Bogle: Fund Fees have Risen Over 60 Years

Vanguard founder Jack Bogle says economies of scale have not been passed onto investors as the market has grown - instead shareholders of fund companies have benefitted

Morningstar News Team 9 May, 2016 | 2:31PM
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John C. Bogle: The reality is that the idea was so bad or so ill-received, that the second index fund wasn't started until 1984 eight years after the underwriting in 1976. And it was also a failure. And the third one went out of business quickly, and then finally by the mid-90s, it started to catch on.

People saw how it worked and it was working beautifully by the 90s after a bad start and it was a bull market, these large cap stocks were doing very well. We eliminated transaction costs because the index doesn't do any trading. We finally got our cost down. I can't remember what they were in the early 90s, but let's say the cost... you could get at one of our index funds for 15 or 20 basis points, and today you can get our S&P 500 index, and some of the others, with the minimum investment of $10,000, for 5 basis points.

You can own the U.S. stock market at a cost of 5 basis points with no additional cost for portfolio turnover. And that is just a return builder when the other, our competitors, have say close to a 1% expense ratio and probably 1%, or half of 1% at least, turnover cost, portfolio turnover internal cost. And then often offered a sales charge which spread over time is another 1% let's say.

So, we're operating to give the investor 7% stock market, 6.95%, and the others taking 2.5% of the 7% are giving 4.5%. Put that in a compound interest table and you are going to get at the end of 25 or 50 years, maybe four times the amount of capital that you have with the costly fund. And this is not just me speaking, Scott. This is Bill Sharpe, the Nobel Laureate and he has been on this game, cost matters game, almost as long as I have.

Almost every firm, well, every firm in the industry but Vanguard is operated in a way that puts the manager in the driver seat and not the fund shareholder. This is the way the industry is organized, and the fund directors, even the independent directors seem powerless to stop it.

Maybe they don't know, maybe they don't care, maybe they don't look at themselves that way. But it's amazing that this idustry has gone from, oh I guess, when I came into it in 1951, the average expense ratio of a fund, weighted average expense ratio was probably 50 basis points. And the industry has gone from $3 billion to $16 trillion, and the expense ratio, the average weighted expense ratio, has gone up to for managed equity funds to 85.

Now how can that be? Why didn't somebody say, let's give some of these economies of scale which are enormous in this business to the shareholders of the funds, instead of the shareholders of the management companies. And the management companies are hot stocks. You just track them. There are half a dozen, a dozen of them my guess, out there, and with a few exceptions, over time they do much better than the shareholders of the funds.

And I think that's – the industry is going to have to start to think more about mutuality and more about at least the minimum, more about sharing even in retrospect. So, would be a painful thing for the managers, the economies of scale which are boundless and huge, and that's a big step for the industry to take.

The industry won't take it, but one fund will and then another will. And right now though, the fees are still, is much higher than they were when I came into this business, and they've got to come down, because the fees are the differences between investment success and investment failure relative to your peers.

Scott Cooley: I won't ask you to endorse a competitor. But are there firms out there that don't have a mutual ownership structure that you think do a good job of kind of keeping the cost down for?

Bogle: Well, I don't see anybody is really doing a good job of keeping cost down. And people, let say they have low cost, mean they are below the industry norm, and the industry norm for the average actively managed funds, I think I said 85, that's a number out of the ICI, taking index funds out of the equation. And so if you're at 65, you think of yourself as low cost.

For god sake Scott, don't compare yourself with Vanguard, who are going to run the index funds at 5 basis points rather than 65 and run the whole complex at roughly 14 or 15 basis points, counting the managed funds and that's very low costs. So, I think somebody ought to – maybe Morningstar would be willing to do this and they call them high cost, average cost and low cost, I think there needs to be a fourth category called very low cost and there will only be one firm that's in that category.

Now that having been said, if you want to be in the index fund business you have to have low cost to compete. So, Fidelity has very low cost on their index funds, very competitive, totally competitive with ours, but they're when you think about almost the only firm that has a significant index fund business unless you're an indexer like BlackRock or State Street, Vanguard and so on. And so they don't – they have to compete their but they don't want to compete with the rest of their funds on costs.

Something has to happen to bring that down, I mean it's kind of amazing to think I mean I think at T. Rowe price that has a bunch of index funds, they have costs of 20 or 25 basis points I mean that seems well the 25 basis points is 400% bigger than 5 and I don't – I honestly don't see how the directors can accept that and they are by the way pretty good on this. There are funds out there or were at least that had a sales charge on the index fund of 5% or something and a 1% expense ratio. So, you're going to the index fund, you're behind the eight-ball and every year you fall further behind the eight-ball.

Somebody asked people at Wells Fargo how their fund could be so expensive, and this was some years back and their PR person said, I think we're getting good judgement, said, you don't understand there are cash cow, they are Wells Fargo's cash cow, the fund should be shareholders cash cow unequivocal. Did I make myself clear, Scott?

Cooley: I'm getting it.

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