Last week, I went to a security analystsâ€™ luncheon featuring John Bogle, the retired founder of the mutual fund company Vanguard Group. Bogle didnâ€™t have nice things to say about his colleagues. He said that too many mutual fund companies charge high fees and manage funds for their own short-term benefit rather than what is best for investors over the long haul. In an efficient market, itâ€™s very difficult for a money manager to outperform the market indexes. Vanguard made its mark selling index mutual funds, which look like the market indexes. They perform no better and no worse than the stock market as a whole, and thatâ€™s okay.
The people in the audience were professional investors: analysts and portfolio managers for banks, insurance companies, mutual funds, and pension funds throughout Chicago. They came out in force for Bogle, even though they knew that he wasnâ€™t going to flatter them.
Bogle gave an overview of history which shows that this current market mess should not have been a surprise to anyone. He cites one major destabilizing trend: the movement away from individual stock ownership to institutional ownership. Most institutions have an individual as a beneficiary; they include pension funds, mutual fund companies, trust accounts, and charitable endowments. These funds view investments as tradeoffs between risk and return, nothing more. Bogle says that they changed the nature of the game, but the underlying rules were not adjusted.
Because most of us now have the risk of investing for our own retirements, usually through mutual funds, these rules matter.
One of the new features in the market, Bogle says, is the maximization of investment return. Now, that sounds like a good thing, doesnâ€™t it? But itâ€™s not, if it causes the money manager to take on too much risk, and the only way to beat the market is to take on extra risk. It also caused investment companies to seek out exotic investments in hopes that it would give them an edge, leaving us with such good ideas at the time as collateralized debt obligations and credit default swaps. Finally, it led company managers to concentrate on short-term stock price rather than the long-term value of the business. That led to games with accounting, risky decisions, and bad acquisitions. Bogle said that it is easier to hype the value of a companyâ€™s stock than it is to build value in the business, and heâ€™s right. Itâ€™s hard to get people to part with their money for whatever good or service youâ€™re selling.
Bogle also says that fee structures let mutual fund companies make money no matter what happens to their customers, and thatâ€™s wrong. Letâ€™s take what I consider to be a criminal charge, the 12b-1 fee. Named for the section of the 1940 Act that seems to permit it, the 12b-1 fee is a charge that mutual fund companies place on their customers to pay for their advertising. Got that? The mutual fund company charges YOU for ads it places to attract new customers. Iâ€™m not opposed to paying up for things that benefit me, but how on earth does covering a mutual fund companyâ€™s advertising expenses make me better off? Thatâ€™s their cost of doing business, not mine.
Given the audience, Bogle didnâ€™t have many recommendations for individuals who own mutual funds. He was more interested in making the investors-who-lunch squirm. But Iâ€™ll extrapolate for you. First, Bogle really dislikes all the gimmicky mutual funds out there, developed for marketing reasons rather than to fit real investor needs. Go for nice and simple funds; index funds are great for most people. Pay attention to the fees on your funds. Ask fund companies how they vote your shares when they vote for corporate boards, and make careful choices when it is your turn to vote for the fund companyâ€™s board. Donâ€™t throw that proxy statement away!
One of the triumphs of democratic capitalism is that the stock market and mutual funds let all of us be investors. But we all have some responsibilities, if only to hold those we hire to manage our money accountable for their decisions.