Friday, November 02, 2007

John Bogle: The Old Tiger Still Roars

In 1951 John Bogle wrote his senior thesis at Princeton. His subject was mutual funds. More than half a century later, the founder of Vanguard and godfather of indexing is still writing material of Ivy League caliber, delivered in the form of books and lectures.

Two recent lectures deserve attention.

His speech to FINRA deals with the growth and deterioration of the mutual fund industry:
[T}he past half-century has been one in which a beautifully simple concept—owning a broadly diversified list of investment-grade stocks (and/or bonds) at low cost, investing for the long-term rather than speculating for the short-term, designed for fund investors who buy and hold for the long-term—has become a complex, expensive, confusing exercise in, to a greater or lesser degree, speculation, giving rise to a huge depletion of wealth for the 100 million American families who own mutual funds.

In that half-century period, we—at least, too many of us—have tried lots of clever, faddish ways to gather more assets from the investing public—option-income funds, “government plus” funds, short-term global funds, adjustable-rate preferred-stock funds, to say nothing of funds investing in “sin” stocks, etc. Nearly all of them have come and gone, and fund failures have now risen to an annual rate of about 5 percent. Not bad? Only until you realize that at that rate, a decade hence, fully one-half of today’s 4700 equity funds will be gone—consigned to the dustbin of history.
In Black Monday and Black Swans, Bogle widens his gaze, contemplating the human frailties that contributed to the Crash of '87 and the Mortgage Derivatives Meltdown of '07:
. . . probability is a slippery concept when applied to our financial markets. We use the term risk all too casually, and the term uncertainty all too rarely. This distinction was first made by the late University of Chicago economist Frank H. Knight, who spelled it out in his seminal work, Risk, Uncertainty, and Profits, in, well, no uncertain terms.

Here’s what Knight wrote:
. . . uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated. The term “risk,” as loosely used in everyday speech and in economic discussion, really covers two things which . . . are categorically different. The essential fact is that “risk” means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character. A measurable uncertainty, or “risk” proper, is so far different from an immeasurable one that it is not in effect an uncertainty at all.

Knight continues:

The facts of life in this regard are in a superficial sense obtrusively obvious and
are a matter of common observation. It is a world of change in which we live, and a world of uncertainty. We live only by knowing something about the future; while the problems of life or of conduct at least, arise from the fact that we know so little . . . in business as in other spheres of activity. We act according to (our) opinion, of greater or less foundation and value, neither entire ignorance nor complete information, but partial knowledge.
Later in the speech, Bogle returns to themes covered in his 2005 book, The Battle for the Soul of Capitalism.
[C]apitalism has changed for the worse. In a half-century we’ve moved from an ownership society where individual shareholders owned 92 percent of all stocks and financial institutions owned only 8 percent (Chart 6) to an agency society in which institutional shareholders now own 74 percent of all stocks. But we haven’t changed the rules. These mutual fund and pension fund managers have largely ignored the interests of their principals—fund shareholders and pension beneficiaries. To restore balance to the system, we need a new fiduciary society in which the interests of these 100 million principals—the last-line investors of America—come first.

John Bogle doesn't much care for most wealth managers. He feels their fees and commissions turn the zero-sum game of trading stocks into a losers game. Wouldn't be surprised if most wealth managers didn't care much for Bogle. But despite his idealism (or because of his idealism) the Old Tiger, whom Time places among the world's 100 most important and influential people, deserves close attention.

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