in the secondary literature on Swensen and the Yale model, and it is one of the more widely read mainstream profiles of the period before the financial crisis tested the model in earnest. The article is one of the few extended on-record discussions of the topic at the time of its publication and is used as a reference document by writers covering the broader institutional investment industry.

On October 1, 2008, Netflix announced a deal to add roughly 2,500 titles from Starz Entertainment's broadband subscription service to its web streaming offering, with terms undisclosed. The agreement was a major milestone in Netflix's effort to license newer content for its Watch Instantly streaming service, which at the time offered viewing from a library of over twelve thousand titles, most of them older releases. Netflix and other young online video services were finding it nearly impossible to win subscription rights for digital delivery from the Hollywood studios, especially for newer films, so the network's willingness mattered: the network, a unit of Liberty Media, had bought rights to distribute subscription movies over every electronic delivery platform for its Starz Play broadband service and was selling access through affiliates such as Netflix, having struck a similar arrangement with Verizon. For Hastings's company, the deal validated the strategy of assembling a credible streaming catalog through whatever licensing windows the studios would tolerate, inching the young service toward the content depth its subscribers expected from the red-envelope business.

Zhang's Burmese-Chinese parents immigrated to China and worked as translators at the Foreign Languages Press before separating during the Cultural Revolution; Zhang moved with her mother to Hong Kong at age 15, living in a room with only two bunk beds, and worked five years in small garment and electronics factories to save enough for airfare and self-support to study in London.

Buffett wrote that the financial crisis had created the rare conditions in which the prices of high-quality businesses' debt and preferred equity offered returns that would have been unthinkable a year earlier. He argued that the investor's task in a panic is to have both the capital and the temperament to act when others are forced to sell, and that the chief obstacle is rarely the absence of opportunity but the absence of liquidity and nerve when opportunity appears.

On deploying capital during the 2008 panic.

A New Order of Things – Bringing Mutuality to the “Mutual” Fund The 27th Annual Manuel F. Cohen Memorial Lecture By John C. Bogle Founder and former Chief Executive, The Vanguard Group At the George Washington University Law School Washington, D.C. February 19, 2008 I’m profoundly honored by the privilege of delivering the Manuel F. Cohen Memorial Lecture for 2008 here at the National Law Center of the George Washington University. Part of my pleasure comes from the fact that, during the later time of his 27-year tenure at the Securities and Exchange Commission, I came to know Chairman Cohen (universally known as “Manny”). He had served on the staff from 1942 until 1961 and as a member of the Commission from 1961 until 1969, serving as its Chairman during the final five years of his tenure. I remember him as being wise, smart, blunt, tough, intolerant of beating around the bush, and a pillar of personal rectitude and professional integrity. It should go without saying that I had the highest admiration for this consummate public servant. He left the Commission in 1969 to enter the private practice of law at Wilmer, Cutler and Pickering, but continued to speak out on issues affecting the securities field, lecturing here at the George Washington School of Law. One of his speeches, given when he was SEC Chairman, sets the theme for my own lecture this afternoon. That speech, delivered at the 1968 Federal Bar Conference on Mutual Funds, was entitled simply “The ‘Mutual’ Fund.

The case frames the JLR acquisition as a test of whether Tata could run luxury automotive brands that Ford had failed to extract value from, and notes that the timing during the 2008 financial crisis allowed Tata to transact at a distressed price relative to earlier valuations of the same assets.

Lu was born into a peasant family, dropped out of school at 15, and worked as an ironsmith before co-founding a small factory with six other farmers in July 1969 to produce small agricultural machines.

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 2008 decreased to $77,562,000 ($10.89 per share) from $93,405,000 ($13.12 per share) in the previous year. Consolidated net income decreased to $82,116,000 ($11.53 per share) from $109,161,000 ($15.33 per share) in 2007. These figures included realized after-tax investment gains of $4,554,000 ($.64 per share) for 2008 and $15,756,000 ($2.21 per share) for 2007. 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, Virginia and engaged princi- pally 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) : Amount Per Wesco Share (2) Amount Per Wesco Share(2) December 31, 2008 December 31, 2007 Year Ended Wesco-Financial and Kansas Bankers insurance businesses — Underwriting gain (loss) . . . . . . . . .

Lu grew the original agricultural-machinery workshop into Wanxiang Group, a large manufacturing conglomerate and leading producer of automobile components, while also serving as a part-time EMBA professor at Zhejiang University.

At 19, Zhang saved enough to travel to the UK, worked in a fish-and-chip shop run by a Chinese couple to support herself, studied English at a secretarial school in Oxford, and took Margaret Thatcher as a personal role model before starting a career in finance in Hong Kong and New York.

. . . . . . . . . . . . . . . $ (2,942) $ (.42) $ 7,040 $ .99 Investment income . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64,274 9.03 65,207 9.16 CORT furniture rental business . . . . . . . . . . . . . . . . . . . . 15,744 2.21 20,316 2.85 Precision Steel businesses . . . . . . . . . . . . . . . . . . . . . . . . 842 .12 915 .13 All other “normal” net operating earnings (loss)(3) . . . . . . . (356) (.05) (73) (.01) 77,562 10.89 93,405 13.12 Realized investment gains . . . . . . . . . . . . . . . . . . . . . . . . . . 4,554 .64 15,756 2.21 Wesco consolidated net income . . . . . . . . . . . . . . . . . . . $82,116 $11.53 $109,161 $15.33 (1) All figures 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 office 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. This supplementary breakdown of earnings differs somewhat from that used in audited financial statements which follow standard accounting convention. The foregoing sup- plementary breakdown is furnished because it is considered useful to shareholders. The total consolidated net income shown above is, of course, identical to the total in our audited financial statements.

Buffett publicly acknowledged that he had made an error in buying a large position in ConocoPhillips near the top of the oil price, and that the position had been reduced at a loss. He used the admission to make the broader point that mistakes of timing on commodity-sensitive businesses are a recurring hazard, and that the discipline of staying within the circle of competence applies to industries whose economics depend on a commodity price one cannot forecast.

On the ConocoPhillips error.

”1 And, yes, he put quotation marks around the word mutual. The title—and the theme—of my remarks today follows that same formulation: “A New Order of Things—Bringing Mutuality to the ‘Mutual’ Fund.” Please note that the word mutual is again bracketed by quotation marks. 1 “The ‘Mutual’ Fund,” an address by Manuel F. Cohen before the 1968 Conference on Mutual Funds, Palm Springs, California, March 1, 1968. Note: The opinions expressed in this speech do not necessarily represent the views of Vanguard’s present management.

Swensen's ECON 252 lecture devoted significant attention to the critique of his own approach that had been published in Barron's magazine after the 2008 drawdown. The article had argued that the endowment model had failed because the Yale endowment experienced a roughly 25 percent drawdown during the financial crisis. Swensen's response in the lecture was twofold: first, that the drawdown was less severe than the drawdowns experienced by institutions with conventional equity-heavy allocations; second, that the relevant measure of the model's success was the long-cycle compound return, not the year-to-year mark-to-market drawdown. Swensen was also careful in the lecture to acknowledge the limits of the model. He argued that the endowment approach is poorly suited to institutions without the staff to evaluate external managers, the governance to maintain the strategic allocation through cycles, and the long horizon to commit capital through multiple vintage years. The model, in his framing, is a framework for institutions with specific structural advantages - and applying it to institutions without those advantages produces high fees and mediocre returns rather than the long-cycle outperformance the Yale endowment has achieved. The lecture closed on the distinction between speculation and investment, a theme Swensen returned to throughout the talk. He argued in the lecture that the speculative activity of trying to time market moves is fundamentally different from the investment activity of constructing a portfolio of risk premiums that compound real wealth over a long horizon. The endowment model is, in this framing, an explicit rejection of speculation in favor of disciplined portfolio construction - and the long-cycle returns of the Yale endowment are presented as the empirical evidence that the investment approach outperforms the speculative approach over full market cycles.

In the same interview, Klarman reflected on the recurring pattern by which markets convince each generation that this time is different. He noted that the phrase appears, almost without fail, in the late stages of every bubble: the technology bubble of the 1990s, the housing bubble of the 2000s, the crypto and special-purpose-acquisition-company episodes of the early 2020s. The substance changes; the rhetorical move does not. He argued that the pattern is rooted in the institutional memory of the market. Each generation enters finance without having lived through the prior cycle's deflation. By the time the prior lesson would have been useful, the people who learned it have retired, and the new entrants have only seen the rising part of the curve. The phrase 'this time is different' is, in this view, less an analytical claim than a confession that the speaker has not studied the comparable prior episode. Klarman's prescription was deliberately old-fashioned: read the histories, study the prior episodes, and notice that the architectural similarity across cycles is greater than the surface similarity of the underlying assets. An investor who has read the 1929, 1969-1974, and 1990 episodes will recognize the shape of the 2008 episode while it is unfolding, rather than treating each new development as unprecedented. The willingness to read backward is, in his framing, an underappreciated source of edge.

It highlights Tata's explicit decision to keep JLR's design and engineering leadership in the United Kingdom rather than relocate it to India, a posture of buying capability without displacing it that became a template for how later Indian outbound deals would be structured.

Icahn's argument followed his standard template: no division of a conglomerate can be properly valued or managed when its results are averaged with unrelated businesses, and a company losing share in its core product market must restructure before decline becomes permanent. The eventual split, with Google buying the mobility arm months later, was claimed by his camp as vindication of the thesis.

The Starz arrangement showed how Netflix structured early streaming economics. The additional Starz films were included at no additional charge for subscribers with unlimited plans, which started at $8.99 a month, and subscribers also got the opportunity to watch a live feed of the Starz television network on their computers. About one thousand of the Starz titles were available immediately, with more added in the following weeks. Netflix simultaneously began offering a Starz Play-only subscription at $7.99 a month for customers who wanted the premium channel's streaming service alone. Ted Sarandos, then chief content officer, called the coupling of Starz Play with Netflix's growing streaming library an important step forward for both companies and for consumer choice, and described the deal as reflecting the creative ways Netflix was working with content partners to expand what subscribers could watch instantly, in addition to the one hundred thousand titles available on DVD through the mail. The template, incremental catalog expansion priced into an existing subscription, became the foundation of Netflix's licensing strategy until originals supplanted it.

