Bogle Goads Funds to Focus on Shareholders
May 22, 2000
NEW YORK - The mutual fund industry has "lost its way" by caring more about boosting assets under management to raise fees, and therefore profits, for the investment adviser, instead of focusing on long-term performance in the best interest of shareholders, said John Bogle, founder and former senior chairman of the Vanguard Group of Malvern, Pa. Bogle is now president of the Bogle Financial Markets Research Center, also of Malvern.
Bogle made his characteristically forthright remarks at a meeting on the Investment Company Act sponsored by the Practising Law Institute here last week.
Fund expenses have increased 100 percent since 1950, from an average of 77 basis points 50 years ago to 1.58 percent in 1999, Bogle said. What is more disconcerting, "is the staggering 4,300-fold increase in the dollar amount of direct fund operating expenses, from $15 million in 1950 to $65 billion in 1999," Bogle said. Bogle challenged the fund industry to disclose how this $65 billion is being spent.
Funds have also been guilty of promoting short-term performance, Bogle said. They do this by pouring inordinate amounts of money into advertisements highlighting outstanding performance figures and encouraging "performance-chasing," Bogle said. The only purpose of such "well-oiled marketing machinery" is to attract greater assets, and therefore boost fees and line the pockets of investment advisers, he said.
Frequent trading by fund portfolio managers has also prompted the public's fascination with short-term investments, with portfolio managers themselves turning over more than 90 percent of a fund's portfolio each year, Bogle said.
Portfolio managers' high turnover of equity holdings has had the added negative effect of lowering a fund's return by an average of three percent because of the incursion of capital gains taxes, Bogle said. Funds lose another 50 to 100 basis points a year in performance by actively trading and thus incurring more commissions and market impact costs, Bogle said.
This has fostered a short attention span among individual investors, Bogle said. Today, an investor holds a mutual fund for three years or less, whereas in 1960, a mutual fund investor held a fund for 14 years or more, he said.
Redemption figures that mutual fund tracking agencies report fail to include exchanges between funds in a fund family, Bogle said. If these figures were added to redemption figures, it would become apparent that 50 percent of all fund shareholders either redeemed or exchanged fund shares in 1999, he said. In the 1960s, seven to 10 percent of investors redeemed shares annually, Bogle said.
"Given the high fees and operating costs, the short-term investment horizons and the substantial transaction and tax costs that go hand-in-hand with this rise in investment activity, it is small wonder that mutual fund returns have lagged so far behind the substantial returns generated by U.S. stocks during this greatest of all bull markets," Bogle said.
The performance of all types of equity funds has lagged three percentage points behind the S&P 500, the S&P 400 and the Russell 2000 benchmarks over the past 15 years, Bogle said. While these discrepancies may not seem great, over a 15-year period, they can dramatically detract from a fund's value, reducing an equity fund's return to 40 to 60 percent below the benchmark, Bogle said.
Fund directors are not sufficiently considering how their funds perform compared to these benchmarks, Bogle said. They should not only be concerned, they should seriously question these poor returns, as well as their funds' high management fees and compensation levels, he said.
Directors, independent or not, do not seem to be up to the task of properly managing funds, Bogle said. Because all directors are compensated by the fund management company, it is impossible for them to truly serve fund shareholders, Bogle said.
Fund directors "are serving two masters-the management company and the fund shareholders-and that is the root cause of the problem," Bogle said. "Shareholders need to be put back where they belong- in the driver's seat of this critically-important financial machine."