The Vanguard Group

 

Reflections on the Spirit of Entrepreneurship


Remarks by John C. Bogle, Founder and Chairman
Before The Greater Philadelphia Venture Group Philadelphia, Pennsylvania
September 16, 1997

Thank you so much for this opportunity to address you on the subject of "the spirit of entrepreneurship." This was the title suggested by your Chairman, and one on which I'm delighted to reflect today

This happens to be a particularly timely moment for my reflections. For, while I'd never spent much time thinking about entrepreneurship in personal terms, my insouciance was shattered just a month ago. I received in the mail a copy of a 25-page paper discussing my career, written by a Yale senior. It described me (I'm embarrassed about saying this, but, obviously, not too embarrassed to say it!) as "a classic Schumpeterian entrepreneur."

It was Austrian economist and Harvard professor Joseph A. Schumpeter who, in his 1911 work, "The Theory of Economic Development," first identified the entrepreneur as the moving force of economic development. That Schumpeter has become a sort of pop-hero of the so-called "supply side" political movement is not to denigrate his seminal approach to economics. Indeed, entrepreneurship is clearly one of the driving forces in the economic boom that is sweeping the globe today, most obviously manifested in the flowering of the technological revolution. It is hardly hyperbole to describe these years that bridge the transition from the Twentieth Century to the Twenty-First as "the age of the entrepreneur."

But few expected it to be that way. Some 30 years ago, many believed that entrepreneurship was dead. In 1967 in "The New Industrial State," John Kenneth Galbraith delivered the eulogy. Referring to the entrepreneurial corporation largely in the past tense, he postulated a new economy that would be characterized by corporate planning, oligopolies, and scale. The Fortune 500 companies would be in the saddle and would drive the American economy, and the conglomerate (if you have forgotten this concept—or never heard of it—you can learn more about it in your business history books) would be the paradigm for the future. Yet at about that same time, a young kid with a crew-cut, unknown to himself, even in his dreams, was beginning to move from a tried-and-true, buttoned-down career of conventional corporate advancement to a once-in-a-lifetime opportunity to be an entrepreneur.

A Merger That Led to a Revolutionary Structure

In 1966, I had been put in charge of Wellington Management Company and told to "do whatever it takes" to get the company back on track. It was a wonderful, proud company and an industry leader since its founding in 1928 by Walter L. Morgan—one of the grand old entrepreneurs of the mutual fund industry, alive and well today at age 99 and still a powerful source of friendship and support for me—but it was facing critical problems. I suppose it was partly business necessity, partly impetuousness, and partly the bullish spirit of that era that persuaded me that the best hope for the company was to engage in a merger, one that astonished the investment community.

Twas done quickly—in 1967. Our giant (for those ancient days) $2 billion firm joined forces with a tiny Boston firm called Thorndike, Doran, Paine and Lewis. It brought what I thought at the time was remarkable investment talent to Wellington, and also "conglomerated" this conservative and narrowly focused firm, giving us entrée into the private investment counsel business and the "hot product" side of the mutual fund industry. The combination received considerable public attention. The fledgling Institutional Investor magazine ran a cover story entitled "The Whiz Kids Take Over at Wellington." Business Week described "a free-form financial corporation offering a complete line of financial services worldwide . . . that may shake the entire industry."

We started off with a bang, and by the time 1967 was over, Ivest Fund was to have the best five-year record in the fund industry. Our strategy had paid off, and our business boomed. But a bust soon followed. The Go-Go Era collapsed in 1968, and then came the terrible 1973–1974 bear market (down 50% from high to low; yes, it could happen again). The new investment talent proved a painful disappointment, and the bloom was off the rose. The merged firm's fund assets under management, which had increased from $2 billion to $3 billion, had tumbled below the $2 billion mark as 1974 began. The strange bedfellows, who had fallen from whiz-kids to goats in just seven years, had a falling out, and my Boston partners mustered the power to fire me as President of Wellington Management Company on January 23, 1974. (Now, why do I remember that exact date?) The vote was 10 to 2, with only myself and director John Neff—then portfolio manager of Windsor Fund, and to this day a legendary contrarian investor—dissenting.

In a sense, of course, life is often fair. I made a big error and I paid a high price. My determination to move quickly, my naiveté, and my eagerness to ignore the clear lessons of history had led me into a serious lapse of judgment. My error had resulted in failure—but, just maybe, reflected the attributes of a budding entrepreneur.

