John Bogle: The Conscience of Capitalism

| July 27, 2011

 

Monika Mitchell asks John Bogle, do we have a moral responsibility to others as business leaders?

“We each have a responsibility to leave everything we touch a little bit better…”

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Good-b’s CEO Monika Mitchell and Editorial Advisor, Ann Graham, formerly of strategy+business, were privileged to spend two hours earlier this year with Wall Street legend: John Bogle at the state-of-the art Pennsylvania headquarters of his self-created multi-billion dollar mutual fund, Vanguard. His office was stacked with papers, books and projects revealing an octogenarian as fully engaged in new ideas and innovations as he has been for the past 40 years.

John Bogle is a man with a mission: To bring a moral conscience back to an industry that has served him well and that he  has served in kind. To be a maverick among some of the world’s smartest market makers is a feat in itself. To remain humble, courageously independent, and magnanimous while doing so is an even greater accomplishment. John Bogle is warm, witty, welcoming and passionately devoted to making the world a better place. His singleminded vision of wealth-building with integrity has paved the way for those of us who follow in the world of money who truly believe that business can be a Force for Good.

By Ann Graham and Monika Mitchell

When John C. Bogle, the founder and former CEO of The Vanguard Group, Inc. launched his investment management company in 1974 — in the middle of a bear market — he gave it the name Vanguard “without a lot of thought,” he says. “I didn’t have to look up what it meant in Japanese.  But one of its many meanings is leader of a new trend, and thirty-seven years later, we have yet to find our first follower. Our market share is a third larger than any market share in the history of the industry,” Bogle declares with pride born of hard work and competitiveness, not hubris.

Indeed, Vanguard began operations on May 1, 1975, with 11 mutual funds and approximately $1.8 billion in assets. Today, the firm has nearly $2 trillion under management and invested in an array of mutual funds, exchanged-traded funds, commingled trust funds and other accounts that follow a variety of active, quantitative, and index strategies. Vanguard and its closest competitor, Fidelity Investments, Inc. are “locked in battle”, says Yahoo Finance, for the title of ’the largest retail mutual fund manager on the planet,’ Both firms took top honors in Institutional Investor’s 2011 Money Management Awards.

Jack Bogle found his life’s calling as a scholarship student at Princeton University, some 60 years ago. During his senior year, he wrote a comprehensive analysis of the modern mutual fund for his undergraduate thesis. In 1951, he joined an industry pioneer, the Wellington Management Company, eventually rising to chief executive. But by 1974, the maverick side of Bogle was having “difficulties dealing with the new Boston partners” he had brought aboard via a merger in the late-1960s, according to the American Business Hall of Fame. Bogle says, “my four partners banded together to fire me.” On September 24, 1974, fired from Wellington, Bogle started Vanguard in the midst of the 1973-74 “Papa Bear” stock market.

The goal was to create a firm with the “mutualized” structure he hinted at in his 1951 thesis. Vanguard is entirely owned by its mutual fund clients — the form of ownership his Wellington partners had rejected. (Today, nearly 30 percent of Wellington’s portfolio is represented by mutual funds that it manages for Vanguard.)

Among Bogle’s first, and most noteworthy, contributions with Vanguard were the creation of the world’s first index mutual fund and the elimination of sales loads. Both moves were based on Bogle’s belief that the mutual fund industry’s management fees were excessively high — an unresolved problem he continues to fight nearly 40 years later.

Like any authentic individualist, Bogle has his foes. But among friends and fans (known as “The Bogleheads”) he is seen as the “conscience of Wall Street,” a “financial philosopher,” and the “investor’s best friend.” “No one has fought the battle for better business on Wall Street longer or harder than Bogle,” economist Jeff Madrick wrote in a review of Bogle’s book, “The Battle of the Soul of Capitalism” (Yale University Press, 2006).

A skilled man of letters and finance, Bogle is a prolific source of personally reflective and professionally hard-nosed writing about the industry he loves and the Jekyll and Hyde nature of financial markets. In Bogle’s memoir “Enough: True Measures of Money, Business, and Life” (John Wiley & Sons, 2009), he describes his dogged  pursuit of fair play and a fair shake for investors “as a battle on the one hand…and on the other a ‘lover’s quarrel’ with our financial world,” paraphrasing the American poet, Robert Frost.

He is the author of eight other books, including classics on the mutual fund industry —“Bogle on Mutual Funds (1993) and “Common Sense on Mutual Funds” (1999 and 2009)– as well as multiple collections of his speeches and essays. His latest is an encyclopedic anthology of his writings called “Don’t Count on It!: Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes (John Wiley & Sons, 2010) (Find more on The Bogle E-Blog.) Having stepped down from the chairmanship of Vanguard in 2000, he now leads the Bogle Financial Markets Research Center and maintains a rigorous writing and speaking schedule.

Walking across the spacious courtyard of Vanguard’s corporate campus in Valley Forge, Pennsylvania, we pass by a statue of him as a younger man, his “Dorian Gray,” he quips. But Jack Bogle is no Dorian Gray.