Buffett described derivatives as 'financial weapons of mass destruction' in a passage written before the crisis fully unfolded, and reiterated the warning in its aftermath. He argued that derivatives' accounting, counterparty risk, and leverage were opaque even to sophisticated participants, and that Berkshire itself held only a small and well-understood derivatives book whose risks had been priced conservatively.

On the systemic risk of derivatives, restated.

The ECON 252 lecture also addressed the role of absolute-return strategies in the endowment framework. Swensen argued that the conventional fixed-income allocation is structurally unattractive for a long-horizon investor - long nominal bonds expose the institution to inflation risk and offer poor real returns - and that selected absolute-return strategies, whose returns are uncorrelated with broad market direction, are a better substitute for the diversifying role that fixed income has historically played in institutional portfolios. He was careful in the lecture to distinguish the small number of absolute-return managers whose returns are genuinely uncorrelated from the much larger number of high-fee hedge funds whose returns are actually high-beta proxies for long-only exposure. Swensen's treatment of the asset class in the lecture also addressed the operational costs of running an absolute-return portfolio. The office's staff must continuously evaluate the underlying managers, negotiate terms, and re-underwrite the strategy over time. The lecture argued that the institutional infrastructure required to do this is itself a structural advantage - the institutions that maintain the staff capacity to evaluate absolute-return managers can capture the diversification benefit, while institutions that lack the staff capacity are systematically sold the high-fee median product whose returns do not justify the cost. The lecture closed on Swensen's broader view of the institutional investor's role. He argued that the long-horizon investor's job is to identify the risk premiums that compound real wealth - the equity-risk premium, the illiquidity premium, the absolute-return premium from genuinely skilled managers - and to construct a portfolio that harvests those premiums over multiple cycles. The discipline to maintain the strategic allocation through drawdowns, the patience to commit capital through multiple vintage years, and the staff capacity to evaluate the underlying partnerships are, in Swensen's framing, the operational preconditions for harvesting the premiums that produce long-cycle institutional outperformance.

The same analysis contrasts the eventual profitability of JLR with the Corus acquisition, whose timing near the top of the steel cycle weighed on Tata Steel's results for years, illustrating that the globalisation strategy succeeded deal by deal rather than uniformly across the portfolio.

From 1995 to 2022, Zhang and her husband Pan Shiyi built SOHO China into a major office developer during China's property boom, before stepping down from the company ahead of the sector's subsequent downturn.

The fact is that “mutual” remains an inappropriate adjective to apply to our business. The operation of virtually all mutual funds is about as far from the concept of mutuality as one can possibly imagine. Hear Chairman Cohen on this point in that 1968 speech: “The basic idea of a ‘mutual’ fund is deceptively simple,” he said . . . “(but its) salient characteristics raise a serious question whether the word ‘mutual’ is an appropriate description.” While the policyholders of mutual insurance companies and the depositors in mutual savings banks were at least putatively sharing in the profit of their institutions, mutual funds, he said, were different, noting that fund shareholders paid fees to their external managers, corporations in business to earn profits for their own shareholders, with a completely different, and often opposed, set of interests. Chairman Cohen pointedly observed that “the (external) fee structure has provided a real opportunity for the exercise of the ingenuity for which fund managers have established an enviable reputation. After all,” he said in his speech, “that is where the money is, and despite the common use of the word ‘mutual,’ the principal reason these funds are created and sold is to make money for the people who sell them and those who manage them.” Of course he was right. Virtually all mutual funds are organized, operated, and managed, not in the interests of their shareholders, but in the interest of their managers and distributors.

Klarman closed the Security Analysis discussion by emphasizing that the most important decision an investor makes is not which securities to buy but what kind of investor to be. He argued that the choice of philosophy - value, growth, macro, quantitative, thematic - is upstream of the security selection, and that the mistakes that destroy capital are usually philosophical in origin. He observed that investors who attempt to be all things - value when value is in favor, growth when growth is in favor - typically end up being neither. The philosophies imply different behaviors, different time horizons, and different definitions of risk. An investor who changes philosophies to fit the cycle has no fixed criterion by which to evaluate his own decisions, and therefore no way to learn from his errors. The implication is that the firm's identity as a value investor is not a marketing position but a discipline that constrains every other choice. Baupost's cash stance, its preference for distress, its willingness to abstain from popular themes, and its insistence on a margin of safety are all expressions of the same underlying commitment. The cost of that commitment is the years when the style is out of phase with the market; the benefit is a multi-decade record that has compounded through every kind of regime. In Klarman's framing, the philosophical choice is the binding one, and every other decision is a downstream expression of it.

parent. The arrangement became effective in 2001 and has covered hull, liability and workers’ compensation exposures relating to the aviation industry, as follows: for 2006, to the extent of 121 ⁄2% of the hull and liability pools and 5% of the workers’ compensation pool; and, since 2007, 16.67% of the hull and liability pools and 5% of the workers’ compensation pool. The Berkshire subsidiary provides a portion of the upper-level rein- surance protection to these aviation risk pools on terms that could result in the Berkshire subsidiary having a different interest from that of Wes-FIC under certain conditions, e.g., in settling a large loss. At the beginning of 2008, Wes-FIC entered into a retrocession agreement with National Indemnity Company (“NICO”), another Berkshire Hathaway insurance subsid- iary, for the assumption of 10% of NICO’s 20% quota-share reinsurance of Swiss Rein- surance Company and its principal property-casualty affiliates (“Swiss Re”). Under this agreement, which was enthusiastically approved by Wesco’s Board of Directors, Wes-FIC has assumed 2% of essentially all Swiss Re property-casualty risks incepting over the five- year period which began on January 1, 2008, on the same terms as NICO’s agreement with Swiss Re. Wes-FIC’s share of written and earned premiums under the contract for 2008 were $265.2 million and $183.2 million, representing a very significant increase in Wes- FIC’s reinsurance activities to date.

33 on the Forbes China Rich List with an estimated 13.13 billion yuan (about $1.87 billion) -- and was reported as the richest person in Zhejiang Province.

Is there something improper, or wrong, or unethical about having funds operated with this purpose? Perhaps not. But if this structure is not illegal per se, there seems to be something about the way in which the industry has evolved that flies directly in the face of the provisions in the Investment Company Act of 1940 that require that investment companies be “organized, operated, and managed” 2 in the interests of their shareholders, “rather than in the interest of their managers and distributors.”3 (Interestingly, the phrase mutual funds does not appear in the statute.) A Lone Exception to the Conventional Structure Now, when I said that virtually all funds operate under this external management structure, please note that I did not say all. The creation of Vanguard in 1974 marked my attempt to create a family of 2 Investment Company Act of 1940, 15 U.S.C. § 80a- 1(b)(2) (2000), available at http//www.sec.gov/about laws/ica40.pdf. 3 In re: The Vanguard Group, Inc., Investment Company Act Release No. 11,645, 22 SEC Docket 238 (Feb. 25, 1981).

It is important to keep in mind that premiums assumed under the contract in each of the next four years could vary significantly depending on market conditions and opportunities. It is the nature of even the finest property-casualty insurance businesses that in keeping their accounts they must estimate and deduct all future costs and losses from premiums already earned. Uncertainties inherent in this undertaking make financial statements more mere “best honest guesses” than is typically the case with accounts of non-insurance-writing corporations. And the reinsurance portion of the property-casualty insurance business, because it contains one or more extra links in the loss-reporting chain, usually creates more accounting uncertainty than in the non-reinsurance portion. Wesco shareholders should remain aware of the inherent imperfections of Wes-FIC’s accounting, based as it is on forecasts of outcomes in many future years. Wes-FIC’s underwriting results have typically fluctuated from year to year, but have been satisfactory. When stated as a percentage, the sum of insurance losses, loss adjust- ment expenses and underwriting expenses, divided by premiums, gives the combined ratio. The combined ratios of Wes-FIC have been much better than average for insurers. Wes-FIC’s combined ratios were 101.0% for 2008, 93.9% for 2007 and 94.0% for 2006. We try to create some underwriting gain as results are averaged out over many years. We expect this to become increasingly difficult.

Co-founded a small agricultural-machinery factory with six other farmers in Xiaoshan, Hangzhou in July 1969.

Since the 2010s, Zhang and Pan have shifted their assets and business activities toward the United States; per Wikipedia's current infobox, Zhang now also holds roles as founder of Closer Media and CEO of Closer Properties, and a January 2026 Bloomberg video interview describes her discussing US investment as a way to diversify from China.

The factory developed into Wanxiang Group, a large manufacturing conglomerate and a leading global producer of automobile components, with Lu remaining president of the board until his death in 2017.

mutual funds that was truly mutual, doing away with the conflict of interest that exists between funds and their advisers; by returning the enormous profits that accrue to external managers directly to the fund shareholders themselves. The now-150 funds in our group actually own our manager, The Vanguard Group, Inc., roughly in proportion to their share of the Group’s aggregate assets, and share in the total expenses incurred by the funds in their operations in approximately the same proportion. (That is, if a given Vanguard fund represents one percent of our assets, it would own one percent of Vanguard’s shares and assume one percent of Vanguard’s operating expenses.) The directors of the funds and their management company are identical. Eight of our nine directors are otherwise unaffiliated with the company, and only one (the chief executive) serves as an officer. No director is permitted to be affiliated with any of the funds’ external advisors.4 Our funds essentially operate and manage themselves on an “at-cost” basis, enabling our shareowners to garner the extraordinary economies of scale that characterize investment management (i.e., the costs of managing $10 billion of assets is nowhere near ten times the cost of managing $1 billion). It is fair to describe Vanguard as the only truly “mutual” mutual fund complex. This shareholder-first structure has produced enormous savings for investors in the Vanguard funds. For example, in 2007, our composite expense ratio of 0.

Float is the term for money we hold temporarily, and, as long as our insurance underwriting results are break-even or better, it costs us nothing. We expect that the new business venture with NICO will significantly increase Wes-FIC’s float, from its yearend 2008 balance of $164 million, thus providing additional opportunities for investment. 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, reflecting the sound management of President Don Towle and his team.

