识别显而易见之事的非凡能力

*** A Perspective *** Remarks of the Founder and former Chief Executive of The Vanguard Group on receiving the 2005 Outstanding Financial Executive Award from Financial Management Associates International (FMA) Chicago, IL, October 15, 2005.

The Uncanny Ability to Recognize the Obvious John C. Bogle „I’m deeply honored to receive your 2005 Outstanding of articles I’ve read in the academic journals over the Financial Executive Award. Coming as it does from a years (mostly the Financial Analysts Journal and the global organization renowned for its development and Journal of Portfolio Management; much of your own dissemination of knowledge and financial decision Financial Management journal is well over my head) making; it’s a very special treat. I’m profoundly humbled and even written nearly a dozen myself, my intellectual to stand before so many of you, among the most noted credentials fall far short of those of most of you here finance academicians, investment practitioners, and today. Truth told, when I see a page that is filled only policy makers in the field, and bask today in the with formulas—Sigmas and Deltas and Lambdas—to reflected glory of the true “stars” of our field who have the near exclusion of text, I move quickly on to the previously won this coveted award. next article.

Confession being good for the soul, I’m also Continuing my confessional litany, I have little somewhat surprised to be your choice for this knowledge of the convoluted intricacies of financial prestigious award. While I have spent nearly five and analysis and accounting standards, and have not one-half decades in this field—including more than done investment research on stocks and bonds since three decades as the leader of two wonderful mutual my early years as a rookie in this wonderful field. fund management organizations (Wellington in 1965– Worse—or, come to think of it, better!—I created a 1974 and Vanguard in 1974–1996), I have never thought method of investing which deliberately and of myself as a particularly competent executive—an purposefully ignored analysis, accounting, and assessment that I imagine my long-suffering colleagues research. For in substance, the index mutual fund shared. But I was always surrounded by a crew—bless simply buys the entire stock market portfolio—blue them all, not just the higher-ups—who knew how to chips, blithe spirits, downtrodden dogs, and even get the things done that needed to be done. bankruptcy candidates—and holds it for Warren I also confess that while I’ve been enlightened, Buffett’s favorite holding period: “Forever.” indeed often transfixed, by the scores—no, hundreds— Of course I didn’t invent the idea of indexing. (I’m not sure any individual did.) But the founding of the John C.Bogle is the Founder and former Chief Executive of world’s first index mutual fund in 1975—initially “First The Vanguard Group. Index Investment Trust” and now “Vanguard 500”— Note: The opinions expressed in this speech do not necessarily was, I think, a seminal moment in the history of represent the views of Vanguard’s present management. indexing. Although nearly two decades were to pass BOGLE — THE UNCANNY ABILITY TO RECOGNIZE THE OBVIOUS 115 before its position in the mutual fund firmament was then, is more than broad diversification. It is rock-largely accepted, we can now say that the original bottom expenses, enabling a minimal-cost index fund heresy that was indexing has at last become dogma. not merely to earn, but to deliver almost all of Proof? Known as “Bogle’s Folly” at the outset, it is whatever returns it may earn. The net return, in short, now the largest mutual fund in the world. Including its approaches 100% of the gross return. In effect, sister “500” funds, its first cousin “5000” stock index Vanguard rebates to its owners the enormous profits funds, its brother bond index funds, and its in-law index that other investment managers sock away for sector funds, investors at Vanguard have some $375 themselves. Having provided shareholders with this billion invested in passive strategies, one-half of the at-cost operating structure, we also dedicated long-term assets we supervise. ourselves to eliminating extraneous costs and maximizing operating efficiency, and quickly became I. Indexing as the Core the fund industry’s low-cost provider by a wide margin.

Today, our index funds operate at an average expense Whatever the case, using the index mutual fund as ratio of about 15 basis points (0.15 of 1%), while the the core—if not the entirety—of a diversified equity average equity fund carries a ratio of about 1.50%, or portfolio is now dogma in college and business school ten times higher. finance classes, and I thank you for that. It is advocated, Amazingly, that 1.35 percentage point advantage is as far as I can tell, by almost every American who has only the beginning. Passively managed index funds won the Nobel Prize in economics. And most recently, that buy and hold the market portfolio—remember even the leader of one of America’s most successful “Forever”?—incur essentially zero transaction costs. endowment funds—Harvard—sang, indeed shouted, With portfolio turnover of actively-managed equity its praises. Here’s what Jack Meyer said: “The funds now averaging nearly 100% per year, their investment business is a giant scam. Most people think estimated transaction costs come to as much as 1%. they can find fund managers who can outperform, but Adding, say, another percentage point to the index most people are wrong. You should simply hold index fund cost advantage brings its edge to 2.4%. funds. No doubt about it.” But there’s more! Index funds are readily available Of course anyone who ever thought about the issue on a “no-load” basis without sales commissions. (It of indexing could easily have started the first index fund would be unwise, even insane, to buy any other kind!) before I did. The opportunity was there for the taking. Most actively-managed (and heavily marketed) funds, But only the newly-formed Vanguard—we began on the other hand, have front-end sales commissions operations in May 1975 and by September the proposal averaging perhaps 5%. Even if held for a full decade to form “First Index” was on the Board’s agenda—had (most aren’t!), add another 50 basis points of cost. both the opportunity and the motive. Why the motive? We’re now up to 2.9%.