At 82, Bogle exudes a healthy mix of ego, modesty, and self-knowledge — the kinds of qualities we yearn for in a leader of his stature in these days of mind numbing displays of weakness among the powerful. When it comes to matters of character, he avers: “I am a tough guy.”

If Oliver Stone were to come calling to pitch a Bogle-inspired sequel to Wall Street – Money Never Sleeps it would most likely be called Money Isn’t Everything.

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(Ann G & John chat about “money and morality”)

No one is more aware than Jack Bogle that money can’t buy immortality. “I am in my ninth decade, how about that, and I just celebrated the 15th anniversary of my heart transplant,” he said cheerfully as we made our way coatless through a chilly early Spring fog. In reality, Bogle is actually referring to a rebirth-day, one that recharged both his heart and his determination to challenge the practices of his peers in the money management industry. In a lively two-hour interview with Good Business International, he talked about a wide range of his  passions, peeves, and prognoses for a better and healthier financial system for the planet.

Good-b: Arguably, the growth of the mutual fund industry has been a major cause of the shift from individual to institutional stock ownership over the past half-century. Is the shift you describe from the “ownership society” to the “agency” society — and the rise of speculation and decline of stewardship that has come with it — a permanent change?

Bogle: This agency dominance is never going to go away. The problem is if you’re an agent and you’re not investing your own money, you’ve got a lot of other things to keep you going. Adam Smith has a saying “Managers of other people’s money [rarely] watch over it with the same anxious vigilance with which… they watch over their own.”

The focus in the mutual fund business and in the pension business is on short-term performance.  It’s absolutely idiotic but it is not going to change. There may be a few good long-term managers.  Every time someone says, “What about Warren Buffett?” I say, “Name two.”  But very few people can name a second person.

Good-b: Except for Charlie Munger who works with him.

Bogle: Well, yes, and someone might have said five years ago, Bill Miller, but they don’t mention him anymore. Or Peter Lynch, but that’s 18 years ago. Peter Lynch was a good manager, but when he was earning his best returns, Magellan was a private fund.

Good-b: The absence of fiduciary duty is one of the biggest problems that led up to the financial crisis. It’s pretty obvious that almost nobody honored it. You talk a lot about fiduciary duty in the public dialogue on financial reform.  Can you explain your position as it relates to institutional money managers?

Bogle: I believe the government should have a federal standard of fiduciary duty that says agents represent their principals first. They have to do due diligence on the securities they select.  And they have to set appropriate fees.  They cannot be publicly held.  They’re required, as a matter of national policy, to vote the proxies of the corporations in their portfolios in the best interests of their shareholders.

But I don’t think there’s one easy answer. I’m afraid we’ve got to be satisfied with incremental changes that come down to investors and pension fund managers acting more intelligently. If we did have a fiduciary duty for institutional money managers, it would force the corporations that they control in today’s agency system to honor the fiduciary duty to their clients.  So it’s kind of a cause and effect thing spread throughout the system. That would help. But, sooner or later, this is a societal issue. Most mutual fund investors, in particular, just don’t seem to care about anything but short-term performance.

Good-b: What is the legal context for establishing new standards for fiduciary duty in the mutual fund industry?

Bogle: Fiduciary duty has been around for about eight centuries. It’s basically derived from English common law and is state law in the US.  If you read the Delaware Charter, it says nothing about a board of directors having a fiduciary duty to put the corporation’s shareholders’ interests first.

There is some language or [lore] in the courts about investment advisors having a fiduciary duty. It has been upheld in a legal case the SEC vs. the Capital Gains Research Bureau Inc.

It turns out that mutual fund advisors are registered under the Investment Advisors Act of 1940. So why isn’t the mutual fund manager a fiduciary to its shareholders? I don’t know the answer. No one’s ever been able to give it to me.

Good-b: As we look at the current generation of leaders of financial institutions, it doesn’t feel like they share the appreciation of the “value in values” that kept previous generations of leaders more grounded. Why do you think this is so?

Bogle: Well, this is going to sound awfully simple to you, but I begin with one word: Money. People might have more pristine motives, but making money is always lurking in the back of their mind.

And it is not just money but comparisons to how much other people are making. When you know other people are making a lot of money, you’re more inclined to say, “Why can’t I do that, too?”

Our attitudes change when we see what’s going on around us. It used to be that there were certain things one did not do, which I call moral absolutism.  Today there is a feeling that if everybody else is doing it I can do it, too.  That’s what we would certainly call moral relativism.

The money you can make on Wall Street today is significantly greater than you could make on Wall Street many years ago — which is also part of a big change that people ignore.  It was different when investment banks were private companies. If you’re in a private partnership and your own money is at stake, you don’t have 30:1 leverage.  You don’t have a balance sheet loaded with junk. The fact of the matter is that today’s financial engineers subtract value from society rather than create it.

