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The Greatest Hits of the Index King

The New York Times
Richard Teitelbaum
October 8, 2000

What keeps mutual fund executives awake at night?

The thought of a 50 percent drop in the Nasdaq composite index? Or of a star portfolio manager leaving to start a hedge fund? Scary stuff, sure, but I think the industry's worst nightmare would be John C. Bogle as Securities and Exchange Commission chairman.

Unfortunately for fund investors, Mr. Bogle, 71, the founder of the Vanguard Group, is not rumored to be on anybody's short list for a top job at the S.E.C. But if his latest broadside, John Bogle on Investing: The First 50 Years, is any guide, that is not likely to keep Mr. Bogle from unloading on the matters that have irked him for the past half-century: ineffectual governance by fund directors, anemic fund performance and the seemingly outrageous fees that investors are charged for the privilege of parting with their assets.

The book, Mr. Bogle's third, makes for an auspicious kickoff to a McGraw-Hill series, ''Great Ideas on Finance,'' by top-flight financial thinkers.

Bogle fans will find themselves on familiar ground here, especially when it comes to topics that deal with the fund industry. The core question, provided that you accept Mr. Bogle's line of argument, is: Why do fund companies do things that so flagrantly ignore fund shareholders' interests?

For him, the answer is obvious: The corporate structure of fund companies poses an inherent conflict of interest.

Fund companies, or the financial conglomerates that own them, put their own shareholders' interests ahead of those of fund shareholders. ''A man cannot serve two masters,'' Mr. Bogle observes. So it hardly seems surprising that fund directors, appointed by the parent company, seldom stand up for those whose interests they are charged with representing.

It needn't be that way. As Mr. Bogle tells it, in 1974 he himself helped persuade the directors of 11 funds run by Wellington Management (which had recently fired him as president) to turn over administration of the funds to his new company, Vanguard. That established the funds' independence and in turn validated Vanguard's own pioneering corporate structure: the firm is owned by the funds that it manages, which are in turn owned by their shareholders. So the only interests to be served by directors are the funds' shareholders, the entire enterprise ultimately focusing on lower expenses and higher returns.

As Mr. Bogle puts it, Vanguard embodies ''the majesty of simplicity in an empire of parsimony.''

The book is mostly a collection of Mr. Bogle's speeches over the last 30 years to a range of audiences, from the Owen School of Management at Vanderbilt University to the Philadelphia chapter of the American Association of Independent Investors. For hard-core Bogle-ites, the book also includes his 1951 college thesis, an analysis of the fund industry.

Of course, Mr. Bogle wields a wicked pen, as when he takes on marketing efforts by free-spending rivals that he says resemble ''white sale ads that would do Bloomingdale's credit.'' Or the payments that investors are forced to make to financial intermediaries, like stock brokers, exchanges, and rival fund groups, which he says ''hardly represent capitalism's finest hour.''

Other great investors may polish a homespun, almost cornball style -- Warren E. Buffett comes to mind -- but the erudite Mr. Bogle, in the first 100 pages alone, cites Gertrude Stein, Felix Frankfurter, Rudyard Kipling, Cervantes, Shakespeare and Cato. And yet I have never read as clear a description of Economic Value Added, a way of measuring corporate returns, as the one here. In the rarefied subgenre of investment writing, Mr. Bogle has no equal.

The speeches are grouped thematically -- on investment strategies, on Vanguard and so forth -- not chronologically. So readers must flip back to the beginning of each chapter to remember just when Mr. Bogle was cautioning against ''unbridled optimism'' or advising that ''today is far more likely to be a time of investing opportunity than the harbinger of Armageddon.''

For the record, Mr. Bogle's past stock market forecasts are mixed. But they are convincingly reasoned and unerringly focused on the three key factors that contribute to future returns: price-to-earnings multiples, earnings growth and dividend income. Obviously, these are points to think about, given the current high P/E of the Standard & Poor's 500, the low dividend yield and worries about the effects of a slowing economy on earnings.

But market forecasting, he reminds us, is a risky endeavor, and not one to which he himself claims any particular genius. Look to history for guidance, while remembering, as he puts it, that ''the stock market is not an actuarial table'' and that future gains are impossible to divine.

Because investors cannot forecast returns, he says, why don't they focus on things that are predictable and controllable, like reducing risk and expenses?

These ruminations on investing, filling the first third of the book, are a succinct primer -- at least for the novice investor and certainly for those fund holders groaning under the yoke of high management fees.

All the arguments and data about investing, of course, highlight Mr. Bogle's great invention: the index mutual fund. You know the drill: An actively managed fund, with its higher trading costs, taxes and expense ratios, is outperformed over time by a low-cost, indexed one. An initial investment of $10,000 in the average equity fund in 1984 would have grown to $57,000 by late 1999, while a like amount invested in a fund tracking the Wilshire 5000 index would have grown to $100,000. Because this is a constant Bogle theme, readers must digest similar exercises again and again.