For if I had within my persona an entrepreneurial spark, that date marked its bursting into flame. Rather than accepting defeat and quietly fading away to another career, I pulled out an idea I had been actively nurturing for five years, and had publicly vetted in another Institutional Investor article in January 1972 ("A Wellington Whiz Kid Grows Older"). Indeed it was an idea that arguably had hung in the background for 23 years, beginning with my senior thesis on the tiny mutual fund industry, written at Princeton University in 1951. The idea, simply put, was that the mutual fund industry would do better for itself if it gave investors a fair shake. The collapse of my career in 1974 presented the opportunity to put in place a new structure that would do exactly that.

Whether it was entrepreneurial spirit, foresight, or an extraordinary instinct for self-preservation, I sprung my big, indeed rather revolutionary, idea on the board—but not the same board that fired me. The directors of the Wellington-managed mutual funds, as it happened, were scheduled to meet the very next day, January 24. In this context, you should understand that under federal law, a majority of a mutual fund's board must be independent of its investment manager. So, while I had lost on Tuesday at one board table, I figured that I had a fighting chance of winning on Wednesday at the other, where my adversaries still had considerable power, but not omnipotence.

The idea was simple in concept: The funds would now manage themselves, with an eye solely on the interests of their shareholders, rather than entrust the management role to an external company seeking profit for itself. To do so, the funds would simply acquire the mutual fund activities of Wellington Management Company and operate on an "at-cost" basis. (At then-market prices, the purchase would have had a two-year payback. It would have been a great deal!) Such an acquisition, which would have "mutualized" the mutual funds, would have been a move without precedent in the history of the mutual fund industry.

The Struggle to Develop the New Structure

Alas, ever the optimist, I failed to take into account the power of inertia. Unprecedented extreme moves are rarely the province of a thoughtful, conservative board of directors, especially a board where the stakes are high and the board is philosophically and politically—Philadelphia versus Boston—divided. The idea failed, but I had a fallback plan. We would internalize only the business side of the funds—operations, administration, legal, and accounting—and leave investment management and marketing—not only the fun side, but the arena where I had built my earlier career and where our future would be determined—to Wellington Management Company. The compromise was struck, and I and some 28 souls who trusted me to make it all work moved from Wellington to become full-time employees of the funds—Wellington, Windsor, and seven others.

I confess to being a bit devious—but only in a worthy cause!—at this point. While I accepted the compromise, I had no thought whatsoever that the structure just put in place would remain intact. Rather—though I said very little about it—I was certain that our future required full mutualization, also running the investment management and marketing activities in-house. Only then could we determine our own future. And only in this way could whatever entrepreneurial spark I had fully flourish.

The first step was to give the new fund-owned company a strong name. (To my horror then—but a blessing in disguise—the fund directors had determined that the Wellington name—except for Wellington Fund itself—would remain with my adversaries.) I picked a name borne partly out of Duke of Wellington and Napoleonic War era British history, and borne partly out of my lifelong love of the sea. These two were connected in my mind by Lord Nelson and his flagship in Britain's smashing victory at the Nile in 1798. It was a name that also reflected my conviction that we were truly onto a new and better way of running a mutual fund complex. It was, of course, the name "Vanguard."

After heated debate, the fund board approved the name. "The Vanguard Group, Inc." was incorporated on September 24, 1974. By this time, the bottom of the bear market was at hand, and our assets, which had fallen from the $3 billion peak, through $2 billion, were down to $1.4 billion—a decline of more than 50%. And hard times were to face us for eight years, until the summer of 1982, when the great bull market that I must credit for the lion's share of our growth began. That bull market, unprecedented in financial history, remains intact to this day.

The hard times we faced were reflected in tough financial markets, magnified by the poor performance of Ivest Fund and Wellington Fund, although Windsor, under John Neff's aegis, performed admirably. Believe it or not, the Dow Jones Industrial Average, which had reached 1,000 in 1966 still languished at 1,000 in 1982—16 years later. (Over the next 15 years, a rather different market environment would take it to 8,000!) Our firm experienced 80 consecutive months of capital outflow, with more shares redeemed by investors than purchased, every single month.