Kansas Bankers was chartered in 1909 to underwrite deposit insurance for Kansas banks. Its offices 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 39 mainly Midwestern states. Kansas Bankers offers policies for crime insurance, check kiting fraud indemnifi- cation, Internet banking catastrophe theft insurance, Internet banking privacy liability insurance, directors and officers liability, bank employment practices, and bank insurance agents professional errors and omissions indemnity. Because of recent events in the banking industry, including a number of bank failures, we are less confident in the long-term profitability of Kansas Bankers’ long-established line of deposit guarantee bonds than previously. These bonds insure specific customer bank deposits above Federal insurance limits. After sustaining a loss of $4.7 million, after taxes, from a bank failure in the latter half of 2008, Kansas Bankers discontinued writing deposit guarantee bonds, and in September 2008 it began to exit this line of insurance as rapidly as feasible. The aggregate face amount of outstanding deposit guarantee bonds has been reduced, from $9.7 billion, insuring 1,671 institutions at September 30, 2008, to $3.

21 percent (21 “basis points”) was 76 basis points below the 0.97 percent (97-basis-point) composite weighted average expense ratio of our largest competitors. That saving, applied to our average assets of $1.2 trillion during the year came to almost $10 billion for 2007 alone. By 2009, cumulative savings for our mutual fund owners will have crossed the $100 billion mark. Whence “Mutual”? The Vanguard structure is unique in industry annals. While the first mutual fund (Massachusetts Investors Trust, formed in 1924) was managed by its own trustees rather than by an external company—a structure it abandoned in favor of the external structure in 1969—its shares were marketed and financed by a separately-owned distribution company. And while the funds in the Tri-Continental (now Seligman) group were for many years operated at cost by their management company, the manager reaped 4 The investment advice for approximately 70 percent of Vanguard’s fund assets—largely index, bond, and money market funds—is provided internally by Vanguard itself. The remaining 30 percent is advised under contracts held by a score of external advisors.

4 billion, insuring 796 institutions at February 15, 2009, the first date that non-renewals and non-voluntary cancellations became effective. It is believed that few of the institutions Kansas Bankers insures are facing significant risk of failure. Because of aggregate limits as well as the purchase of reinsurance, the after-tax risk to Wesco from the failure of any single bank insured by Kansas Bankers is limited to a maximum of $7.6 million. Thus, we believe that Wesco’s shareholders’ equity is not significantly at risk as Kansas Bankers rapidly exits this line of insurance. This decrease in exposure to loss, of course, will cause a sharp decline in Kansas Bankers’ insurance volume, inasmuch as premiums from guarantee bonds not only approximated half of Kansas Bankers’ written premiums for 2008, but also represented the entirety of the business it has recently conducted in 16 of the 39 states in which it is licensed to write insurance. When Wesco purchased Kansas Bankers, it had been ceding almost half of its premium volume to reinsurers. In 2008 it reinsured only about 14%. And, because it has also restructured the layers of losses reinsured, it is now better protected from the downside risk of large losses. Effective in 2006, insurance subsidiaries of Berkshire Hathaway became KBS’s sole reinsurers. Previously, an unaffiliated reinsurer was also involved. The increased volume of business retained comes, of course, with increased irregularity in the income stream.

substantial (if undisclosed) profits by serving as the broker-dealer for the funds’ portfolio transactions.5 In 1978, this structure, too, was converted into an external manager structure. Since the word “mutual” did not appear in the Investment Company Act of 1940, whence did it arise? I’ve looked through those old Investment Companies manuals published by Arthur Weisenberger & Company all the way back to the 1945 edition, and it is not until that 1949 edition, a quarter-century after the industry began, that I find the first mention of mutual funds. But while the derivation of the term remains a mystery, the paradoxical fact is that it first appears only a short time before the industry began to abandon its early mutual values. History confirms that from the inception of the first U.S. mutual fund in 1924 until the late 1940s, the predominant focus of mutual fund management was on portfolio selection and investment advice, rather than on distribution and marketing. In fact, the managers who founded not only Massachusetts Investors Trust, but State Street Investment Corporation and Incorporated Investors, the original “Big Three” of the fund industry, put themselves forth as “the twentieth-century embodiment of the old Boston trustee.”6 During the industry’s early years, sales of fund shares were often the responsibility of separate underwriting firms financed by distribution revenues from sales loads, and predominately unaffiliated with fund managers.

For example, “the primary concern of the State Street (Research and Management Company) partners was that they not be distracted by the sales effort. As they wrote to investors in 1933, ‘it is our intention to turn over the active selling and the commissions to dealers . . . thereby leaving us free to devote . . . our entire time and effort to research and the study of the problems of investment.” 7 (The partners were even better than their word; in 1944 the fund entirely ceased the sale of its shares.) The same spirit was echoed by Judge Robert F. Healy, the SEC Commissioner primarily responsible for the development of the legislation leading to the Investment Company Act of 1940. Here’s how he opened his testimony at the hearings for the Act in 1939: “The solution (to the industry’s) shocking record of malfeasance . . . was a group of expert trust managers who do not make their profits . . . distributing trust securities, styled principally for their sales appeal, but from wise, careful management 5 While the funds operated by TIAA-CREF and USAA have a shareholder-oriented structure that is similar in philosophy to Vanguard’s, they differ by being managed, in effect, by insurance/annuity providers that are themselves mutual, owned by their policy holders. While the funds pay fees to the manager in the same way as in the conventional external model, those fees are far below industry norms. 6 Michael R. Yogg, Passion for Reality, Xlibris, 2006, page 77.78

Kansas Bankers’ combined ratios were 111.6% for 2008, 55.1% for 2007 and 73.8% for 2006. We continue to expect volatile but favorable long- term results from Kansas Bankers. CORT Business Services Corporation (“CORT”) In February 2000, Wesco purchased CORT Business Services Corporation (“CORT”) for $386 million in cash. CORT is a very long-established company that is the country’s leader in rentals of high- quality 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.

of the funds entrusted to them.” 8 The SEC Commissioners, Judge Healy said, “were anxious to protect the fund investor from the distorting impact of sales. Products (italics added) designed for their appeal to the market did not, and do not, necessarily make the best investments.” 9 Legendary industry pioneer Paul Cabot, one of State Street’s founders and a major force in the drafting of the 1940 Act, agreed with the SEC on this point. Earlier, in 1928, he had described the abuses in the investment-trust movement of the day as “(1) dishonesty; (2) inattention and inability; (3) greed, by which he meant simply charging too much for the services rendered. ‘Even if a fund is honestly and ably run, it may be inadvisable to own it simply because there is nothing in it for you. All the profits go to the promoters and managers.’”10 While the derivation of the term mutual remains obscure, the prudent idealism that undergirded the spirit of the industry when the 1940 Act was drafted arguably justified the use of the term. Yet mutual fund actually came into being just as the industry began to turn away from its original spirit of mutuality, from its early mission of stewardship of investor assets to its modern-day mission of salesmanship, a mission, as Chairman Cohen seemed to be suggesting, that would make the use of the term “mutual” something of a joke.

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 $410 million for calendar 2008, versus $396 million for calendar 2007. Of these amounts, furniture rental revenues were $340 million and $327 million, furniture sales revenues were $62 million each year, and rental relocation revenues were $8 million and $7 million. CORT operated at after-tax profits of $15.7 mil- lion for 2008 and $20.3 million for 2007. Since its acquisition, CORT has made several “tuck-in” acquisitions, most recently, the residential furniture rental division of Aaron Rents, Inc., and earlier in 2008, the estab- lishment of international operations through the purchase of Roomservice Group, a small regional provider of rental furniture and relocation services in the United Kingdom, now doing business as CORT Business Services UK Ltd. CORT has also started up a nation-wide apartment locator service, originally intended mainly to supplement CORT’s furniture rental business by providing apartment locator and ancillary services to relocating indi- viduals.

Paul Arnold, long CORT’s star CEO, and his management team, have devoted much effort over the past two years, expanding and redirecting CORT’s rental relocation services toward the needs of businesses and government agencies who require a skilled and able partner to provide comprehensive and seamless relocation services for the temporary relocation of employees worldwide. CORT’s operating results are subject to economic cycles. When we purchased CORT, its furniture rental business was rapidly growing, reflecting the strong U.S. economy, phenomenal business expansion and explosive growth of IPOs and the high-tech sector. Shortly thereafter, with the burst of the dot-com bubble, followed by the events of September 11 and a protracted slowdown in new business formation, CORT’s operations were hammered, reflecting generally bad results in the “rent-to-rent” segment of the furniture rental business. There followed a far-too-short period of improving business conditions which have more recently given way to increasingly difficult recessionary conditions, perhaps the beginning of the worst economic recession in decades. Under Wesco’s ownership, CORT has continuously undertaken to improve its com- petitive position. With several websites, principally, www.cort.com and www.apartment- search.

The Straw That Broke the Camel’s Back As with any transformation, multiple, doubtless innumerable, factors were responsible for the sea change that gradually subverted the fund industry’s mission. Operating for decades as an industry composed of a group of small firms, entirely privately-owned by the professional managers who were actually providing the advisory services, and focused on earning a return on the capital that investors had entrusted to them, the industry gradually morphed into a group of giant firms, largely publicly-owned and controlled by corporate executives whose mission was asset gathering, and focused on earning a return on the capital of the owners of the management company. But the proverbial “straw that broke the camel’s back” of the traditional industry was when the owners of privately-held management companies gained the right to sell their ownership positions to outsiders, and then to the public, and finally to giant financial conglomerates.125

com, professionals in more than 80 domestic metropolitan markets, affiliates servicing more than 50 countries, almost twenty thousand apartment communities refer- ring their tenants to CORT, many ancillary services, and its entrée to the business com- munity as a Berkshire Hathaway company, CORT is better positioned than previously to benefit from an economic turnaround, certain to occur in due course. Near term, we expect more of the difficult business conditions of the recent past. 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 profits of $0.8 million in 2008 and $0.9 million in 2007. These figures reflect after-tax LIFO inventory accounting adjustments decreasing after-tax income by $0.7 million for 2008 and $1.0 million for 2007. Precision Steel’s operating results for 2008 also reflect the benefit of $0.in

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

connection with the 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 benefit from the reversal of those environmental-related expenses, Precision Steel would have reported after-tax operating income of $1.3 million for 2008 and $1.9 million for 2007. Precision Steel is continuing to suffer not only the ongoing effects of a long-term reduction in demand caused by customers’ (or former customers’) unsuccessful compe- tition with manufacturers outside the United States and a trend towards smaller-sized orders, but also, the difficult effects from deepening recessionary conditions. In 2008, Precision Steel’s service center volume was 37 million pounds, down from 39 million pounds in 2007 and 69 million pounds sold as recently as 1999. Volume for the fourth quarter of 2008 was only 6.2 million pounds, down 34% from the corresponding 2007 figure. Apart from the recessionary-caused weakness, the general and ongoing decline in Precision Steel’s physical volume is a serious reverse, not likely to disappear in some “bounce back” effect once the economy recovers. Nor do we expect that ongoing price increases like the approximately 111% rise that has occurred since 1999, holding dollar volume roughly level despite a precipitous drop in physical volume, will continue.