Good-b: Can regulation make a difference?

Bogle: Visualize someone trying to dam a stream. Wall Street and their lawyers and their money managers will find ways around whatever Washington does, just like water finds ways to get through big rocks. One way or another, regulation really can’t do the job, particularly regulation drafted by two political parties at war with each other . Further, given Wall Street’s incredible lobbying power, you are going to get really a pretty poor bill that probably won’t solve any problems. The problem with the financial reform bill is, as the Republicans say, “We agree totally.  We just want to do it differently.”  And that’s the same thing as disagreeing.

Good-b: You also talk about the problem of the speculative culture of secondary securities market trading overpowering the primary markets for newly issued securities. What’s the concern there?

Bogle: We are supposed to be directing capital to its highest use, right?  But the level of trading in the secondary market is about 200 times the volume in the primary market of new issues, as I point out in “The Clash of the Cultures” speech. Wall Street is raising capital for industry, as it always has, in reasonable amounts considering the needs of the corporations. The problem is that primary capital formation or capital allocation — call it whatever you want — it has been totally overshadowed by all this speculation in the secondary markets. I have had a lot of critiques by good and honest people of my Clash of the Cultures piece in the Journal of Portfolio Management, and they persuaded me that I overdid it a little bit.  Because we do need liquidity, I never said we didn’t.  But I doubt very much we need as much liquidity as we have out there today.

The other problem for companies is that speculators don’t give a damn about corporate governance.  They don’t give a damn about executive compensation.  They don’t give a damn about anything except the price of the company’s stock, which is basically a momentary illusion.

Good-b: How do you think the proposed merger of the NYSE Euronext and German’s Deutsche Börse will affect the clash of the cultures in the capital markets?

Bogle: My research for Clash of the Cultures suggests that about 50 about percent of the market’s trading volume has already gone to these high frequency traders.

And I think there’s going to be a lot of abuse there.  There’s a lot of abuse already. I look at the markets in the classical way. If we can get all investors in a single market and everybody has to go there, markets aren’t competing with each other. Under those conditions, you should get the best price and I’m sure you would. The problem with that is when you only have one market, its run like a utility, which puts the kibosh on innovation. The system the NYSE had was clearly archaic. You know, little men in tan coats walking around the floor with pads. (If you want to know more about the little men and their pads, click on “The Big Bored”— The editors.)

Good-b: How do you see the relationship between the quality of a company’s management and the performance of the stock?

Bogle: If you read the first edition of Benjamin Graham’s “Intelligent Investor” he spends about 25 percent of that book talking about what you do when a company’s management isn’t good. The fabled “Wall Street Rule” is if you don’t like the management — sell the stock. This may be a good idea or a bad idea. It certainly isn’t necessarily a moneymaking idea.

So if you don’t like the management, improve the management! It’s not complicated. The stock price, as I said earlier, is a momentary illusion. The only thing that matters is the intrinsic value of the corporation, or what its business is worth as determined by the discounted value of its future cash flow. But that’s hard to quantify. GAAP accounting principles are extremely weak. There are so many rules you can drive a truck around them. But the fact that we don’t always know the future cash flow doesn’t mean the theory is wrong.

Good-b: Can you explain what underpins your theory of stock indexing?

Bogle: In the long run, 100% of the return on stocks is determined by corporate America’s performance. It is determined by the dividend yield when you buy the stock plus the subsequent growth in earnings.

The same is true of Treasury bonds. The yield when you buy them is the best possible predictor of their returns over the subsequent decade or so. It seems so frightfully simple, but the problem is, when the stock market’s misaligned with fundamental values, it can be misaligned for years. You’ve got to go back to fundamental value. That’s all there is.  And if people are paying too high a price, the stock will come down.  If they’re paying too low a price, the stock will go up.

John Maynard Keynes didn’t quite get it.  He worried about the risk in a stock.  But the risk in the stock market arguably is far less than the risk in a single stock. As far as I can tell, he never contemplated the idea of owning the stock market instead of owning the stock.

Good-b: As businesses try to define the value human capital, is character something we can or should try to measure?

Bogle: Character is not measurable.  Integrity is not measurable. Jack Welch is a perfect example. Firstly, I think the GE earnings statements when he was CEO were totally bereft of integrity.  Second, even if you believed them there’s no such thing as dividing integrity into two. Even if you prove to me a person has integrity in his business life, you’d also have to prove to me that such a person has integrity in his personal life.  Integrity is indivisible; you either have it or you don’t. I’m a tough guy when it comes to standards.

Good-b: What’s your philosophy of a responsible company and how does it tie back to our actions as individuals?

Bogle: I think each of us have a responsibility to leave everything we touch in our lifetime a little bit better. Whether it’s a family. Whether it’s a community. Whether it’s a corporation. Whether it’s society. If we can do that and everybody does it, we’re going to have a great world. And even if the majority of people do it, we’re going to have a great world.

I guess that’s my fundamental principle.

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