But bad times helped us in critical ways. With business so poor, the directors were open to suggestions for improvement. I had long believed that having the lowest expense ratios would not be good enough to establish us as the legitimate, low-cost provider of mutual fund services. We would also have to eliminate all sales charges. So I urged the board to abandon the old broker-based channel in favor of appealing directly to self-motivated investors, the better to serve a public which, I posited, would be increasingly well-educated and savvy about investing. Wellington Management Company resisted, and we were able to wrest control of marketing and distribution from them, cut expenses again, and make an unprecedented conversion to no-load distribution in early 1977. (Another close call, 8 to 5, at a still-divided board.)

Now we were both administrator and distributor. So we turned our attention to the third leg—investment management—of the three-legged stool on which mutual fund activities rest. The boom in money market funds, which were to grow to more than 50% of industry assets in 1985, gave us our entrée. The board approved (9 to 2—a landslide for a change) our assumption of advisory responsibility internally for our money market and bond funds in 1981. Slashing the expenses of these funds by doing the job ourselves at rock-bottom cost, we raised net income for shareholders accordingly. Our resultant superior yields, combined with our existing strategies of peerless investment quality and defined maturities, has made us the dominant force in fixed-income funds today.

So by 1981—just six years after we began as a tiny administrative business—we had become the full-fledged mutual fund organization that I had sought, without success, to become in 1974. Our fund assets had grown to $3.7 billion. The conversion to our truly "mutual" structure was without precedent. And along the way, we had taken just one more unprecedented action, in fact our very first action after we got up and running in 1975. We formed the first index mutual fund. The modern Vanguard that the world knows today was in place.

The Inescapable Logic of Our Index Fund

Oddly enough, my Princeton thesis ("funds should make no claim to superiority over the market averages") might have been the genesis of my interest in indexing. The idea was simply to match the market and, by keeping costs at minimal levels, to win the game in the long run. I've always had a bit of an intellectual bent to go with the opportunism and determination that were required to develop the full Vanguard structure. As an avid reader of the academic journals, my intrigue with the concept of index investing had been focused and fortified. I had watched the concept gain a toe-hold among a few banks and pension funds during the mid-1970s, but no index mutual fund existed.

The opportunity to create the first index mutual fund—and make it work—was in itself exciting. Technically (I argued), it wouldn't involve "investment management" for our new firm, which the board had decreed as taboo. Instead, the fund would be passively managed, simply tracking the market. I knew it would work if run economically by an "at cost" operation like ours. It was the opportunity of a lifetime, and we grabbed it.

As soon as Vanguard began operations, we developed a plan for the formation of the first index mutual fund in history. The board (once again, after considerable controversy) approved it four months later, in September 1975, and it was incorporated in December. Then named First Index Investment Trust—though known more familiarly in the industry as "Bogle's Folly"—the fund began operations with $11 million of assets in August 1976. It's had a good run, solidly outpacing the returns of about three-quarters of all actively managed funds. And the now-well-known 500 Portfolio of the renamed Vanguard Index Trust, with assets nearing $50 billion, is the second-largest mutual fund in the world. It constitutes about one-half of our index book of business of 26 passively managed stock and bond funds, now approaching $100 billion in assets. These assets, in turn, compose nearly one-third of our asset total today. Standing alone, our index funds would be the nation's seventh largest mutual fund complex. All in all, it wasn't too bad an idea.

Schumpeter's Three Entrepreneurial Standards

Looking at this history, our Yale senior sought to reach his conclusion. If I were to be deemed an entrepreneur, I would have to fulfill the three tests of entrepreneurial drive set forth by Schumpeter: first, the dream and the will to found a kingdom; second, the will to conquer and the impulse to fight; and third the joy of creating and exercising one's ingenuity. Here's what the Yale paper found:

"First, the dream and the will to found a kingdom . . ." Here, the paper, using Schumpeter's standard, generously dates my dream as first arising in my Princeton thesis. He notes, correctly to be sure, that "the dream was in and of itself not remarkable . . . particularly for a young idealist. What was remarkable was that he had the determination to stick with it until he had created . . . a new sort of investment company, 'of, by, and for the investors'—not the investment managers." And the author is right. That is just what Vanguard is today.