It is hard to imagine how such “new products and services would be beneficial” to the fund’s shareholders, even as they would likely benefit the management company, which became a subsidiary of the insurance behemoth. In fact, the merger hurt the fund shareholders. “Performance lagged, and the manager’s position in the industry declined from tops to average.”13 By 2002, Metropolitan Life abandoned the fund business, selling State Street Management and Research Company to Blackrock Financial for an estimated $375 million. Among Blackrock’s first moves was to put State Street Investment Corporation out of its misery, merging the industry’s third-oldest fund into another Blackrock fund. I still refer to this event as “a death in the family.” The Floodgates Open The sale and resale of State Street exemplified what might be called the “trafficking” in fund advisory contacts that greatly concerned the Commission during the drafting of the 1940 Act. But while the SEC and the industry agreed that the management contract was an asset of the fund, the 1940 Act 11 Ibid, page 209. 12 Ibid, page 213 13 Ibid, page 213.

We do not consider Precision Steel’s recent after-tax operating earnings of approx- imately $1 million annually to be a satisfactory investment outcome, particularly when compared with its after-tax operating earnings which averaged $2.3 million for the years 1998 through 2000. And, because of the intensifying recession, more difficulty for Pre- cision Steel will surely lie ahead. Terry Piper, who became Precision Steel’s President and Chief Executive Officer in 1999, has done an outstanding job in leading Precision Steel through very difficult years. But he has no magic wand with which to compensate for competitive losses among his best customers or from the deepening recession. He is undertaking the difficult task of paring costs to an endurable level. 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 office building in downtown Pasadena, where Wesco is headquartered. Adjacent to that building is a parcel of land on which our construction of a multi-story luxury condominium building is almost complete. We are also seeking city approval of our plans to build another multi-story luxury condominium building, at a later date, on a vacant parcel of land in the next block.

failed explicitly to articulate this sound principle. It would be only a matter of time until a sale would take place. That sale opened the floodgates to public ownership of fund management companies. The date was April 7, 1958, when the United States Court of Appeals for the Ninth Circuit ruled that the 1956 sale of shares in Insurance Securities, Incorporated (ISI), at a price equal to nearly 15 times its book value, did not constitute “gross misconduct” or “gross abuse of trust” under Section 36 of the 1940 Act. The SEC had gone to court to oppose the sale, on the grounds that the excess price represented a payment for succession to the adviser’s fiduciary office. The Court agreed with the Commission that “the well-established principles of equity barred a trustee standing in a fiduciary relationship with another from either transfer of the office or exploiting such a relationship for personal gain. But it weighed even more heavily the fact that the value of the contract, rather than representing an asset of the trust fund, represented the reality that the manager receives a profit for rendering its services in return for stipulated fees that the fund had contracted to pay. Well-decided or ill-decided by the Ninth Circuit (I believe the latter14 ), the U.S. Supreme Court refused certiorari. And that was that.

That narrow legal decision, now almost exactly a half-century ago, played a definitive role in setting the industry on a new course in which manager entrepreneurship in the search for personal profit would supersede manager stewardship in the search for prudent investment returns for fund shareholders. Within a decade, many of the major firms in the fund industry joined the public ownership bandwagon, including Vance Sanders (now Eaton Vance), Dreyfus, Franklin, Putnam, and even Wellington (the firm I had joined in 1951, right out of college). Over the next decade, T. Rowe Price, and Keystone (now Evergreen) also went public. In the era that followed, financial conglomerates acquired industry giants such as Massachusetts Financial Services (adviser to the fund complex of which M.I.T. had become a part), Putnam, State Street, American Century, Oppenheimer, Alliance, AIM, Delaware, and many others. The trickle became a river, and then an ocean. Today (continuing that somewhat stretched analogy), the tide of public ownership of fund management companies has come in, and the tide of private ownership is at an all time low. Among the 14 A note in the Harvard Law Review of April 1959, Volume 72, Number 6, agreed with me, taking issue with the Ninth Circuit’s decision.

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 (Loss) Other operating earnings (loss), net of interest paid and general corporate expenses, amounted to ($0.4 million) in 2008, versus ($0.1) million in 2007. The components of the $0.4 million of other operating loss in 2008 were (1) rents ($4.outsiders,

including Citibank as the ground floor tenant), and (2) interest and dividends from cash equivalents and marketable securities held outside the insurance subsidiaries, less (3) gen- eral corporate expenses plus expenses involving tag-end real estate. Consolidated Balance Sheet and Related Discussion Strategically, we strive to invest in businesses that possess excellent economics, with able and honest management, at sensible prices. We prefer to invest a meaningful amount in each investee, resulting in concentration, exposing the portfolio to more significant market price fluctuations than might be the case were Wesco’s investments more diver- sified. Concentration has worked out very well in the past as evidenced by significant realized investment gains. Details as to Wesco’s investments can be found in Note 2 to the accompanying consolidated financial statements. Most equity investments are expected to be held for long periods of time; thus, we are not ordinarily troubled by short-term price volatility with respect to our investments provided that the underlying business, economic and management characteristics of the investees remain favorable. We strive to maintain much liquidity to provide a margin of safety against short-term equity price volatility. Since the latter part of 2007, Wesco has invested $1.1 billion, at cost, in marketable equity securities, bringing the aggregate cost of Wesco’s equity investments to $1.

“If (the Act) is construed to incorporate the basic principle that a fiduciary owes individual loyalty to the beneficiary and must avoid any conflict of interest, then a seller should not be allowed to transfer his fiduciary office for personal gain . . .” page 180.

50 largest mutual fund management complexes, only eight have maintained their original private structure—including Fidelity, Capital Group (American Funds), Dodge & Cox, and TIAA-CREF, plus Vanguard, owned by its fund shareholders. Of the remaining 41 firms on the list, nine are publicly-held (including T. Rowe Price, Eaton Vance, Franklin, and Janus) and 32 are owned by banks, giant brokerage firms, and U.S. and international conglomerates. As we shall soon see, this seemingly irresistible tide of public—largely conglomerate—ownership has ill-served mutual fund shareholders. Vanguard Goes the Other Way Only a single firm resisted this epic tide. In the context of my theme this evening, the story of its creation is a story worth telling. As you may recall, in 1960, my employer, Wellington Management Company was among the firms to ride that early wave of industry IPOs. In 1965, when I was given the responsibility of leading the firm, I recognized the challenge involved in serving those two demanding masters whose interests were so often in direct conflict. To state the obvious, we had a fiduciary duty both to our fund shareholders and to our management company shareholders as well. However, when a privately-held management company becomes publicly-held, this conflict is exacerbated. In September 1971, I went public with my concerns.

63 billion at yearend 2008, including an aggregate of $650 million, at cost, invested in the common stocks of Wells Fargo & Company and US Bancorp. The timing of our recent investments could not have been much worse. During 2008, several crises affecting the financial system and capital markets of the U.S. resulted in very large price declines in the general stock market, and in the banking sector, in particular, due significantly to the ongoing liquidity crisis as well as the deterioration of asset quality and earnings reported by the banking industry. Wesco carries its investments at fair value, with unrealized appreciation or depreci- ation, after income tax effect, included as a component of shareholders’ equity, and related deferred taxes included in income taxes payable, on its consolidated balance sheet. As indicated in the accompanying consolidated financial statements, Wesco’s net worth, as accountants compute it under their conventions, decreased to $2.38 billion ($334 per Wesco share) at yearend 2008 from $2.53 billion ($356 per Wesco share) one year earlier. The principal cause of the decrease was the after-tax decline in fair value of Wesco’s investments in marketable equity securities. As a result of further declines in fair values of these investments subsequent to yearend 2008, Wesco’s shareholders’ equity has further declined, by $303 million ($43 per share), through February 24, 2009.

The worldwide economy is currently suffering the effects of a deepening recession, perhaps the worst economic disaster since the Great Depression. We will not attempt to prognosticate the effects that Wesco will suffer or when the economy will recover, but we are certain that in due course, Wesco will prosper. In the mean time, Wesco’s operations will bear their share of economic woes. We will continue to practice Ben Franklin’s advice, that “a penny saved is a penny earned,” as we trim expenses, albeit in higher denomi- nations, to better endure the weakening economic conditions that surely lie ahead. 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.the

Speaking at the annual meeting of my Wellington partners, I began my remarks with a 1934 quotation from Justice Harlan Fiske Stone: “Most of the mistakes and major faults of the financial era that has just drawn to a close 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’ . . . Those who serve nominally as trustees but consider only last the interests of those who funds they command suggest how far we have ignored the necessary implications of that principle.” I endorsed that point of view. Then I revealed “an ancient prejudice of mine: All things considered, it is undesirable for professional enterprises to have public shareholders. Indeed it is possible to envision circumstances in which the pressure for 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 a business and a profession, any conflicts between the two must, finally, be reconciled in favor of the client.” It is a matter of fiduciary principle. I then explored some ideas about how such a reconciliation might be achieved, including, “a mutualization, whereby the funds acquire the management company . . .with

incentives for both performance and efficiency, but without the ability to capitalize earnings through public sale.” Within three years, a situation developed in which I was put in a position in which I would not only talk the talk about mutualization, but would walk the walk.15 Even before the 1973-74 bear market began, the investment returns of the Wellington funds had begun to deteriorate (both on an absolute and on a relative basis) and the large cash inflows they had enjoyed had turned to huge cash outflows. Assets of our flagship, the conservative Wellington Fund, had tumbled from $2 billion in 1965 to less than $1 billion, on the way to a low of $480 million. Wellington Management Company’s earnings plummeted, and its stock price followed suit. This concatenation of dire events was enough to destroy the happy partnership formed by an unfortunate merger I implemented in 1966, and I got the axe as Wellington Management Company’s CEO on January 23, 1974. But—here’s the catch—I remained as chairman of the mutual funds, with their largely separate (and largely independent) board of directors. Shortly before the firing, seeing the handwriting on the wall, I submitted a proposal to the mutual fund board of directors under which the Wellington Group of mutual funds would acquire Wellington Management Company and its business assets. The company would become a wholly-owned subsidiary of the funds and serve as investment adviser and distributor on an ‘at-cost’ basis.

