Tuesday, June 4, 2013

Clash of the Cultures

John Bogle created the first index fund, back in 1975. As the founder of Vanguard and its CEO over a long tenure, he made a career out of making it cheaper for investors to share in the wealth generated by capitalism. Unfortunately, the mutual fund business has taken a turn for the worse in recent decades. In Clash of the Cultures, Bogle sounds off on the industry he helped make enormous, as he believes investors are getting the short end of the stick.

To value investors, Bogle is likely preaching to the converted. He argues that mutual funds are no longer focused on reducing costs, but rather in growing fees and assets under management. This is because of a change in incentives which works against the investor. Mutual fund companies are no longer mutuals, run for the benefit of investors; instead, they are corporations supposedly run for both shareholders and investors. It's not possible for managements of these firms to serve two bosses, however; as it's turned out, it's the shareholders who have benefited at the expense of the mutual fund investors.

For example, at the portfolio manager level, there is little will to exercise action against companies that act against the interests of mutual fund investors. This is because portfolio managers court the business (pension funds, management's personal portfolios etc) of these very same companies, so they don't want to stir the pot.

The growth of mutual funds has also led to more agency costs for investors, as there is now a double-agency dynamic between investors and the companies they own. You have managers of the mutual funds and managers of the corporation both of whom often have no skin in the game.

Finally, but perhaps most obviously, the focus for managers of mutual funds is on increasing fees and returns to shareholders, not returns to investors.

Bogle discusses a number of solutions to these problems, which he sees as destroying his legacy of offering value to mutual fund investors. The solutions range from mutual fund structures returning to "mutual" rather than "corporate" organization, and a number of regulatory implementations.


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