VANGUARD GROUP OF MUTUAL FUNDS
John Bogle founded the Vanguard Group of mutual funds in 1974. When he relinquished the chief executive officer’s position in 1996 the Vanguard Group’s Vanguard Index Trust 500 Portfolio was the nation’s second largest mutual fund.
In addition to building one of the country’s largest groups of mutual funds, Bogle achieved distinction for several pioneering strategies in the mutual fund industry. One of those was the creation of index funds. Another was the strategy of minimizing investor costs by focusing on no-load funds, and in general minimizing management fees.
Bogle liked to write and speak about the mutual fund industry with an emphasis on what he considered to be the right way (his way) and the wrong way to do business. In the preface to his 1994 book he expressed the following views concerning the mutual fund industry and his reputation within it ( Bogle, 1994, p.x).
|“I have come to be known as the iconoclast of the mutual fund industry. Among industry participants, I am surely its sharpest critic. It is not that I consider this to be a bad industry; rather, it is an industry that can do so much better than it is. Somewhere along the road, the industry has lost its way. In my view, too many fund complexes have put the business need for asset gathering, the better to enhance the profits earned by fund managers, ahead of the fiduciary duty to provide efficient asset management at the lowest reasonable price, the better to enhance the returns earned by fund shareholders.”
While Bogle irritated some of his competitors, his views were well received by the financial press. In fact, the press on several occasions referred to him as the conscience of the industry and the investors’ best friend.
Pertinent Aspects of Bogle’s Youth
John C. “Jack” Bogle and his twin brother, David, were born on May 8, 1929. The family at that time lived in the fashionable bedroom community of Verona, New Jersey. But the stock market crash of 1929 forced Jack’s father to sell the family home. The family’s small fortune was wiped out and the boys had to go to work as soon as they were old enough. Jack started delivering newspapers and working in an ice cream parlor at the age of ten. Jack’s father, in the meantime, developed a drinking problem, lost his job in the early 1940’s and separated from Jack’s mother a few years later. Jack would later say that those early experiences turned him into a financial conservative and instilled in him a strong desire to achieve success in order to restore the family’s good name.
When Jack was ready to begin his junior year in high school his mother took him and his brother out of the public school system and enrolled them in Blair Academy. Blair was a private all-boys school designed to give its students an entry into the higher levels of American society. Of course, the family could not afford the fees of a private school, but that problem was solved when the mother’s brother, an investment banker, arranged work scholarships for the boys.
Jack excelled at athletics and academics at Blair. He graduated number two in his class and was voted most likely to succeed. He left the school feeling a deep debt of gratitude. Years later he would become the school’s largest financial contributor and chairman of its board of trustees.
Jack attended college at Princeton University where he majored in economics. He finance his schooling with a scholarship and various student jobs. His mother did not provide any financial support but he, nevertheless, felt a strong obligation to her and his two brothers since the family had decided that only one of the three boys could go to college. The other two would have to work full time to support the family. This situation further fueled Jack’s motivation to achieve professional success.
In his senior year at Princeton Jack was required to write a thesis. He chose to study the mutual fund industry. At that time the industry was small and relatively unknown. But he was intrigued by an article in the December 1949 issue of Fortune in which claimed that the mutual fund industry had great future potential. Jack’s 123-page thesis earned him a grade of A+. More important in retrospect is the fact that his thesis laid out the basic principles which he would later use in creating his Vanguard Group.
Bogle’s Early Years at the Wellington Management Company
Jack’s first job out of college came about through the kind of networking that causes students to attend prestigious universities. The manager of Jack’s campus dining club contacted Princeton alumnus Walter Morgan and urged him to hire Bogle. Morgan was the founder and chief executive officer of the nation’s fourth largest mutual fund, the Wellington Fund. Morgan had two of his executives interview Bogle and they were so impressed that they urged Morgan to read Jack’s thesis. Morgan read it and was so inspired that he made copies which he gave to each of Wellington’s fifty employees.
Morgan decided to hire Jack without a clear idea of what he would do. On July 5, 1951 Jack became a Wellington employee and for the next several years he performed a variety of clerical and administrative chores working directly with Morgan. Then in 1955 he was officially named Morgan’s assistant. For the next seven years he worked on assignments involving all aspects of the company. He used those assignments as opportunities to gain an intimate knowledge of all aspects of the mutual fund business.
