If we are good stewards, we’ll receive good stewardship in return.
This article originally appeared in the October/November 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
Whether one views the fund industry as in decline or in a prolonged state of improvement depends on one’s time frame. Jack Bogle makes a compelling case for decline in The Clash of the Cultures, in which he cites the rise in fees and the deterioration of stewardship for funds like Massachusetts Investment Trust and Putnam Investors as their management companies moved from partnerships to corporate conglomerates. To Bogle’s thinking, the rise of corporate ownership has been a catalyst for subjugating the best interests of investors to the need for rising profits for the manager. It’s a bleak picture. It’s hard to imagine an investor who would opt for the current versions of many of the industry’s pioneering funds over their former structures and pricing.
I bow to no man in my respect for Bogle’s knowledge of the industry. He has studied it with an eagle eye since his undergraduate days at Princeton. But this impression of inexorable decline doesn’t jibe with my more limited perspective. I’ve been a fund investor since the 1970s and a fund researcher since the 1980s. Over the decades that I’ve followed the industry, I see steady, albeit non-linear, improvement. While the industry is by no means perfect, today it offers investors more low-cost, good-stewardship opportunities than ever before. Moreover, the range of good-quality investment choices facing an investor has never been greater. Financial advisors and their clients have a tool kit today that exceeds that of the top institutions just a decade ago. Fees have come down. Stewardship, as evidenced by manager investment in the funds they manage, is on the rise. Transparency of expenses and holdings, especially for funds domiciled in the United States, is at an all-time high. In short, no sane person would trade the fund options of today for those of the 1980s.
Don’t believe me? Let’s revisit some of the practices common among funds when I started at Morningstar. Loads of 8.5% were the norm. Charging investors full loads to reinvest their income distributions was practiced by several major fund companies, including Franklin Resources. Contractual plan funds that deducted up to 50% of the first year’s investments were promoted by major firms like Fidelity and AIM. Funds did not have to disclose manager names, and many firms hid behind a management team tag or played games with start dates to make their managers look more senior than they were. Fund companies effectively choose their own peer groups, leading to scores of “number one in category” claims that owed simply to miscategorization. Funds were promoted and sold largely on the basis of yield and those “yields” were often inflated by short-term capital gains or return of capital. Worse still, this promotion of yield led to a veritable trail of tears as fund companies wooed investors enticed by double-digit yields into increasingly risky waters, moving from money market to government bond to option-enhanced government bond to corporate to high yield to complex multimarket bond strategies.
Nowhere were investors more poorly treated than at the big wirehouses, which dominated the fund landscape in the 1980s. Responding to client pressure to sell “no-load” funds, these firms began the aggressive promotion of B and, later, C shares, which sought to overcome client resistance to loads without sacrificing any compensation to sellers. In addition to running expensive funds, the wirehouse firms launched gimmicky ones that often blew up on clients. Bogle may think corporate ownership is bad for fund management, but I’d maintain that there’s no worse structure than to have a fund manager being owned by a company with a heavy sales culture. Firms like Dean Witter were abhorrent stewards of fund shareholder capital.
Today’s fund landscape looks little like the 1970s. The wirehouses are all out of the asset-management industry. Asset flows go almost exclusively to funds with lower fees and better stewardship. Bogle’s own shop, Vanguard, has become a towering force in the industry. One can argue that change happened not out of goodwill from the participants, but by the discipline of advisors and investors, but in either case, the result is that shareholder- friendly tactics have won. The single best indicator of whether an asset manager gained or lost market share over the past three decades is whether or not it launched an Internet fund. In short, the good guys have won. Bogle acknowledged this to some degree in our recent conversation at the Morningstar Investment Conference, responding positively when I asked him if in 50 years the industry would be more of a profession and less of a business than it is today. I’d add that the key to that goal will be an informed and demanding shareholder base. In the end, we’ll get the fund industry we deserve. If we are good stewards, we’ll receive good stewardship in return.