Fri, 23 Oct 2015
Rather than an elaborate breakdown of fees, investors would benefit from more clarity on transfer agent fees and the impact of expenses on investment income, says Vanguard founder Jack Bogle.
Christine Benz: You've mentioned fees on a number of occasions today. Let's talk specifically about a recent case that involved a firm using transfer agent fees to pay for distribution. I guess the broader question that I have for you is whether there should be more clarity and transparency for fund shareholders in terms of how fees are broken out. Could it be a little bit clearer about what fund investors are paying for?
Jack Bogle: Well, I think there's obviously a good argument for that. But I have to say, deep down, I don't think it matters. Say you're paying 80 basis points a year for the management fee. Anybody who thinks that fee goes to management is dreaming. Half of it goes to profits for the manager. I did this analysis a few years ago; probably 15 basis points out of the remaining 40 basis points is used for investment management. The advisor's profit is up here; the amount actually used for investment may only be 10 basis points. A lot is spent on marketing.
So, I don't think the additional [transparency would be harmful]. But again, going back to simplification, I don't know what investor really cares if somebody has a fee of 80 and it's 70, 12, 19, and 4 or something, and someone else has a fee of 80 and it's 21, 4, 3, and 1--and that would change with fund size. So, I don't think you really need the breakdown. There has been a lot of argument about it, and I know there has been a lot of thought about it. But I do think that we need a whole new level of information for funds--specifically, information on those transfer agent fees and who gets them.
When we started Vanguard, it didn't occur to me that they would go anywhere other than to the fund that generated the transaction. Why would it go anywhere else? All of a sudden, I become aware of the fact that probably in half of the industry, the manager takes those fees on securities lending. Now someone is suggesting that the manager can take half the fees. I don't see why. The manager is paid to run the fund and making quite enough, thank you, on his management fees. But that should be disclosed--a clear disclosure of where the fees go. I think that would eliminate where we are now.
I also have a couple of other thoughts that I might mention to you about how information is still lacking. We need information in the prospectus that shows how you get the percentage of investment income. You should have the percentage of gross yield in the fund, the percentage of expense ratio, the percentage of net yield, and the percent of the gross yield that's consumed by expenses. You would find that, for most equity funds, somewhere between 40% and 70% of the yield--sometimes 100%--[is being eaten up by expenses]. In a small-growth fund yielding 1%, with a 1% expense ratio, expenses consume 100% of the dividends. People should know that. They'd be stunned. In bond funds, getting reasonable yields today is just shockingly difficult, but you find that while the general level of interest rates has gone from maybe 6% or 7% to maybe 2% or 3%, the fee is still 0.5% plus the rest of the expense ratio--some people could stay at 0.5%. So, they're consuming big chunks of the income that you need. And so, that would be another 1% fee that is consuming your income.
Another one is redemption ratio. Nobody knows what to do with that statement of changing assets.
Benz: Let's talk about how that's calculated.
Bogle: Well, I'd say it's pretty easy. You take your redemptions--both cash redemptions and exchange redemptions--out of a fund and take that as a percentage of the fund's assets. We used to show it to our directors at Vanguard and at Wellington. I've been calculating that number for 64 years. We used to use it as an index of shareholder satisfaction. That's what the chart was called at Wellington.
Benz: So, if people are churning through the fund, they're maybe not that satisfied.
Bogle: If you are redeeming 8% of your assets every year, the shareholders are pretty happy. And the industry redemption rate used to be 6% percent. So, they were happy. Then, all of a sudden, if it went to 12%, your unhappiness level has doubled. It's not quite as easy as that, but it's a great guideline. It's also used--as you probably know, Christine--as a holding period proxy. So, you divide the number into 100 and, at the 5% redemption rate, the average shareholder is holding it for 20 years. At a 20% redemption rate, the average shareholder is staying in the fund for just five years.
Now, as compared with the 6% to 8% redemption rate when I came into the business, the redemption rate, including exchanges out, is running at about 26%. That's four-plus times more. Why is that?
Benz: Does that [percentage] factor in exchange-traded funds as well?
Bogle: No. It does not include exchange-traded funds.
Benz: So, presumably there's much more trading there.
Bogle: They are off the charts there. We don't have a chart for that yet. I'll devise one later on. It would be up in the thousands.
Then, for example, people at one of the large-growth funds, at one point with all this training going on, had assets of somewhere around $200 million, and they had $1 billion of purchases and $1 billion of exchanges every year. Think about that. Is something going wrong here? Where were the directors? Good question. Where are the directors of index funds that are charging 25 basis points? Do they have a fiduciary duty? You can't rely on the directors. Make the information available. It's a commodity product--let's face it. But when they say they're going to charge 5%, I don't know how the directors can sit there and say "aye" for a management charge that couldn't conceivably be explained away. I'm sure they have a little short conversation in which they say that the charge [probably isn't reasonable], but they really need it because they don't want to get in the way of their other funds. And then they go on to the next order of "business," such as valuing money market funds' assets or something.
Benz: Jack, in a lot of ways, though, when you look at fund flows, your message has resonated. The assets are going to inexpensive funds. People aren't buying the pricey funds these days.
Bogle: Well, just to give you an example: Year to date, Vanguard has taken in $148 billion of cash and the rest of the industry has lost, I think, approximately $60 billion. So, we're doing way over 100% of the cash flow in the industry.
I'll be honest. I was never in this business to run a financial giant with $3 trillion worth of assets. I don't know what to make of it. I wouldn't know how to run a company with that amount of assets. We started the company with 28 people. I loved it--and I can still tolerate 1,000 people. But we have 15,000 crewmembers. (In fact, I'm now totally off your subject, by the way.) One of the big things I do when I'm at Vanguard every day is go over to the galley and have lunch and chat with people and chat with our Award for Excellence winners for an hour each. There are probably 140 team meetings they invite me to. I do retirements, 25th and 30th anniversaries. They call me; I'm there. Talk to them, say hello to people.
Three trillion dollars brings a lot of challenges. As I said 25 years ago, for God's sake, let's always keep Vanguard a place where judgment has at least a fighting chance to triumph over process. We have to work against that every day. Hopefully, we're doing that with some success, thanks to the striving of individuals who are giving us their lives in the hope that they will help make better investors out of people who are giving us the money they'll need to live their lives.
So, I'm still thinking about everything--beyond just the numbers--and enjoying myself.
Benz: Jack, thank you so much for being here. It's always a treat to hear your insights.
Bogle: It's always great to be with you, Christine.