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. The Board of Directors recently increased Wesco’s regular dividend from 381 ⁄2 cents per share to 391 ⁄2 cents per share, payable March 5, 2009, to shareholders of record as of the close of business on February 5, 2009. This annual report contains Form 10-K, a report filed with the Securities and Exchange Commission, and includes detailed information about Wesco and its subsidiaries as well as audited financial 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 filings, and the websites of Wesco’s subsidiaries and parent, Berkshire Hathaway, from Wesco’s website: www.wescofinancial.com. Charles T. Munger Chairman of the Board and President February 25, 2009

I openly acknowledged that my mutualization proposal was “unprecedented in the mutual fund industry.” The cautious fund board nonetheless asked me to expand the scope of my proposal and undertake “a comprehensive review of the best means by which the funds could obtain advisory, management and administrative services at the lowest reasonable costs to the fund shareholders.” My first report, completed on March 11, 1974, was entitled “The Future Structure of the Wellington Group of Investment Companies.” It spelled out the ultimate objective for the fund shareholders: Independence. The goal was “to give the funds an appropriate amount of corporate, business, and economic independence,” under a mutual structure that was clearly contemplated by the Investment Company Act of 1940. But, I added, such independence had proved to be an illusion in the industry, with “funds being little more than corporate shells . . . with no ability to conduct their own 15 Time does not permit me to present the compelling economics of my proposal for fund shareholders, or the story of the tortuous path of the negotiations, under which funds would acquire Wellington’s mutual fund business. (Its counseling business would have been returned to the pre-merger partners.) An expanded version of the transaction can be found in my speech “The Mutual Fund Industry, From Alpha to Omega,” at Boston College Law School on February 20, 2003, available at www.johncbogle.com.

affairs . . . This structure has been the accepted norm for the mutual fund industry for more than fifty years.” On June 11, 1974, perhaps unsurprisingly, the board rejected my proposal to have the funds acquire the manager, and chose a different option, the least disruptive of the seven options that I had offered. We established the funds’ own administrative staff under the direction of its operating officers, with my continuing as their chairman and president. We would also be responsible, as the board’s counsel, former SEC Commissioner Richard B. Smith wrote, “for monitoring and evaluating the external (investment advisory and distribution) services provided” by Wellington Management. The decision, the counselor added, “was not envisaged as a ‘first step’ to internalize additional functions, but as a structure that . . . can be expected to be continued into the future.” Since the Board agreed that Wellington Management Company would retain its name (and Wellington Fund would also retain its name), a new name would have to be found for the administrative company. I proposed to name the new company “Vanguard” and the Board approved, albeit somewhat reluctantly. The Vanguard Group, Inc. was incorporated on September 24, 1974. Without apparent difficulty, the SEC soon cleared the funds’ proxy statements proposing the change, which the fund shareholders promptly approved. Vanguard began operations on May 1, 1975.

No sooner than the ink was dry on the various agreements, the situation began to change. The creation of Vanguard, as I’ve written, “ . . . was a victory of sorts, but, I feared, a Pyrrhic victory . . . and the narrow mandate that precluded our engaging in portfolio management and distribution services would give Vanguard insufficient power to control its destiny. Why? Because success in the fund field was not then, and is not now, driven by how well the funds are administered. Though their affairs must be supervised and controlled with dedication, skill, and precision, success (will be) determined by what kinds of funds are created, by how they are managed, by whether superior investment returns are attained, and by how—and how effectively—the funds are marketed and distributed.” We first determined to start a new fund that we would manage internally. Paradoxically (if not disingenuously), it would be a fund that arguably didn’t conflict with our limited mandate, for, technically speaking, it wasn’t managed. It was the world’s first index mutual fund, modeled on the Standard & Poor’s 500 Stock Index. Incorporated late in 1975, its initial public offering was completed in August 1976. While the offering raised a puny $11 million, despite that unhappy start, Vanguard 500 Index Fund is now among the largest mutual funds in the world.

Decision — Introduced BYD to Munger; Berkshire bought ~10% (~$230M). Context: 225M H-shares at ~HK$8; “Munger deserves 100 percent of the credit.” Outcome (known): Multi-bagger anchor position; BYD held “about 22 years” per the 2024 interview.

Our control over fund marketing came only shortly thereafter. On February 9, 1977, after yet another contentious debate, the fund board accepted my recommendation that the funds terminate their distribution agreements with Wellington Management, eliminate all sales charges, and abandon the broker-dealer network that had distributed Wellington shares since its inception in 1929. (I argued that we weren’t violating the memorandum of understanding by internalizing distribution. Rather we were eliminating distribution.) While the board approval was by the narrowest of margins, Vanguard moved, literally overnight, from a seller-driven, load-fund channel we had relied upon for almost a half-century to the buyer-driven, no-load channel we maintain to this day. Only 21 months after Vanguard began operations, the fledgling organization had become a fully-functioning fund complex. What we called “the Vanguard Experiment” in fund governance was about to begin in earnest. Let’s See How it All Worked Out It will soon be 34 years since Vanguard began operating under its unique mutual structure, and almost exactly fifty years since that ghastly Ninth Circuit decision opened the door of public ownership to fund managers and led to the age of conglomeration that has now overwhelmed the industry. Surely it must occur to you that the philosophies underlying these two events are diametrically opposite.

Outside ownership, in effect, demands that investment funds be viewed as products of their management companies, manufactured (in the current grotesque parlance) and distributed to earn a profit for the company. Mutual ownership, on the other hand views mutual funds, yes, mutual funds, as trust accounts, managed under the direction of prudent fiduciaries.16 It’s high time to look at the record, and compare the results achieved by the firms following these opposing philosophies. As I’m fond of saying, over our three-plus decades of our existence, Vanguard has proven to be both a commercial success and an artistic success. A commercial success, because our structure has been proven to be a superb business model. The assets we manage for investors have grown from $1.4 billion at our 1974 founding to some $1.2 trillion today. At this moment, in fact, we may well be the largest firm in our industry. (In fairness, Vanguard, American Funds, and Fidelity have gone back and forth in the lead position for several years now. Each of these giants manages about three times the fund assets of the next largest firms, Franklin Templeton and Barclays Global.) 16 I intensely dislike the use of the word “product” to describe an investment company, and, early in Vanguard’s history, banned its use at the firm.

Of course, the stock market boomed during that period (at least through early 2000), and the fund industry could hardly help but flourish. Nonetheless, Vanguard’s market share of industry assets has soared from a mere 1.8 percent in 1980 to 10.6 percent currently, without a single year of decline. Let me illustrate the impact of that rise in share: if it had remained at 1.8 percent, assets of the Vanguard funds today would be $220 billion. Thus, fully $1 trillion of our growth—80 percent of it—has come from our increased market share; that is, out of the pockets of our competitors. (Not bad, dare I say, for a firm in which I consistently drummed home this philosophy: “market share is a measure, not an objective; market share must be earned, not bought.”) How did we earn that commercial success? By our artistic success, which I define as providing superior investment returns to our shareholders. The data indicate that the performance of the Vanguard funds was indeed superior. To the contrary, the financial conglomerates that now dominate this industry generally produced performance returns that were distinctly inferior. There are, of course, lots of ways to measure fund performance. I’ll use one of the more sensible methodologies, relying largely on the Morningstar system, in which the risk-adjusted returns of each fund are compared with the risk-adjusted returns of its peers over a full decade (albeit with a heavier weighting on the recent years of the decade).

For example, a given manager’s large-cap growth fund is compared with other large-cap growth funds; its investment-grade intermediate-term corporate bond fund with other peers, and so on. Under this system, 10 percent of funds receive five stars (the top rating) and 10 percent one star (the bottom rating); 22 ½ percent receive four stars and 22 ½ percent receive two stars; the middle 35 percent receive the average grade of three stars.17 My deceptively simple methodology is to calculate, for each fund complex, the percentage of its funds in the four- and five-star categories, and subtract from that total the percentage of funds in the one- and two-star categories. The result: the balance between funds that provided distinctly superior returns and those that provided distinctly inferior returns. While I’ve never seen this done before (although there’s lots of promotional bluster for funds that get four- or five-stars), my own view is that staying out of the one-and two-star categories is at least an equally important benefit for shareholders. 17 By weighting the analysis by number of funds rather than by assets, this procedure has one strength not in evidence in other methodologies, which almost invariably ignore the impact of sales loads. My methodology captures the returns of “B” and “C” shares, usually smaller in assets but which have sales loads built into their expense ratios.

We measured the returns achieved by the 50 largest fund complexes, defined as the firms managing at least 40 individual funds, excluding money market funds. (The complex with the largest number of funds, Fidelity, includes 471 long-term funds.) Only one of these firms managed less than about $25 billion. This remarkably representative list includes more than 8,800 funds with some $7 trillion in fund assets, 80 percent of the industry’s long-term asset base. The full study is clearly too extensive to inflict on this audience, but I’ve presented it in Appendix I as an attachment to the published version of this lecture. What I’ll now present to you (Chart 1) is a summary showing the scores of six of the top firms, the bottom six firms, and six fairly well-known firms that achieved roughly average performance records for their funds. The top-ranking fund complex, in terms of providing superior returns to its investors, was Vanguard. With 59 percent of our funds in the top group and less than 5 percent in the bottom group, the firm’s performance rating is +54.18 Joining Vanguard among the top three are DFA and TIAA-CREF, both at +50. (More than coincidentally, all three firms are focused largely on index-like strategies). At number four is T. Rowe Price (+44), followed by Janus (+38) and American Funds (+26).