Without casting doubt on Mr. Bogle's credentials as a zealous champion of the individual investor, it is fair to question some of the barbs he tosses at critics. Or the defensiveness that he displays on the matter of Vanguard's competitors.

A case in point is his take on some recent challengers to Vanguard's lineup of index funds, namely exchange-traded funds, or E.T.F.'s. Like index funds, exchange-traded funds track market indexes and offer bargain-basement expense ratios.

But E.T.F.'s can be bought and sold throughout the trading day, while standard mutual funds can be bought only at that day's closing price. E.T.F.'s are also sometimes even more tax efficient than Vanguard's 500 Index fund.

But Mr. Bogle criticizes them because of the ease with which they can be traded, positing that such liquidity encourages high turnover among investors. Perhaps, but because hyperactive traders have little effect on those who hold their E.T.F.'s, his criticism seems off the point.

Although he is best known as a fund investor's advocate, he offers abundant wisdom in his speeches on a wide range of issues affecting the overall health of the capital markets. He cites the insidious effects of managing earnings - when companies massage their income figures through accounting tricks - and the growing wave of stock options that dilute the equity of corporate America.

Moreover, the idealism that has characterized Mr. Bogle's career is reflected in his personal life. He discusses his own heart transplant, in 1996, in a speech entitled ''Telltale Hearts,'' a personal thank you to families of organ donors. It is a plug, to be sure, for more people to make such donations, but a noble one.

And in a commencement address, to the Haverford School, the prep school in Pennsylvania, he cautions against rampant materialism, the worrisome fallout from a seemingly never-ending bull market. ''Two thousand five hundred years ago, the Greek philosopher Protagoras told us that 'Man is the measure of all things,' '' Mr. Bogle said. ''Today, I fear, we are becoming a society in which 'Things are the measure of the man.' ''

 

Ever the Foe of Market Guesswork

The New York Times
By Richard Teitelbaum

INVESTORS in index funds should circle Dec. 31 on their calendars. That date will be the 25th anniversary of the incorporation of John C. Bogle's grand invention, the First Index Investment Trust, today known as the Vanguard 500 Index, the largest stock mutual fund in the United States. And the pioneering fund company that Mr. Bogle founded, the Vanguard Group, has grown apace, with some $575.5 billion in assets under management at quarter's end.

And Mr. Bogle himself? Nearly five years after a heart transplant, the wiry, irascible evangelist of common-sense investing keeps quite busy writing, researching and giving speeches. He gave up most of his day-to-day responsibilities at Vanguard last year and now, at 71, he presides over his own organization, the Bogle Financial Markets Research Center. In an interview, he spoke of some abiding concerns, especially indexing and the hyperventilating market, and shared thoughts about his latest projects.

RICHARD TEITELBAUM Q. Though it has gained wide acceptance, indexing as a fund strategy still comes in for criticism - that indexes like the Standard & Poor's 500 are too narrowly focused on large caps, for example. Do the critics have a point?

A. I'm not bothered with the S.& P. 500. The S.& P. 500 represents 75 percent of the market, and in the long run I would be flabbergasted if it didn't have the same return as the Wilshire 5000 Total Market index, because of the reversion to the mean - large caps do better for a while and then small caps do better. Returns have been identical.

Q. What is the right question to be asking about indexing?

A. ''Do we have the right indexes?'' You don't need to structure an index so that it throws out a stock when it gets too big. So we're thinking about whether there are better ways to index.

Q. You don't see yourself as a market forecaster, but you do make forecasts. How do you approach the task?

A. I believe profoundly that earnings and dividends are the only long-term, long-term determinants of stock prices. P/E is a short-term, speculative determinant, although there may be a little upward bias as our economy has gotten more stable. What I do is challenge investors to say: ''Don't tell me what the market return will be. Tell me what you think the fundamental return will be, and then we'll guess together at what the speculative return will be.'' That makes thinking about the market a rational exercise, rather than just a guessing exercise.

Q. Seen that way, where is the market headed?

A. Earnings are growing 8 percent, more or less, and the dividend yield is a little over 1 percent. That gives you a fundamental return of a little over 9 percent. The market P/E is 30, and if it reverts to the mean I'd say it's likely to be about 20, leaving an investment return of about 5 percent going forward. Of course, the market never returns the same two years in a row, so it is more likely that you'll see a period of significant decline, and then higher growth rates from then on.

Q. You gave up your seats on the boards of Vanguard's funds nearly a year ago. Do you miss that part of the business?

A. No, I'm having the time of my life. I talk about the differences between relinquishing your intellectual and moral power, which I couldn't possibly relinquish such as they may be, and relinquishing your power over the person - your power to manipulate people and things of that nature. I don't miss those kinds of power at all. I'm doing what I want to do, and I'm hoping that with the five extra years of life that the Lord has given me, I'm still doing things for shareholders.

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