In the late 1950s Jack began to encourage Morgan to add a second mutual fund. The Wellington Fund was a balanced fund with investments in both stocks and bonds. Bogle proposed the creation of a new fund that was devoted solely to stocks. Morgan liked the idea and introduced the new fund in 1958. Originally called the Wellington Equity Fund, it was renamed the Windsor Fund in 1963.
The Wellington funds were managed by a separate entity called the Wellington Management Company. In 1960 Walter Morgan took the management company public. While he maintained a controlling interest, he sold a substantial number of shares to others, including Jack Bogle who bought 10,000 of the company’s 877,800 shares.
The Merger of Wellington and TDP&L
In 1965 Jack was named executive vice president and given a mandate to increase the management company’s revenue. The obvious way to do so was to increase the amount of money being managed. And the best way to do that, in Jack’s opinion, was to introduce a new high performance fund. But that meant finding a high powered investment manager. Jack believed the best way to obtain such a manager would be through a merger. That line of thinking led him to negotiate a merger with the Boston based investment counseling firm of Thorndike, Doran, Paine and Lewis (TDP&L). TDP&L managed the best performing mutual fund in the country, the relatively small Ivest Fund.
The merger took place in 1966. It gave the owners of TDP&L a 40 percent share of the equity in the newly enlarged Wellington Management Company. In the views of both sides of the merger TDP&L was bringing research and investment talent plus a reputation for conservative management. The merged entity would thus be able to offer investors a much wider range of mutual fund investment options.
The merger did not work out well for Jack Bogle. Even though he was named president and CEO of the merged firm, he had difficulties dealing with the new Boston partners. Eventually open hostility broke out between Jack and the Boston group. In part that was due to Jack’s health problem. He suffered from a heart condition which caused him to be hospitalized periodically and eventually led to the implantation of a pacemaker. In addition, there were differing views with respect to investment strategies. For example, when Jack proposed launching a bond fund in 1970 he was opposed by the Boston partners. One of them is reported to have to Jack that the bond fund proposal was, ” The stupidest idea I’ve ever heard of.” (Slater, p. 39). Finally, part of the hostility was due to contrasting management styles. Jack was a detail man who had great confidence in himself but did not believe in participative management. The Boston partners, on the other hand, believed in participative management with an emphasis on consensus. Furthermore, they were not sticklers for details and this caused Jack to lose respect for them.
Poor financial performance of the funds in the early 1970’s exacerbated the management conflict. A sharp drop in the stock market in 1973 caused total assets under management at Wellington to fall from a peak of $ 2.6 billion in 1972 to $ 2 billion at the end of 1973. The Wellington Management Company’s earnings fell from $ 2.7 million in 1972 to $ 1.9 million in 1973. And the company’s stock, which had sold for $ 40 a share at the time of the merger, had fallen to $ 8 per share by early 1974.
The conflict between Jack Bogle and the Boston group came to a head and was resolved at the management company board meeting of January 23, 1974. By a vote of ten in favor and two abstentions the board fired Jack. To ease Jack’s pain the board also voted to continue to pay him his current salary to serve as a consultant.
Bogle’s Battle to Regain Control
Jack’s response to his firing was to appeal to the boards of directors of the Wellington funds. These groups were separate from the board of the Wellington Management Company which had just fired Jack. While separate, the boards of the funds were essentially captives of the management company and the chairman of each fund’s board was traditionally the CEO of the management company. That was the way things were done in the mutual fund industry. Nevertheless, Jack suggested that each of the boards consider taking over the management company’s functions.
The boards of the mutual funds decided to break tradition by having Jack remain as their president. In addition, they collectively asked Jack to conduct a major study of future directions for the funds. And they asked the Wellington Management Company to pay Jack’s salary and give him an office while Jack conducted the study.
Jack’s next move was to propose that the fund boards assume responsibility for their own administrative functions ( legal, accounting and shareholder service functions). On June 20,1974 the board of the Wellington Group of Investment Companies voted to do so. It was agreed that the Wellington Management Company would continue to serve as the investment advisor and principal underwriter for the funds. However, the annual fee paid by the funds to the management company was to be reduced to reflect the fact that the management company would no longer handle administrative services. The amount of the annual reduction was $ 1 million.
