Was Bogle’s Princeton Thesis Eerily Prescient?

On this episode of The Long View, Eric Balchunas joins us to discuss the beginning of Vanguard and his latest book, The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions. Here are a few excerpts on the Bogle Effect and the storied history of Vanguard and Bogle's career from Balchunas' conversation with Morningstar's Christine Benz and Jeff Ptak:

The Bogle Effect

Benz: So, Jeff referenced that your book is called The Bogle Effect, and you've referenced this in your remarks so far. But what is the Bogle Effect, in your opinion? Balchunas: I used to use the phrase where I think—I still do—the Vanguard Effect. When you see Schwab lower their fees and then BlackRock and Fidelity, it's sort of all a byproduct of Vanguard and having to compete with them. So, we used to call that the Vanguard Effect. And as I explored this book, I had a few different titles in mind. But I wanted to put his name first and foremost, because I felt like without this guy himself none of this would have happened. And then, obviously, with the Vanguard ownership structure was very unique. So, those two things I thought were the core catalysts to all the change we see. Index funds merely a byproduct of that initial core. And the effect is just generally the ripple effects across all of the industry. And as I just mentioned before, it's well beyond index funds. Obviously, Vanguard has active funds. The passive funds are actually changing the way other active funds behave. It's getting more concentrated so they can complement Vanguard. Vanguard is getting into wealth management. Wealth management has them getting into private equity. So, you go on and on, and you realize that this is going to be a big deal for a long time. It's not just a passive thing or an index fund thing. And so, I really wanted to put the spotlight on Bogle's character and uniqueness and the structure's uniqueness and build from there and give that the credit for the explosion that is going to continue to ripple out through the whole enchilada.

Pivotal Moments in Bogle’s Past

Ptak: In the book you trace Bogle's life career and long arc. So, I wanted to focus for a moment on the early stages of his life and career. Bogle, he came from what had been a wealthy family, but he didn't lead a life of privilege as a young person. How do you think those early life experiences set him on his future course? Balchunas: I think they were pivotal. I think a couple of things maybe later were equally as pivotal. But obviously, your childhood is major. First of all, he was always working. He was a scholarship kid. He had a taste or a sniff of the Great Depression. I always tell people, like especially my mom and my family, I would say, "Visiting Jack Bogle was like hanging out with my grandfather, not my father." He was not a boomer. He was a World War II-type guy. He had the same sense of humor. The office had like pictures of warships and stuff, just like my grandfather. And that generation was very thrifty generally. They had just seen things that the rest of us haven't. And I think he had enough of that that was a nice core for him. And obviously, working off of scholarships, he had to work, doing all kinds of jobs, including setting bowling pins. And in my life, as I've met people who had to work through college, they tend to be the most successful people. That's a really good ethic to begin with. So, I think thriftiness was important. Obviously, that paid dividends later. And in fact, I do think there was some genetics at work though. His great grandfather was a populist fighter of insurance companies. And Bogle lists some of his great grandfather's speeches in one of his books. And it's fascinating how similar their language is. His great grandfather was the one who said, "Gentlemen, cut your costs." He just copied it. So, there was some genetics at play, I believe, and of course, obviously, the environmental aspects that I said as well. And I think his father was not a great achiever; he didn't achieve a lot and had trouble holding down a job. And I think that also probably sparked Bogle to want to make something of himself.

