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Bogle's Key Factors for Measuring Stewardship

Christine Benz

Christine Benz: One of your passions, Jack, is talking about the stewardship of fund management companies, and in [your recently published book, The Clash of the Cultures], you go through what you call is a stewardship quotient where you look at some criteria that you think any company managing your money should have. And let’s talk about what you think are the key things investors should focus on when they are evaluating the quality of fund company stewardship.

Jack Bogle: Sure. And by stewardship, just to be clear, I mean to what extent is the firm putting the interest of its mutual fund shareholders ahead of the interest of its managers? And that comes down to, in many respects, issues of cost. So, you start off with expense ratios; if they are very high, the directors aren't doing their job. They should be competitive or low; maybe much lower. Nobody can reach Vanguard alas, and we're starting to drive that a little bit ourselves anyway. But that’s number one.

Number two, they should be focused on long-term investment strategies, not short-term speculative strategies. They should be investing prudently. You can measure that somewhat by the rate of portfolio turnover. The average turnover of a mutual fund portfolio in this business today is almost 100%, and that means they hold the average stock for one year. That is unequivocally speculation, and it costs money. It's hidden money, but they never tell you--nobody tells you--you basically don't really know with any firm numbers. But the cost of that is kind of undisclosed. I use a rule of thumb of around 0.5%-1.0% of the turnover. So, if you turn over at 100%, those costs are 50 basis points to 100 basis points a year. Well, in some cases that's higher than the expense ratio of the fund. So that's a big factor.

Independence of directors [is another factor]. You don't want the board to be dominated by the management company. You don't want the chairman of the board of the fund to also be the chairman of the board of the management company. You want independence on the board. A whole host of other things like that: Do they carry a sales commission, do they have 12b-1 fees? Those are big negatives for shareholders, positives for managers. And you can go right down, and I think I had 15 of them on the list. I guess the last one I'll mention, which I think is extremely important if somewhat subtle, and that's: Is your fund management company independent to operate in your interest?

Well, the fact of the matter now, Christine, is there are 50 large mutual fund managers and 38 are owned by giant financial conglomerates. And these giant financial conglomerates have a terrible conflict of interest. They want to earn a return on their capital, the money they buy the mutual fund manager with. But the shareholders want to earn an optimal return on their capital, and they conflict on these issues of cost and performance. I think one thing, if we can develop a fiduciary standard, which I keep working on.

Benz: A federal fiduciary standard.

Bogle: A federal fiduciary standard, I would ban that conflict. They would have to divest those funds, the publicly owned funds. I think I said the conglomerates own 38 of the 50 largest companies, and it's about probably six publicly held managers. And that's 44 managers that have a different kind of conflict. Why does a shareholder buy a management company?  Because he thinks it's going to earn more and more money, I mean, this is not complicated. And when the managers own a lot of the company themselves, they want to earn a lot more money. And it's not at all clear, by the way. To be crystal clear on this point, even privately held managers Capital Group, for example, Fidelity, and Dodge & Cox are not free of these conflicts.

Benz: They have an interest in driving their own profitability, as well.

Bogle: Sure. And Vanguard is not free from conflict. Our executives want to make money, they want to build the firm, and that's OK. So, it's a question of degree. But nobody, I want to be very clear, that no one is free of these conflicts.