To provide the administrative services Bogle formed a new corporation which was named The Vanguard Group. The name was taken from the name of the flagship commanded by Lord Nelson in the famous British victory over the French fleet at the 1798 Battle of the Nile. The Vanguard Group was jointly owned by the eleven funds in the old Wellington Group which would henceforth be known as The Vanguard Group of Investment Companies. The date of Vanguard’s incorporation was September 24, 1974.
Bogle claimed that in creating the Vanguard Group he was establishing a new method of corporate governance. He argued that Vanguard was revolutionary in the sense that it was the only “mutual” mutual fund because of the way it distributed profits. All other mutual funds generated profits which went to the management company. But in Vanguard’s case any profits earned were returned to the funds. Thus, as a practical matter, Vanguard attempted to operate at cost and pass the savings on to the shareholders.
The next major step in obtaining Vanguard’s independence from Wellington Management was the 1977 decision to take the distribution of fund shares away from Wellington. At the time the fund shares were distributed through stockbrokers who charged a sales commission or “load.” Bogle proposed by-passing the stockbrokers and marketing directly to customers. The 1977 decision committed Vanguard to a “no-load” form of distribution. From the investor’s standpoint this was an advantage because the sales commission or load previously charged for the purchase of fund shares had reduced the investor’s return on the investment.
The final step in severing the close ties with Wellington Management consisted of removing parts of the investment management function from Welllington. In 1980 two outside investment advisors were hired for two new fund which Vanguard was introducing. In 1981 Vanguard took over the advisory function for its money market and municipal bond funds. Subsequently, Bogle added other investment advisors for Vanguard’s various equity funds. In 1995 Vanguard had 14 different independent investment advisors. Only in the case of Vanguard’s stock index funds did Vanguard handle the investment advisory function internally.
Bogle’s Strategy for Vanguard and its Evolution
Jack Bogle’s vision for Vanguard was largely contained in his Princeton University senior thesis. There he argued the case for mutual fund companies which (1) kept sales and operating costs to a minimum, (2) were innovative in developing new types of funds, and (3) were honest and candid in communications with the investor. All of these visionary elements came to pass as Jack led Vanguard through twenty-one years of impressive growth between 1974 and 1995.
In terms of the vision of a low cost operation the most significant development was the early decision to convert to a mutual corporate structure and adopt a no-load approach. The mutual corporate structure eliminated the expense that other funds incurred in paying profits to support a management company. The no-load approach eliminated the high front end sales fees that most competitors charged.
Another significant element of Jack’s low cost strategy was to minimize advertising and promotion expenses. By the 1990s Vanguard claimed to spend about one-tenth as much on these items as did its major competitors (Slater, 1997).
Vanguard’s frugality was also evidenced by its expense ratio (the fund’s average expenses as a percentage of the fund’s average net assets). In 1974 Vanguard’s expense ratio was 0.71 percent compared with 1.08 percent for the entire industry. By 1993 Vanguard’s expense ratio had fallen to 0.30 percent while the industry ratio had risen slightly to 1.10 percent.
Jack also fulfilled his vision of innovatively introducing new types of funds. The three most significant innovations were his introduction of bond funds, the creation of money market funds and the introduction of the stock market index fund (and also a bond market index fund). In each case there was widespread professional criticism of the new fund when it was introduced. And in each case there turned out to be a long term sustainable market for the new product.
Jack took particular pleasure in the performance of the stock market index funds. It was his opinion that very few fund managers would consistently beat the overall market over a reasonable period of time. Furthermore, he believed that it was impossible to identify those rare managers in advance. It therefore made sense for investors to put their money in a fund which, instead of trying to beat the market, simply tried to keep up with it. An index fund would do just that. Furthermore, since the index fund simply tried to mirror the market, there was no need to pay the salary of a high priced star fund manager to manage the portfolio.
Vanguard’s first index fund was introduced in 1976 and sought to index the Standard and Poor’s 500 Stock Index. In February, 1996 that fund became the nation’s number two mutual fund in terms of assets and had beaten eighty-five percent of all diversified stock funds over the past 15 years (Spear, 1996). Kiplinger’s Personal Finance Magazine reported that only six of Vanguard’s own actively managed funds beat the Index 500 over the preceding five years (Spear, 1996).
At the end of 1995 The Vanguard Group offered eighty-five different mutual funds. Twenty-nine of those were traditionally managed portfolios with outside investment managers. The most famous of these was the Windsor Fund which had been managed by John Neff for many years. Another thirty-seven funds were in the defined asset class category (money market funds, bond funds). Finally, nineteen of the funds were index funds. Together the eight-five funds had assets of just under $180 billion. One year later the Vanguard Group offered ninety-eight funds with total assets of $237 billion.