Bogle’s Princeton Thesis

Benz: The academic thesis that Bogle wrote when he was a Princeton undergraduate was eerily prescient. Can you talk about the main thrust of the argument he made in that thesis? Balchunas: It really is something how the seeds of Vanguard are in there. Basically, he wrote this thesis that says something along the lines of future growth can be maximized by reducing sales charges and management fees. Funds can make no claim to superiority over the market averages. And the principal role of the investment company should be to serve its shareholders. That's pretty good. That definitely gives some credence to the way Bogle wrote the rest of his life, because circumstance definitely played a big part, but Bogle would put himself as the hero. And some people will push back against that, and there's definitely some truth there. But those core statements are pretty much the foundation of Vanguard. A lot of things had to happen first, but they're right there. And one interesting tidbit about the Princeton thesis—two of them. One is, he was looking for an idea for the thesis in the library at Princeton. He didn't know what he was going to write about. And he picked up Fortune. And there was an article on mutual funds in that magazine. And it was deep in the magazine, and it wasn't on the cover. You had to be curious to get it. I think his curiosity and reading a lot helped him a lot in his life. In addition, I looked at what was on the cover of other magazines at the same time and Time magazine at the time had Conrad Hilton on the cover. So, I do imagine what if he picked up Time instead? It's interesting how two different paths—he maybe had been a low-cost hotel guy. But the other thing that's interesting is Michael Lewis—I interviewed him for the book—and Michael Lewis has a binder he keeps. And when I told him this, he goes, "Wow. I got to print that out because I have a binder that I keep of Princeton thesis that have changed the world." I'm not sure if he is planning to write a book about it. But the atom bomb was first devised in a Princeton thesis; Teach for America. And there's this history of Princeton thesis having a lot of things that were seeded right there that became actual major accomplishments or events or ideas that formed.

The Serendipitous Start of Bogle’s Career

Ptak:

That's fascinating. You mentioned serendipity and the role that it played in his choice of thesis. I wanted to talk about another somewhat odd confluence of events. This one took place when Bogle was working for his first employer, which was Wellington Management Company. Can you talk about what happened when Bogle was working there and how that, in essence, brought Vanguard into being?

Balchunas:

I'll try to keep this as short as possible because it is a long story literally. And part of the challenge of writing this book was to condense this so I didn't bore the non-nerd people. And I kept rewriting this section, so my mom understood it. Because you can get lost in the weeds here with structures and mutual funds versus the investment advisor. But the long story short is, Bogle in the ‘60s was given control of Wellington by his boss at a young age. So, he was running Wellington at age 35. And they were having problems, because in the ‘60s, it was like this past decade where the arcs of the world were crushing it, and boring investors were really having a tough time. And Wellington was more on the boring side. It was conservative. It was a balanced fund. And so, in order to, as Bogle puts it, "I was selling nutritious bagels, but everybody wanted donuts." He figured he'd have to sell donuts.

So, he went over and looked out to partner with an equity manager. And it's interesting. He went through a bunch that said no—Capital Group, Franklin—and I think the fifth or sixth one that he chose was Thorndike, Doran, Paine and Lewis. And they remind me a lot of ARK. They were a high-flying growth manager that was just crushing it. Some of those stocks like Xerox back in the day were like the Teslas of their day. And so, for a while, it worked. It was a good partnership. The flows started coming back in. But then, the bear market hit. And these guys had a real falling out. And I think Bogle felt like he had betrayed his mentor and the company by selling out and giving these other hotshot growth managers too much power in their partnership. They had effective voting control. So, they got into a fight, fingers were pointed, and basically, they fired Bogle.

And so, instead of going off and licking his wounds, like I probably would have done, he basically fought back, and he found a little leverage, which was that he was still the president of the mutual funds themselves. And so, there's this wonky detail that the mutual funds are like shell companies, and the president of those funds actually had some control over—they're like general contractors; they can decide who is doing what role. So, he used that leverage to basically dig in and fight with them. Over the next couple of months, they had a lot of, they called the bifurcation period, and ultimately, the board of the fund said we need a solution. So, Bogle had to come up with a solution that would make everybody happy and somehow pass the board, which had some of his new partners on it, but also some of his older Wellington people who are fans of Bogle, but it had to be unanimous.

Anyway, long story short, what they decided and what Bogle came up with, was the idea to create a back-office company that would just do the boring stuff that Wellington didn't want to do. And they wanted to manage money; OK, fine, you do that. We'll keep you as investment advisor; we'll do all the back-office stuff; I'll run that company. And by the way, we'll make it mutually owned. That way, nobody thinks I'm trying to get out of here and put a bunch of money in my pocket. And so, that's how Vanguard was born as the sort of boring, mutually owned back-office company. And it was just a way to save his job in a way and appease all these different parties so they would be able to resolve this nasty, really unusual situation. I think you're right that that is very serendipitous. And I think it was a great study in just how sometimes the best things come from the worst experiences, and I would say this is a great example of that.

This article was adapted from an interview that aired on Morningstar's The Long View podcast. Listen to the full episode.