I have just come back from the US having visited Vanguard fund management’s campus outside Philadelphia.
It is not like any competitor I have ever visited as the whole place has the feeling of academic research institution not massive fund manager.
That impression is underlined when you talk to John Bogle, who set the outfit up in 1975 as a mutual. Bogle is an extraordinary figure not least because of his astonishing grasp of detailed analysis, numbers and academic research, and his campaigning work for private investors.
An army of Bogleheads now base their portfolio allocations on the great man’s utterances, most of which are based around three themes – index funds, cost and mutuality.
I will not bang on about the first two if only because I have already sounded off about the need to lower end costs to the consumer and the efficiency of index funds, but mutuality is a fascinating theme.
Bogle discusses his ideas on the relationship between investors and their fund managers in great depth in a paper entitled A New Order of Things which can be downloaded at www.lawreview.law.wfu.edu/documents/issue.43.1089.pdf
Bogle is perplexed by a paradox. When he set up Vanguard in 1975 as a mutual he thought he was onto something, as he felt a mutual properly aligned the interests of the investor with those of the fund manager. He thought the relationship between the fund manager and the industrial-scale companies that manage their funds is broken and dangerous. Bogle reasoned it was better to have the investors own their own fund allowing any saving in costs to passed onto them directly.
What seemed like a sensible idea on paper has not worked out as an industry trend – not one mutual has been set up in the US fund management industry since Vanguard, even though Vanguard is itself now a leviathan and obviously successful.
Bogle is clearly puzzled by this and questions whether we are all in danger of breaking a key fudiciary principle summarised in this wonderful quote from a leading US Justice Harlan Fiske Stone who remarked on his “ancient prejudice of mine: All things considered… it is undesirable for professional enterprises to have public stockholders… It is possible to envisage circumstances in which the pressure for… earnings growth engendered by public ownership is antithetical to the responsible operation of a professional organisation. Although the field of money management has elements of both, differences between a business and a profession must, finally, be reconciled in favour of the client”.
In the absence of mutuals, Bogle argues strongly for better corporate governance through a six-point plan that suggests not only should 100% of a fund’s directors be unaffiliated with the management company, but the chair of the fund also be independent of the management company and the funds retain independent legal counsel and compliance. Our investment trusts go some way to answering these demands but our version of ‘mutual’ funds (unit trusts) fail disastrously. In effect the fudiciary requirement has been passed on to the regulators.
Bogle argues a mutual structure might act as a form of fiduciary protection in the absence of this legal framework but I am not so sure. I, like Bogle, find it odd no one has set up a mutual funds company here in the UK, unlike the many mutual credit unions being set up to rival the mainstream banks. Large professional or trade union groups could easily set up their own mutual fund groups that invest in cheap bulk index schemes that pass on any savings direct to the customer.
To be fair, mutuality might not also be all that Bogle claims it is. We do have old mutuals in the fund management space here in the UK but their record on passing on costs to the end user is deplorable and I include the Co-op in that bitter analysis. They have nearly all failed as mutuals to undercut the private firms and they still charge the same as their peers and sell the same dreadfully packaged rubbish to their investors. Why hasn’t the Co-op and its various entities started selling 15 basis point index funds to its poorer clients ? Why do high street building societies continue to sell structured product junk to their customers rather than ultra cheap products, passive or active? I think it is shameful that smart outfits like HSBC and Fidelity have been the only ones to take up the fight on costs!
David Stevenson is a Financial Times columnist and consultant. Email him at davidcstevenson@gmail.com