Honestly, I think most objective observers would agree that over the past decade, at least five of these six firms have been conspicuous in delivering superior risk-adjusted returns, a judgment that confirms the methodology. Again more than coincidently, this six-firm list is dominated by four management companies that are not publicly- owned—Vanguard, DFA, TIAA-CREF, and American—and none are controlled by conglomerates. On the other hand, each of the bottom six firms are units of giant brokerage firms or financial conglomerates. Their ratings range from -40 for Goldman Sachs to an astonishing -58 for Putnam, with only 4 percent of its funds in the top category and 62 percent rank in the bottom category. Strikingly, every one of the 17 lowest-ranking firms on the 50-firm list is conglomerate-held, while only one of the firms among the top ten can be similarly characterized.19 In the middle group—all producing more or less average scores (mostly less) for their funds— include one publicly-held firm (Franklin, +9), one owned by a giant investment banker (Morgan Stanley, 18 Full disclosure: two much smaller firms have higher ratings; Dodge & Cox, with 4 funds, at +100; Royce and Associates, with 31 funds, has a score of +65. 19 The success of Neuberger Berman, ranking #8 with a score of +19, was largely achieved before its 2003 sale to Lehman Brothers.

Chart 1. Major Mutual Fund Managers: Fund Performance * *Morningstar ratings as of 12/2007. (Long-term funds only) Returns Highest Returns Average Returns Lowest American Funds 6 Janus 5 T Rowe Price 4 TIAA-CREF 3 DFA 2 Vanguard 1 Columbia Funds 12 AIM Inv. 11 Barclays Global 10 Fidelity 9 Morgan Stanley 8 Franklin Temp. 7 Putnam 18 ING Investments 17 John Hancock 16 MainStay Funds 15 Dreyfus 14 Goldman Sachs 13 Manager 59% 4 or 5 Stars Highest 5% 1 or 2 Stars Lowest % of Funds Ranked Major Mutual Fund Managers: Fund Performance* 54% -14 -14 -4 -3 -58 -55 -43 -40 -40 -40 Highest minus Lowest

+2), one privately-held (Fidelity -3), and three owned by conglomerates (all below par, at -4, -14, and - 14). Putting the three groups—high-performing, average-performing, and low-performing—together, it seems patently obvious that the truly mutual structure (which has only a single entrant) and the other three privately-held structures that dominate the top group have provided consistently superior returns for their shareholders, with an average score of plus 48—54 percent in the top group and only 6 percent at the bottom. This positive score stands in sharp contrast with the inferior scores that characterize the financial conglomerates at the bottom, with an average score of minus 46—13 percent in the top group and 59 percent in the one- and two-star categories. Performance Evaluations from a Higher Authority While the performance methodology I have chosen is inevitably imperfect, I believe that it is not only entirely reasonable, but a significant enhancement over most other methodologies. But, let’s not rely only on the statistics to evaluate fund performance. Let’s find out how the fund shareholders themselves regard the funds they actually own. Happily, thanks to a survey done in 2007 by Cogent Research LLC, we have measures of how fund shareholders feel about the mutual fund firms that manage their money. (The study focused on shareholders who have mutual fund investments of at least $100,000.)

The Cogent study, reported by The Wall Street Journal,20 measured client loyalty, presenting investors with a scale representing the extent of their trust in their managers—10 the highest rating (“definitely recommend” to other investors), 1 the lowest (“definitely not recommended”). Each firm was scored by subtracting the percentage of shareholders who rated the firms at five or below (“detractors”) from the percentage who rated the firms at nine or ten (“supporters”). Only 11 of the 38 firms evaluated had positive loyalty scores. The average score was -12, a message about investor confidence in the fund industry that would not seem to be much of a tribute. Simply put, fund shareholders seem to “get it.” When we juxtapose these loyalty scores for each firm with its performance scores, we see a remarkable, if by no means exact, correlation. (Chart 2) In fact, Vanguard’s performance score (+54) and its loyalty score (+44), both the highest in the field, were quite similar. Putnam’s scores, also similar (-58 and -54, respectively), were the lowest in the field. Of course there is a relationship between how well one has served investors and how loyal they are! 20 The Journal published the ratings for only eight of the firms in the survey. The other ratings were made available for this paper. Many of the firms in the performance survey were not included in the loyalty survey.

Chart 2. Major Mutual Fund Managers: Fund Performance and Shareholder Loyalty 54% -14 -14 -4 -3 -58 -55 -43 -40 -40 -40 Highest minus Lowest 54% -14 -14 -4 -3 -58 -55 -43 -40 -40 -40 Highest minus Lowest Returns Highest Returns Average Returns Lowest American Funds 6 Janus 5 T Rowe Price 4 TIAA-CREF 3 DFA 2 Vanguard 1 Columbia Funds 12 AIM Inv. 11 Barclays Global 10 Fidelity 9 Morgan Stanley 8 Franklin Temp. 7 Putnam 18 ING Investments 17 John Hancock 16 MainStay Funds 15 Dreyfus 14 Goldman Sachs 13 Manager American Funds 6 Janus 5 T Rowe Price 4 TIAA-CREF 3 DFA 2 Vanguard 1 Columbia Funds 12 AIM Inv. 11 Barclays Global 10 Fidelity 9 Morgan Stanley 8 Franklin Temp. 7 Putnam 18 ING Investments 17 John Hancock 16 MainStay Funds 15 Dreyfus 14 Goldman Sachs 13 Manager -30 n/a n/a 44% -47 -48 n/a -18 -54 -11 -10 n/a -45 -32 Client Loyalty Score % of Funds Ranked

There were also numerous significant disparities between the two scores. Most of them were explained, I think, because the performance ratings that I presented reflect the returns reported by mutual funds. But such reporting has a major failing. To be blunt about it, fund investors could hardly care less about reported returns when they vastly overstate the returns that they’ve actually earned. That’s often the case in this business, for fund marketers have a seemingly irresistible impulse to promote shares of a fund only after the fund has achieved sterling performance, an impulse, alas, that also seems irresistible to fund investors. Following such superior performance, however, such funds seem to have an almost equally irresistible impulse to revert not only to the market mean, but even below it. What goes up, it seems, must go down. The most glaring gap between performance rating (+38) and loyalty rating (-30) appears for the Janus funds. Let’s examine their records. During the ten years ended December 31, 2007, the five largest Janus funds turned in an average annual return of 9.3 percent, a solid margin over the annual return of 5.9 percent for the S&P 500 index. During the first three years of that period, however, the Janus returns soared far above the Index return, and as the market soared to new heights some $50 billion of investor capital flowed into the funds. In the bear market that followed, the funds collapsed.

Result: most Janus investors actually experienced dismal returns. To summarize the math: for the decade, these Janus funds reported time-weighted returns averaging 9.3 percent per year, a compound ten-year return of +157 percent. The Janus fund investors, on the other hand, earned dollar-weighted returns averaging but 2.7 percent per year on the money they actually invested, a compound return of only 38 percent. That is, the returns actually earned by Janus shareholders for the decade fell fully 119 percentage points behind the returns that the Janus funds reported. That truly remarkable lag doubtless accounts for the gross disparity between the funds’ high scores in reported performance and their low loyalty scores based on what Janus shareholders actually experienced. Such experience also likely characterizes the lack of shareholder loyalty at Morgan Stanley, AIM, and Columbia (Bank of America). Costs Rear Their (Ugly) Head The data are clear, then, that truly mutual investing has not only reaped rewards for its clients but has also earned their loyalty. Equally clearly, the financial conglomerates have not only failed their investors, but have earned (if that’s the right word) their opprobrium. How do we account for these differences in return?performance

ratings, even though much of the impact of those variations evens out over a period as long as a decade, and even more of the disparity is mitigated when the management firms run a hundred funds or more. It turns out, however, that there is one factor that plays a major role in the relative returns of peer funds. Happily, it is a factor that persists over time: the costs that funds incurred in delivering their returns to investors. It must be obvious that funds with similar objectives, managed by competent and experienced professionals, and compared over an extended period of time are more likely to achieve similar (and inevitably market-like) returns. But only before the costs of investing come into play. Fund costs come in many guises. The major costs are: (1) the expense ratio (annual percentage of asset value consumed by management fees and operating expenses). (2) Sales loads, representing the cost to acquire fund shares. (3) Transaction costs, the real—but hidden—expenses incurred in the execution of the investment decisions made by the fund’s portfolio managers. Since transaction costs are not publicly available, the “all-in” expense ratios I’m using—including sales loads built into the B and C share classes—are the most satisfactory measure of fund costs. Now let’s add to our previous chart a column showing the expense ratios for the equity funds in each group.21 Chart 3.

The three firms with the highest performance ratings are the very same firms—in the very same order—that have the lowest annual expense ratios, averaging 0.30 percent. For the top- performing group in total, the average ratio is 0.69 percent. Expense ratios for the middle group average 1.24 percent, fully 80 percent higher.22 The bottom group of performers, on the other hand, have the highest expense ratios, averaging 1.57 percent per year, 110 percent above the top-performing group. Together, these data tell us that, when looking to the sources of mutual fund returns, yes, costs matter. But please don’t take my word for it. In fact, these data merely confirm what industry experts and academics have been saying for decades. Morningstar puts in unequivocally: “expense ratios are the fund world’s best predictor” of performance, adding that, “all studies show that expenses are the most powerful indicator of a fund’s performance.” (Italics added.) Nobel laureate (in Economics) William F. 21 Since the largest variations in fund expense ratios come in equity funds, I have excluded bond fund expense ratios—which are generally lower—from this comparison. This practice also eliminates the distortion that would be created when firms manage different proportions of bond funds to stock funds. 22 The funds managed by Barclays, with a ratio of 0.41 percent, largely follow lower-cost index or index-like strategies.

Sharpe is equally unequivocal “The smaller a fund’s expense ratio, the better the results obtained by its shareholders.”23 He wrote those words in 1966(!), and confirmed them in 1996. “If you had to look at one thing only (in selecting a fund), I’d pick expense ratio.” 24 Sharpe’s observations have met the test of time, nicely confirmed by the data that I have just presented. Crude data showing the relationship between expense ratios and Morningstar ratings suggests that an extra percentage point of cost means one less star in ratings; a percentage point reduction in cost means one more star. That is, if a three-star fund had an expense ratio one percentage point lower, it would be transformed into a four-star fund; if the same fund had a ratio one percent higher, it would become a two-star fund. Despite this powerful data, however, despite the opinion of experts, and despite the common sense that tells us that investment costs are the central element in determining the relative returns of mutual funds within their peer groups, price competition remains conspicuous by its absence from the mutual fund industry. Price Competition? Investors seem to be largely unaware of the direct and causal relationship between fund costs and fund returns. The industry’s only three very low cost firms dominate the performance statistics, yet together they constitute a mere 14 percent of industry assets. How can the industry continue to maintain expense ratios that average 1.