Because the creation of Vanguard was in itself a first— And there’s still more. Passively-managed index a unique, truly mutual mutual fund group, controlled funds are highly tax-efficient, while their actively-not by a separate management company but by its managed cousins, trading madly, are highly tax-owner/shareholders, and operated on an “at cost” basis. inefficient. For taxable investors, a difference of, To do its job, the basic index fund takes diversification say, another 150 basis points, bringing the total cost to the nth degree. It owns essentially the entire market, advantage held by the index fund to 4.4% points per and thus assures that its investors are guaranteed to year. (And if you pay a financial adviser another capture the gross return of the stock market (or the 1% . . . well, you can do the math. But I’ll leave that bond market, or any discrete segment of each.) But what cost aside.) makes indexing work is not the assured earning of the Does it matter? Think about the numbers: if the stock market’s gross return. As a group, all fund managers do market is generous enough to reward equity investors exactly the same thing. While they are but a subset— with an 8% annual return over the years ahead, and if albeit a large subset, now owning a remarkable 28% of our administration in the nation’s capital and our all US stocks—the record is clear that together, fund central bankers have the guts and discipline to hold managers provide average gross returns that match the inflation to 2 ½%, then the real return on stocks would market’s. Hard as it may be for these smart, experienced, be 5 ½%. If actively-managed funds persist in foisting intelligent investment professionals who manage mutual on their investors high-cost “products” (as the industry funds to admit it, as a group, we’re average. is wont to call their mutual funds), the real return on the average actively-managed fund—after costs and after II. The Real Magic of Indexing taxes—could come to just 1.1% per year.