While he lauds Vanguard for having "a real and tangible sense of purpose," the author points out, correctly I think, that my Princeton thesis provided but a "nucleus of a vision" of a new industry, and "a blurry one at that," and that Vanguard is not as idealistically driven and preordained as the public version of our founding suggests. To this degree, he views Vanguard's creation as a myth—albeit "a good one." But in all, I pass his first test: "Bogle has realized his dream."

"Second, the will to conquer, the impulse to fight, to succeed for the sake, not of the fruits of success, but of success itself." Turning to this Schumpeterian standard, the paper describes how I conquered a bad situation, by dint, in the author's words, of "sheer force of will." But he notes that without these external circumstances, there is a question as to whether that internal will would have had the opportunity to function. He concludes, doubtless correctly, that "were he not forced to act out of the ordinary, he would not have acted out of the ordinary. . . . because his conservative nature (I'm sure that's accurate) ensured that his entrepreneurial passions would remain largely checked until circumstances called for their release."

He also describes me as a fighter, noting that "the fight first to secure Vanguard's independence and then to see it triumph has been the story of Bogle's life since 1974." He describes the rivalry between Vanguard and Fidelity as a "feud," although I really look at it as a fair fight between two firms with approaches toward investing that are polar opposites—philosophically, conceptually, and strategically. Not surprisingly, he also touches on another fight—my 35-year struggle to conquer a failing heart, capped by the miracle of receiving a new one just 18 months ago. Together, these three examples give his basis for affirming my impulse to fight.

Turning to the fruits of success, the Yale senior agrees with Schumpeter that material and monetary gain is not the prime mover in the entrepreneurial process. He recognizes that my motivations were "not so purely altruistic as the Vanguard myth would suggest," since my early actions were based importantly on wanting to control my own career. However, he concludes that I've enjoyed success for its own sake, not for its fruits, for I own none of a company worth (his guess, and fair enough) between five and ten billion dollars, even as he points out that I haven't done badly in a financial sense. That's true as well. Then he says, in a neat turn of phrase, "once a man has more than enough for himself, only the fool measures his success in terms of coin and treasure." Entrepreneurs or not, we should all take heed of that thought.

I warned him that "I do not have a great mind," but he credits me with two traits that may be good substitutes: "the gift of making the obscure seem obvious and the opaque transparent" and "the determination and energy to be a tireless crusader for his ideas." I suppose it has been these gifts—called for throughout a career marked by a sense of purpose, success and failure, elation and disappointment, close calls, a bit of foresight, and no small amount of luck—that have been the major part of the basis for my quest to make this a better world for mutual fund investors.

"Third, the joy of creating, getting things done, of simply exercising one's energy and ingenuity." This final standard, the author argues, is at the heart of the Schumpeterian understanding of the entrepreneur. He finds this evident in the innovative Vanguard structure and in the creation of the first index fund. "While this concept was scorned by the investment community" he points out, "today it is hailed as the hallmark of responsible investing." He states that the entrepreneur must be both prime mover and doer, "able to give his creations—his gems of vision—the force of hard work so that they might last and be noticed

A Slice of the World in Context

In all, the author concludes that I qualify under Schumpeter's three standards of entrepreneurship—the dream of a kingdom; the will to conquer and the impulse to fight for success, primarily for its own sake; and the joy of creating and exercising energy and ingenuity. "The best entrepreneur is an educated man," the paper adds. He gives me credit for what I told him was "an uncanny ability to recognize the obvious." And honestly, I think that's most of what I've offered. He credits that gift "as arising from a naturally curious mind combined with a liberal education, facilitating an understanding of the nature and context of a business, and putting his own slice of the world in context."

You now know enough about Vanguard, I hope, to decide for yourselves whether I'm truly "a classic Schumpeterian entrepreneur" . . . or even an entrepreneur at all. So, let me conclude by putting this saga of my own (infinitely small) slice of the world in context. Times have changed since Vanguard began in 1974. "The tyranny of compounding" at a fairly consistent 26% annual growth rate has turned a tiny firm into a giant corporation. The original crew of 28 now totals 5800. The dream has become the reality. Clearly, if an entrepreneur is defined as a leader who turns an idea into an enterprise, and if $300 billion of assets qualifies as an enterprise, then the day of the entrepreneur at Vanguard has passed. The skills of the manager, not the leader, are—must be—in the driver's seat. The creator, however, remains the spirit and the missionary, and the mission remains unchanged: a fair shake for fund shareholders.

And that's, I suppose, my story—so far.

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