5 percent per year, five times as high? (Yes, along with Vanguard, T. Rowe Price, American Funds, and Fidelity—with costs that average 1.1 percent, somewhat below industry norms, but many times Vanguard’s costs—accounted for about one-third of all industry cash flow last year. But that still leaves two-thirds of the cash flowing largely into high-cost funds.) The fact is that there are many “signs the mutual fund marketplace may not be performing in a way one would expect in a satisfactorily functioning competitive market.” That is the opinion of the general counsel of the U.S. Securities and Exchange Commission.25 One sign, he adds, is “the law of one price,” the principle that, in an efficient, competitive market, nearly identical goods will sell at nearly identical prices. That’s obviously because with full information . . . “no rational buyer would pay more.” Yet without such price convergence in the fund field, “American investors may be being deprived of the long-term returns they deserve.” 23 “Mutual Fund Performance,” Journal of Business, January 1966, page 119. 24 “In the Vanguard,” Summer 1996. 25 Speech by Brian G. Cartwright, before the 2006 Securities Development Conference, December 4, 2006.

Put another way, as a University of Washington professor26 wrote, “as the information about a commodity improves, its price variability will decline.” He quotes the great English economist Alfred Marshall, “the more nearly perfect a market is, the stronger the tendency for the same price to be paid for the same thing at the same time in the market. Price variability, then, is a measure of our ignorance about what the make-up of a commodity is, dividing goods into what the author calls “brand-name commodities” and “caveat emptor commodities.” The fact is that some kinds of funds—money market funds, for example—are clearly commodities. So are index funds. Investment-grade bond funds and U.S. Treasury bond funds (with comparable maturities) are at least commodity-like. What about managed equity funds? When sorted by objectives (i.e., compared to their peers, as in, for example, large-cap value funds), they are also commodity-like in the short run, even more so in the long run. (And since the various equity investment styles tend to revert to the mean over time, all—or nearly all—equity funds tend to be commodity-like in nature in the very long-term.) When brand-name commodities have different prices, then, they quickly become caveat emptor commodities, a lesson fund investors have yet to learn. Clearly, price ought to be the talisman that drives investor choice, forcing fund managers to reduce costs. But that is simply not happening.

Yes, money flows (as I have noted) are increasingly directed toward the lower-cost funds, and Vanguard has been a beneficiary of, indeed a creator of, that structure. But other fund complexes are not following the lead.27 In short, if price competition is defined, not by the action of consumers, but by the actions of producers, then price competition is conspicuous by its absence in the mutual fund industry. Why don’t fund managers compete on costs? Because to do so would be antithetical to their vested financial interests. The fund industry, of course, argues that it is characterized by vigorous competition. To a point that is true: there is competition in the marketplace. Witness the incentives offered to brokers to sell shares and the hundreds of millions of spent each year on print and television advertising. There is performance competition. Witness the ongoing advertising of funds that have had superior past records, or are investing in hot market sectors. But there is little evidence to suggest that there is price competition. Dr. Yoran Barzel, “Replacing the Law of One Price with the Price Convergence Law,” March 28, 2005. 27 I’m often told that Vanguard’s demonstrably low costs—increasingly recognized in the marketplace—are responsible for setting an upper limit on prices among our competitors. But that level is still far too high for my taste.

While the most vigorous industry advocates find “evidence of price competition clear,”28 the data presented by these advocates show that while there were 1,240 fee decreases during 1998-2004, there were even more fee increases—1480 in all. Even these advocates do not dispute “the empirical fact that mutual fund boards of directors rarely ‘fire’ advisers and do not put advisory contracts up for bids among advisers.” Without such competition, mutual fund managers are hardly likely to reduce their fees, and hence their own profitability. Recap of the Issues Let me summarize here the arguments I’ve made so far: In its early years, the investment company industry had many characteristics that well-served fund investors. The focus was largely on private trusteeship; prudence and diversification were the watchwords of investment policy; fund trustees often were a step removed from fund distribution; expense ratios were moderate, and far below today’s levels. Today public ownership—largely by giant conglomerates—overwhelmingly dominates the fund industry, and it has ill-served fund investors. By way of contrast, the results of that “Vanguard Experiment” in mutual fund governance are now clear. It has been both a remarkable commercial success for the firm itself, and an artistic success for its shareholder/owners. Our central idea was to create a firm honoring the industry’s original values.

I expected that becoming the low-cost provider in any industry where low cost (by definition) is the key to superior returns, would force our competitors to emulate our structure. Indeed, I chose the name “vanguard” in part because of its meaning: “leadership in a new trend.” But I was wrong. After more than three decades—during which at least one of our industry peers has described us as “the organization against which others must measure themselves”—we have yet to find our first follower.29 We remain unique. Of course, not everyone shares my view of the positive power of the mutual structure. Hear the American Enterprise Institute (AEI), in a recent book entitled Competitive Equity–A Better Way to 28 “Competition in the Mutual Fund Industry,” by John C. Coates IV and R. Glenn Hubbard, The Journal of Corporation Law, University of Iowa, Volume 33, Number 1, Autumn 2007, page 173-4. 29 I had hoped that when Marsh & McClennan decided to sell its Putnam Management Company subsidiary— obviously a deeply troubled firm whose previous management ill-served its investors in so many ways—it would mutualize and internalize its organization. However, my attempts to persuade three directors of the funds (including its then independent chairman) fell on deaf ears. The fund board approved the sale of the management to a Canadian conglomerate for $4.9 billion.

Organize Mutual Funds30 (Hint: it doesn’t consider the Vanguard way “a better way.”) The authors are skeptical of our claim that we operate on an “at cost basis,” albeit without identifying the basis of that skepticism. They allege that our managers do not accept compensation substantially lower than that paid to other fund advisers, apparently unaware that we fully disclose the rates and fees we pay to the unaffiliated external advisers that manage many of our actively-managed funds. For the record, the average fee paid to the advisers to Windsor Fund is 0.12 percent of fund assets; the fee paid to the adviser to our GNMA Fund is 0.01 percent. (Yes, that’s one basis point.) Despite these shortcomings in their argument, their conclusion is unequivocal: “the idea that the mutual form of organization is inherently superior to the external form . . . is something of an overstatement.” They also allege that conversion to a mutual form would require buying out the existing shareholders (of the management company), ignoring the fact that Vanguard, as noted earlier, did no such thing. In fact the fund directors have the awesome power to simply terminate the manager’s contract and either manage the funds internally or hire new external advisers. (I note that while this never happens in the fund field, it happens with considerable frequency among corporate pension funds.)

The Triumph of Conglomeration In any event, the mutual model remains stuck, still used by only a single firm, and the conglomerate model has triumphed. Early on, and presciently, Chairman Cohen recognized the serious problems that would be created by this conglomeration. In a 1966 speech, he spoke of the “new and more complex relationships . . . (between) institutional managers and their beneficiaries,” and sought “a more adequate scheme of regulation that ultimately will protect beneficiaries from unwarranted action by their managers, and will realize the fullest benefits of their participation” in their funds. He then noted, prophetically, his concern about “public ownership of investment advisers . . . and the beginning of a trend toward (their) acquisition by industrial companies,” which makes it, “increasingly difficult to define the responsibilities of institutional managers,” who may “be obligated to serve the business interests of the very companies in which they invest.” The snowball that began to roll with the onset of public ownership of management companies in 1958 took a while to gather speed. But during the 1980s and 1990s it came into full flower and, as noted earlier, among the 50 largest firms in the industry only nine remain privately-held. This massive wave of 30 By Peter J. Wallison and Robert E. Litan, 2007.

conglomeration by what are essentially giant marketing firms led to a wave of, yes, “product proliferation” that carried the number of mutual funds from 560 in 1980 to 12,039 today. It’s Time for a Change Only two weeks after that 1966 speech by Chairman Cohen, the Commission sent to Congress a massive report by its staff entitled Public Policy Implications of Investment Company Growth (PPI). 31 In that report, the SEC noted the burgeoning level of fund fees (then at an annual level of a mere $134 million, vs. more than $100 billion today). The Commission also called attention to the effective control advisers held over their funds, and “the absence of competitive pressures, the limitations of disclosure, the ineffectiveness of shareholder voting rights, and the obstacles to more effective action by the independent directors.” The Commission also noted “the adviser-underwriter permeation of investment company activities to an extent that makes rupture of existing relationships a difficult and complex step . . . (rendering) arm’s length bargaining between the fund’s board and the managers . . . a wholly unrealistic alternative.” Yet the Commission was “not prepared to recommend at this time the more drastic statutory requirement of compulsory internalization of management (i.e., mutualization).” Rather, the SEC recommended the adoption of a “statutory standard of reasonableness . . .

a basic standard that would make clear that those who derive benefits from their fiduciary relationships with investment companies cannot charge more for services than if they were dealing with them at arm’s length.” The SEC described reasonableness as a “clearly expressed and readily enforceable standard [that] would not be measured merely by the cost of comparable services to individual investors or by the fees charged by other externally managed investment companies . . . [but by] the costs of management services to internally-managed funds and to pension funds and other non-fund clients.” If the standard of reasonableness does not “resolve the problems in management compensation that exist . . . then more sweeping steps might deserve to be considered.” With vigorous lobbying by the Investment Company Institute, the self-anointed representative of fund shareholders but in fact the powerful voice of fund managers, that reasonableness standard was never adopted. Yet, even as fund fees soared and conglomeration gradually took over, transaction after transaction, unchallenged (and, arguably, unchallengeable) after that ghastly 1958 decision by the Ninth 31 U. S.1966

Decision — $650,100 Buffett charity lunch (with Mohnish Pabrai). Context: Auction won June 2007; Spier credits it with redirecting his life. Outcome (known): Documented in his own essay, TIME, and CNBC.