Compounded over the long term (here I’m using 25 The real magic that gives indexing its inviolate edge, years), $1,000 simply invested in stocks at 5 ½% grows 116 JOURNAL OF APPLIED FINANCE — FALL/WINTER 2005 to $3,810; at 1.1%, to just $1,310. Welcome to the real beyond the simple all-stock-market index fund and all world, in which the relentless rules of humble arithmetic bond-market index fund. While our mutual structure in the financial markets—essentially, gross fund return, and our low costs inevitably destined that the honor minus costs and taxes, equals net investor return— of forming the first index mutual fund would be doom actively-managed funds as a group to an abysmal Vanguard’s, those same elements also led to two other failure for their investor/owners. In the mutual fund precedent-breaking innovations: One came in the bond business in the aggregate, you get precisely what you fund sector. (From 1985 through 1990, amazingly, assets don’t pay for. in bond funds were actually larger than equity fund Look, I know that “failure” is a tough indictment. So assets. How times change!) In early 1977, bond funds don’t take my word for it. In his new book, were just that: “managed” portfolios of bonds whose Unconventional Success, another brilliant endowment maturities could be extended or reduced depending fund manager, David Swensen of Yale University on the portfolio manager’s outlook for interest rates. describes “the colossal failure of the mutual fund But, skeptical that bond managers had—or ever industry; resulting from (its) systematic exploitation could have—such prescience, we again did the of individual investors . . . as funds extract enormous obvious. We launched the industry’s first defined-sums from investors in exchange for providing a maturity series of bond funds, including a long-term shocking disservice.” He adds that “excessive portfolio, a short-term portfolio, and (I’m sure you management fees take their toll, and (manager) profits know what’s next!) an intermediate-term portfolio. My dominate fiduciary responsibility . . . Thievery,” Mr. idea was to hold broadly diversified portfolios of top Swensen continues, “even when dressed in the cloak quality bonds (first tax-exempt municipals, later of SEC-approved governance, remains thievery . . . as taxables), and maintain essentially constant maturities the powerful financial services industry exploits in each category. While these three portfolios were vulnerable individual investors.” These are strong not, technically speaking, index funds, in a complex words. But when challenged by The Wall Street Journal municipal market where the existing indexes were that his conclusions were “pretty harsh,” Mr. Swensen flawed, they were—and are—as close as I could get to simply replied: “the evidence is there.” And so it is. making them exactly that. The simple—yes, even Even an active mutual fund manager—in this case, dumb—concept of specifically defined maturities Fidelity’s Peter Lynch, who managed Magellan Fund revolutionized the bond fund sector, and virtually the with such remarkable success from 1973 to 1993— entire industry quickly followed suit. The three-tier concedes the point driven home by Harvard’s Mr. bond portfolio is now the industry standard. Meyer and Yale’s Mr. Swensen: “Most investors,” Low cost, low turnover, and indexing were also the Mr. Lynch acknowledges, “would be better off in an keys to another Vanguard innovation that, like our bond index fund.” Surprising as it may seem; that’s more innovation, would quickly be widely imitated (except, than a mere concession; it is his recognition of an of course, for the low costs). In 1993, we created the undeniable tautology. industry’s first series of tax-managed funds: 1) a growth Warren Buffett, the inestimable oracle of Omaha also and income fund (based on the S&P 500, except that buys into this reasoning: “When the dumb investor avoiding taxable gains would override a precise realizes how dumb he is and buys a low-cost index fund, replication of the index); 2) a capital appreciation fund he becomes smarter than the smartest investors.” So it (focused on an index of lower-yielding large-cap could easily be said that you honor me because I’m a stocks, so as to minimize taxable dividends); and 3) a dumb guy who created a dumb fund—and a dumb fund balanced fund (50% intermediate municipal bonds and management company—for dumb investors. How, you 50% the lower-yielding stock index portfolio). However must wonder, did that happen? Largely because, as a obvious, this then-unique creation may have been a detractor said about me a decade or so ago, the only smart idea. But the fact that we should have created it thing I have going for me is “the uncanny ability to at least a decade earlier than we did suggests that its recognize the obvious.” (When you realize that, by timing, so delayed by my inexcusable stupidity and definition, the obvious is something that anyone can inertia,1 again merits the label “dumb.” recognize, we have a splendid paradox!) Now that you know this truth, I fervently hope that it’s too late for you IV. An Opportunity to Serve Investors to rescind the high honor you’ve just bestowed on me.

But it doesn’t really matter whether the Vanguard III. Extending the Implications of Indexing 1 As early as 1985, R.H. (Tad) Jeffrey, the investment-savvy former head of The Jeffrey Company, implored me to focus It also took no more than this obvious arithmetic to on tax-efficiency. Alas, it took me almost a decade to succumb recognize that the implications of indexing go far to his exhortations.

BOGLE — THE UNCANNY ABILITY TO RECOGNIZE THE OBVIOUS 117 structure, its mission, its index funds, its bond doubling, from 4.8% of profits in the early 1990s to strategies, and its tax-management innovations were 10.3% recently, a period in which earnings dumb or brilliant, obvious or obscure, timely or late. themselves—the measure our CEOs love to brag Each is of a piece with a concept that would capitalize about—grew at a puny 1.9% annual rate. on the obvious weaknesses of an industry that had • The rise of financial engineering—call it lost its way, an idea at least hinted at in the Princeton “manipulation”—in which earnings are managed University thesis that I wrote more than a half-century to meet the “guidance” that these executives give ago: “the principal role of the mutual fund is to serve to Wall Street, quarter by quarter. One of the prize its investors.” tools: raising the assumptions for future returns Simply put, as now must be obvious to every person on corporate pension plans even as prospective in this packed room, fund managers have not done returns eroded. Just think of it: In 1981, when the long-that, consuming a grossly excessive share of the term US Treasury bond yielded 13.9%, the projective returns generated in our financial markets, at the direct plan return was 7%. Currently, with bond yield at 4.7%, expense of fund owners. And it is that fact that explains the projected return averages about 8.5%. It’s not “the massive failure” (Mr. Swensen’s words) of fund going to happen, and pension plan inadequacy will managers to serve the investors who have entrusted it be our next financial scandal. with their hard-earned savings. • The failure of our traditional gatekeepers— In fact, the mutual fund industry is the poster-boy auditors (who became partners, if not co-for one of the most baneful chapters in the modern conspirators, with managements through their history of capitalism. That may sound strong to you, provision of highly profitable consulting and of course it is strong. But in the latter part of the activities), regulators, legislators (who in 1993 twentieth century, we witnessed what has been called forced the SEC to back down on requiring that “a pathological mutation” in capitalism, a mutation from option costs to be treated as—of all things!— traditional owners’ capitalism—focused on rewarding corporation expenses), and especially our the investors who put up the capital and assume the corporate directors who failed to provide “adult risks—to a new form of managers’ capitalism, in which supervision” of “the geniuses” who managed the not only our fund managers but our corporate firms. (The quotes are explained in my book.) managers, aided and abetted by our financial system, arrogated to themselves share of capitalism’s rewards. In investment America: V. “The Battle for the Soul of Capitalism” •As our ownership society of direct holdings of stocks by individual investors nearly vanished— You now can understand why my new book is they held 92% of all stocks in 1950 but hold only entitled The Battle for the Soul of Capitalism. It is an 32% today—corporate control fell into the hands expression of my concern about what went wrong in of giant financial institutions—largely pension corporate America, in investment America, and in funds and mutual funds—whose share rose mutual fund America, and (in each case) why it went commensurably, from 8% to 68%. But these agents, wrong, and how to go about fixing it. My opening beset by conflicts of interest and their own epigram is from St. Paul’s letter to the Romans: “if the agendas, failed to represent their principals. sound of the trumpet shall be uncertain, who shall •Part of this failure came because institutional prepare himself to the battle?” It is a book about the investing moved from an own-a-stock industry battle, and because I believe that the very soul of our (holding an average stock for six years during my capitalistic system is at stake, you will find the trumpet first 15 years in this field) to being a rent-a-stock that I sound to be a certain one. industry, now holding a typical stock for but a Let me focus the brief remainder of my remarks on single year, or even less. Owners must give a damn some of the major flaws that reflect this mutation in about the rights and responsibilities of corporate our capitalistic system, each described in some depth governance. Renters could hardly care less. in my book.