During his tenure as CEO Jack also realized the third element of his original vision – honest and candid communication with shareholders. Over the years he became well known for his cautionary comments in the company’s annual reports and his frequent public criticism of industry advertising. The main target of that criticism was the industry habit of touting past performance and giving the impression that future performance would be equally good. An example of Jack’s contrarian approach appears in Vanguard’s 1996 annual report in which Jack warned investors not to expect the index funds to continue to beat the market forever (p.3). In his words:
|“We emphasize that the large absolute returns provided by our Index Portfolios in 1996 should not be regarded as emblematic of future returns. All of these returns were above long-term historical averages for the stock market; such exceptionally strong results do not persist forever.”
The underlying logic of Jack Bogle’s vision and of its implementation was that long run success for the average investor is best achieved with a conservative investment strategy coupled with a cost minimizing sales and management approach. That logic was not widely accepted when the Vanguard experiment began. In the years that followed some of the principles became widely accepted (such as index funds and no load funds). But the investing public continued to clamor for the chance to beat the market with exceptional funds. So the industry continued to offer such products. Even Vanguard found it necessary to provide those kinds of funds as part of its family of offerings.
Management Style and Personality
Jack Bogle’s ability to innovate flowed directly from his personality. He had a strong need for achievement and a high confidence in his ability to evaluate situations and then make things happen. His competitive personality stood out. One of his former assistants once described it as follows (Slater, 1997):
|“The man is a fierce competitor; his combative nature comes out in debate, in negotiations, in one-on-one battles, as a spokesperson for his beliefs, and in other fields of endeavor, from cross-word puzzles to the squash court.”
Finally, Jack saw a larger purpose to his business career. He believed that what he was doing would make the investment world a better place for the customer.
Jack’s strong opinion of himself had the unfortunate effect of unnecessarily antagonizing he peers and placing stress on those reporting to him. The most vivid example of antagonizing peers is the history of his relationship with the Boston investors during the Wellington Fund period of his career. While the conflict was based on fundamental differences, it was also exacerbated by Jack’s aversion to discussion and his disdain for the abilities of the Boston partners.
Jack’s relationship with his employees was one of love and stress with love usually winning out. One outside observer who did substantial personnel consulting for Vanguard made the following observation (Slater, 1997):
|“(M)ost of the people who have direct contact with Bogle are very intimidatd by him. They respect him but he scares them. They dread going to his meetings because they’re going to be called to task for something …(or) challenged to defend something… Jack Bogle is not a modern-day participative manager. There’s a little trembling in the boots in dealing with him.”
Yet the same consultant went on to say that Jack was regarded as caring for his people and being accessible. There seemed to be a feeling that the rough parts of his personality were more than offset by his strengths. Here for example, is how one of his top executives felt about working for him (Slater, 1997):
|“(Bogle can be ) impetuous, callous, uncaring and mercurial (and he) can make you feel absolutely stupid…It can be maddening to work for him. By the same token, I wouldn’t trade jobs with anybody; I’ve learned the ins and outs of this industry from the very best.”
The executive just quoted went on to say that Jack was totally loyal to his employees and excelled at showing appreciation when someone did good work.
In early 1996 Jack Bogle stepped down as Vanguard’s CEO. Putting his career in perspective during an interview with Mutual Funds magazine, he said ( Hagy,p.56):
|“The recognition we’ve had for doing the right thing the right way is important to me. This is a business where you can get dazzled by big numbers pretty easily and it doesn’t last forever. But the letters I get from shareholders … that’s really a lot of encouragement.”
1. Bogle, John C. Bogle on Mutual Funds: Perspectives for the Intelligent Investor. New York: Dell Publishing, 1994.
2. Hagy, James, Deanne Morgan and Barbara Whelehan, ” 1997 All-Star Awards,” Mutual Funds, March, 1997, pp. 40-57.
3. Slater, Robert. John Bogle and the Vanguard Experiment. Chicago: Richard D. Irwing, 1997.
4. Spears, Gregory, ” The First Family of Frugality,” Kiplinger’s Personal Finance Magazine, September, 1996, pp. 4-48.
5. Vanguard Group. Vanguard Index Trust: Annual Report. Valley Forge, Pennsylvania, December, 1996.
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