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Are the Interests of the Nation and the Investing Public Best Served by Accepting

Are the Interests of the Nation and the Investing Public Best Served by Accepting a Mutual Fund Industry Consigned to “A Permanent Morass”?. John C. Bogle Founder, The Vanguard Group Remarks before the Financial Markets Conference Sea Island, GA April 16, 2004. 2.

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Are the Interests of the Nation and the Investing Public Best Served by Accepting

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  1. Are the Interests of the Nation and the Investing Public Best Served by Accepting a Mutual Fund Industry Consigned to “A Permanent Morass”? John C. Bogle Founder, The Vanguard Group Remarks before the Financial Markets Conference Sea Island, GA April 16, 2004

  2. 2. The Investment Company Act of 1940 Mutual Funds: • Are vested with “a national public • interest and the interest of investors.” • Must be “managed and operated in the • best interests of their shareholders, rather • than in the interests of advisers, under- • writers, or others.”

  3. The Public Interest and the Interest of Investors Require that Funds Provide: 3. • A sound repository for long-term investing. • An efficient medium for accumulating funds • for retirement. • A contribution to the proper functioning of • our capital markets. • Constructive participation in corporate • governance. • Full and fair disclosure of risks, returns, and costs. • Stewardship of shareholder assets that is • independent, conflict-free, and empowered.

  4. 4. That is Not How Fund Organizations Operate Today • “In practice, a mutual fund is a (corporate) • shell . . . another consumer product.” • There is “one and only one reasonable objective • (for a fund advisor), to maximize its own profit.”

  5. 5. Let’s Look at the Record In the Past Half-Century: • The mutual fund industry has moved from a • major focus on stewardship to an overpowering • focus on salesmanship. • Marketing and asset gathering have supplanted • prudent investing as the industry’s highest value.

  6. 6. How Has the Industry Changed? Let Me Count the (Seven) Ways

  7. Once Funds Were Bought to be Held, • Now They’re Bought to be Sold 7. 1949 2003 Number of Equity Funds Large-Cap Blend 66 572 Large-Cap Blend Specialized 9 1,952 Other Div. Equity 381 Specialized 694 International Total 75 3,599 Total

  8. 8. 2. Once Funds Were Managed by Investment Committees, Now by Portfolio Managers Management Mode 1950: Almost Entirely Investment Committees 2003: Investment Committee - 0 (?) Single Portfolio Manager - 2,917 funds Management Team - 601 funds

  9. 9. 3. Once Mutual Funds Were Long-Term Investors, Now Short-Term Speculators Mutual Fund Portfolio Turnover

  10. 10. 4. Once Fund Investors Held for the Long-Term, Now Too Often Only for the Short-Term Investor Turnover of Equity Fund Shares

  11. 11. 5a. Once Cheap, Now Funds Are Dear Equity Fund Expense Ratios

  12. 12. 5b. Once Cheap, Now Funds Are Dear Estimated Total Expenses of Equity Funds Asset Increase: 1,265 x Fee Increase: 1,620 x Turnover Costs Expense Fees Equity Fund Assets (Bil) $797 $3,800 $3.0 $17 $24 $79

  13. 13. 6. Once Corporate Citizens, Now Funds are Corporate Dilettantes Fund Ownership of all U.S. Stock 23% <2%

  14. Mutual 7. Once A Private Profession, Now a Public Business 14. Ownership of Top 50 Fund Organizations 1958 2003 1 7 23 6 6 7 Private Financial Conglomerates International Conglomerates Major Brokerages Public, Independent

  15. 15. How Well Have Funds Served Shareholders? Average Annual Return, 1984 - 2003 13.0% Market Return 10.3% Fund Return Investor Return 6.8% 3.5% The Cost Penalty The Timing and Selection Penalty Source: Dalbar, Lipper.

  16. 16. How Well Will Mutual Funds Serve Retirement Plans in the Future? Growth of an Investment Plan Over 40 Years Ann. Return

  17. 17. The Mutual Fund Scandals: The Symptom of our Structural “Agency” Disease, Not the Cause Remedies: • 4 p.m. cutoff • 2% redemption fees • Disclosure of costs, incentives Will help, but only at the margin. Root Cause: A failure to honor the 1940 Act requirement that funds be managed solely in the interests of shareholders.

  18. Optimal Solution (Not a “Silver Bullet”) 18. Reform Fund Governance by Empowering the Mutual Fund Board of Directors. 1. Require an independent chairman. 2. Allow only one interested director on the board. (Why any? Remember the duty of loyalty, and that “no man can serve two masters.”) 3. Provide the board with objective, unbiased information. • Large complexes: Board gets its own staff. • Small fund groups: Board uses consultant. 4. Federal fiduciary duty statute. (Add “nine little words.”) • “Directors shall have a fiduciary duty to assure that • funds are managed and operated in the best interests • of their shareholders, rather than in the interests of • advisers, underwriters, or others.”

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