•As our professional security analysts came to In corporate America: focus far more heavily on illusion—the monetary precision of the price of the stock—and increasingly ignoring the reality—what really • The staggering increase in managers’ matters is the inevitably vague, but eternally compensation, with the pay of the five highest priceless, intrinsic value of the corporation. Using paid executives of public companies more than Oscar Wilde’s wonderful description of the cynic, 118 JOURNAL OF APPLIED FINANCE — FALL/WINTER 2005 our money managers came “to know the price of managers take, the less the investors make. everything, but the value of nothing.”

VI. Wrapping Up In mutual fund America: Please don’t be intimidated by this litany of flaws •A once-noble industry that had been a profession that have come to pervade today’s debased version of with elements of a business became a business with capitalism. We can fix them. Our nation is moving, if elements of a profession. Our traditional guiding haltingly, toward returning the system to its traditional star of stewardship was transmogrified into a new roots of trusting and being trusted. Our ownership star—salesmanship. Once a business of society is gone and will not return. Our agency society management, we became largely a business in has failed to serve its principals, as corporate managers which marketing called the tune, and our investors and fund managers alike have placed their own have paid a terrible price. interests above the interests of their beneficiaries and • Over the past two decades, the return of the owners. It is time to begin the world anew, and build a average equity fund has lagged the return of the fiduciary society in which stewardship is our talisman. S&P 500 Index by about three percentage points My Battle book is replete with recommendations to per year—10% versus 13%—largely because of speed this metamorphosis. (But you’ll have to read costs. But largely because of poor timing and poor the book to learn what they are!) fund selection, the average fund investor has lagged If this mission is to succeed, all of you here today, by another 3%age points. Result: in this grand era and the tens of thousands of other professionals you for investing, the average investor has captured but represent in the study and practice of financial 27% of the market’s compounded return. Clearly, as management, can—and must—help. Your vital role is Mr. Buffett warns, the principal enemies of equity to educate—to educate—investors everywhere— investors are expenses and emotions. individual and institutional, large and small—on the •When I entered this field all those years ago, nature of traditional capitalism, on the wisdom of long-virtually 100% of mutual fund management term investing, on the folly of short-term speculation, companies were relatively small, professionally- and the productive power of compound interest and managed, privately-held firms. Since then, they the confiscatory power of compound costs, and on have experienced their own pathological mutation. relentless rules of humble arithmetic. With your Today, 41 of the 50 largest firms are publicly-held, leadership, your integrity, your independence, and including 35 that are owned by giant US and global your passion, that mission will be completed. financial conglomerates. To state the obvious, these conglomerates are in business to earn a return on The sooner, the better. their capital, not a return on your (the fund investor ’s) capital. Remember: the more the Thank you again for your wonderful award, and for your kind attention.„