Circuit, even as Chairman Cohen’s worst fears were being realized, even after PPI’s warning 42 long years ago, more sweeping steps have yet to be considered by the SEC. But some baby steps have been considered. In 2004, the Commission recommended a significant strengthening of fund boards, only to be reconsidered and likely watered down by a differently-led Commission in 2008. Of course I’d prefer more sweeping steps. Indeed as I wrote in my book Common Sense 32 nearly a decade ago, “the industry’s further evolution must take one of two critical turns: either a radical restructuring, a change in the status quo, a change that places more power in the hands of shareholders. The radical restructuring would be the mutualization of at least part of the American mutual fund industry. Rather than contracting with external management companies to operate and manage the portfolios, funds—or at least large fund families—would run themselves. Mutual fund shareholders would, in effect, own the management companies that oversee the fund. “They would have their own officers and staff, and the huge profits now earned by external managers would be diverted to the shareholders. Under such a structure, the character of the industry would return to its traditional roots. Funds wouldn’t waste their shareholders’ money on costly marketing campaigns designed to bring in new investors at the expense of existing investors.

With markedly lower costs, they would produce markedly higher returns and/or assume commensurately lower risks. They would provide full and candid disclosure to their shareholder-owners. They’d have no need to organize and market “fund-of-the-moment” funds, and they might even see the merit of market index funds. “The other choice would be the rise of more activist independent mutual fund directors. Independent board members would become ferocious advocates for the rights and interests of the mutual fund shareholders they represent. They would negotiate aggressively with the mutual fund adviser, allowing the management company to earn a fair profit, but recognize that the interests of the mutual fund shareholders must always come first. Independent directors would approve only portfolios that are based on sound investment principles and meet a reasonable investment need. The independent directors would at last become the fiduciaries they are supposed to be under the law. And if the creation and encouragement of activist independent directors is a more practicable solution than the wholesale mutualization of the American mutual fund industry, then perhaps it is an objective deserving of our energies and effort. And who knows? As the values of such a refocused organization move toward the values of the mutual organization, full mutualization for some firms may be only a step further away.

“Regardless of the exact structure, mutual or conventional, an arrangement in which fund shareholders and their directors are in working control of a fund—as distinct from one in which fund managers are in control—will lead to funds that truly serve the needs of their shareholders, meeting the crying need to return this industry to the traditional role of trusteeship that largely characterized its modus operandi through its first three decades. Under either structure, the industry will enhance economic value for fund shareholders.” What’s to be Done? Given the industry’s growth; its sharp turn from stewardship to salesmanship; the army of conglomerates that has swept across it, leaving only a handful of survivors; its failure to produce anything like satisfactory returns to the investors who have entrusted funds with their hard-earned dollars; and, dare I say, the success of the singular, still unique, firm that has, for nearly 34 years now, almost unequivocally demonstrated the value of that internalization that the SEC was unprepared to mandate all those years ago, not a single additional moment should elapse before those long-justified, long awaited “more sweeping steps” are not only considered, but enacted into the law. My idealism tells me to fight for compulsory internalization,33 at long last making it possible to delete those quotation marks around “mutual” fund that reflected the prescient concerns expressed by Chairman Cohen in the speech he delivered in 1966.

But my pragmatism disagrees. Powerful and well- financed lobbyists—led by the Investment Company Institute, the fabulously profitable management companies and their conglomerate owners, and the U.S. Chamber of Commerce (of course!)—would take up arms against such a seemingly radical proposal. The campaign would come with unbridled enthusiasm and virtually unlimited financial firepower, K Street’s dreams come true. Given the state of our nation’s governance, such opposition, self-interested as it obviously is, would defeat “the national public interest and the interest of investors,” the very interests that the 1940 Act was designed to protect. But hope is not lost. There is a way—not, of course, an easy way—to honor the spirit and letter of the Act so that investment companies are organized, operated, and managed in the interests of their shareholders rather than their managers and distributors. It would take a series of logical steps to achieve this goal, some already in the works; some proposed by an earlier Commission and now seemingly 33 But not for all fund complexes, only for complexes that exceed certain thresholds; for example, fund complexes that manage over $25 billion in assets and more than 30 mutual funds.

abandoned; new steps that take us even further toward that goal; one simple—if dramatic—organizational change that would create enormous momentum toward fund operational independence from their advisers; and a change in federal law. Here’s the plan I propose: 1) Require that 100 percent of fund directors be unaffiliated with the management company. There is simply no point in any longer subjecting management company officers to the profound conflicts of interest that they face when they also serve as fund directors. It’s time to honor the principle that “no man can serve two masters.” (As noted earlier, since the firm’s inception the Vanguard funds have prohibited representatives of any external adviser from serving on their boards. It hasn’t seemed to impair the returns we earn for investors.) 2) Require that the chairman of the fund board be independent of the management company, even if, as under the Commission’s 2004 proposal, only 75 percent of the board is required to be independent. Such a separation of powers, ordained for our federal government in the Constitution, is not only a fundamental principle of governance, but simple common sense. 3) Require the retention by the funds of legal counsel independent of the adviser and a chief compliance officer. Both are already mandated by the Commission, but we must require them to be responsible to the fund board, reporting to the independent fund chairman.

4) Importantly, require that the fund boards retain advisers and experts necessary to carry out their duties, in order to provide truly objective and independent information to the board. (I’m guessing that few fund boards have seen the kind of comparative performance, loyalty, and cost data that I’ve presented in these remarks.) The SEC recommended language “authorizing” such a staff (or consultants) in its 2004 recommendations, which now seem to have gone aborning. As I see it, this requirement would apply only to fund complexes of a certain (large) size and scope.34 It’s time to face up to the fact that directors who are overseeing 100 funds or more can’t do so without staff support. 34 For example, complexes meeting the standards outlined in note 33. But in my darker moments, I’d consider applying this requirement only to fund complexes in which a majority of the directors are unable to actually name all of the funds on whose boards they serve. If that requirement is too demanding, then only when directors are unable to specify the exact number of funds on whose boards they serve.

5) A specific regulatory authorization that enables funds to assume responsibility for their own operations, including administration, accounting, compliance, shareholder record-keeping, etc. Such a structure would cut the Gordian knot that gives fund managers de facto control over the funds they manage. 35 It is this very step that was central to the creation of Vanguard, which (as noted earlier) soon enabled the fledgling firm to extend its reach to investment management and then to distribution. 6) Enact a federal standard of fiduciary duty for fund directors. The fact is that mutual fund managers, indeed pension fund managers, public and private alike, face serious conflicts of interest in carrying out their duties. In today’s relatively new agency society, in which financial institutions control more than 70 percent of stock ownership, there has been a serious failure to serve their principals—largely fund shareholders and pension beneficiaries. As the Honorable Leo E. Strine, Jr., Vice Chancellor of the Delaware Court of Chancery, has noted, it would be “passing strange if professional money managers would, as a class, be less likely to exploit their agency than the managers of corporations that make products and deliver services.”36 Yes, the world has changed, and we need to redress that imbalance in favor of the principals. Two Powerful Endorsements Once again, this critical analysis of the mutual fund industry is not mine alone. Listen to Warren Buffett.

“Fund independent directors . . . have been absolutely pathetic. They follow a zombie-like process that makes a mockery of stewardship. ‘Independent’ directors, over more than six decades, have failed miserably.” Then, hear this from another investor, one who has not only produced one of the most impressive investment records of the modern era but who has an impeccable reputation for his character and intellectual integrity, David F. Swensen, Chief Investment Officer of Yale University: “The fundamental market failure in the mutual-fund industry involves the interaction between sophisticated, profit-seeking providers of financial services and naïve, return-seeking consumers of investment products. The drive for profits by Wall Street and the mutual-fund 35 It is a curious fact that the operational function was ignored in the 1940 Act. It refers solely to the other two functions of fund management, investment advice and share distribution (underwriting). 36 Toward Common Sense and Common Ground, Journal of Corporation Law (Iowa), Volume 33, Number 1, Fall 2007, Page 1.

industry overwhelms the concept of fiduciary responsibility, leading to an all too predictable outcome . . . the powerful financial services industry exploits vulnerable individual investors . . . “The ownership structure of a fund management company plays a role in determining the likelihood of investor success. Mutual-fund investors face the greatest challenge with investment management companies that provide returns to public shareholders or that funnel profits to a corporate parent—situations that place the conflict between profit generation and fiduciary responsibility in high relief. When a fund’s management subsidiary reports to a multi-line financial services company, the scope for abuse of investor capital broadens dramatically . . . “Investors fare best with funds managed by not-for-profit organizations, because the management firm focuses exclusively on serving investor interests. No profit motive conflicts with the manager’s fiduciary responsibility. No profit margin interferes with investor returns. No outside corporate interest clashes with portfolio management choices. Not-for-profit firms place investor interest front and center. Ultimately, a passive index fund managed by a not-for-profit investment management organization represents the combination most likely to satisfy investor aspirations.” I regard these two powerful endorsements of the positions that I hold as a clarion call for action.

Yes, it’s time to make fund directors aware of their duty to serve the fund shareowners rather than the entrenched fund managers, and to bring independent leadership—real leadership—to fund boards. That is the purpose of the six changes I’ve delineated. And yes, I’m well aware that, for some firms, these changes may lead to the full mutualization that, in the only case study that exists, has served shareholders so well. Yes, it’s also time to overturn the ghastly legacy of the Ninth Circuit’s erroneous decision in 1958 that opened the floodgates first to public ownership and then to conglomerate ownership.37 It’s also high time for firms that now place asset gathering at the heart of their mission to return to the industry’s professional roots and again act as true fiduciaries. So, yes, it’s time for a new order of things. It’s time to facilitate the development of mutualization in the mutual fund industry. It’s time to go back to the future and honor the vision of trusteeship held by Paul Cabot, and the vision of SEC Commissioner Healy to protect investors from the distorting impact of 37 Interestingly in light of my recommendations here, the note in the Harvard Law Review cited in note 13 concludes with this caveat. “However, the sellers might be allowed to sell control for any consideration if the fund had an independent board of directors . . . with control of the proxy machinery and the power to select another adviser.”

fund sales. And, especially on the occasion of this 27th annual Manuel F. Cohen Memorial Lecture, it’s time to honor Manny Cohen’s legacy, his implicit demand that we build an industry worthy of deleting those darned quotation marks that he placed around the word “mutual,” at last bringing mutuality back to the mutual fund industry. Only then will we honor the crystal clear spirit of the 1940 Act, and protect the national public interest and the interests of investors.