The outspoken sage is outraged that his old company sells funds with 'Wonder Bread' sales tactics while holding itself out as the low-cost choice

June 14, 2013 — 5:25 PM UTC by Lisa Shidler

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Brooke’s Note: I love John Bogle, especially after reading this article. That doesn’t mean I think he’s right. In fact, I very much hope he’s wrong. He stood in front of a mutual fund crowd and blasted away at the idea of spending the big bucks to market those products — singling out Vanguard Group for perhaps his greatest wrath. (My sense is that he feels that the Malvern, Pa. fund giant deserves the special place in his doghouse reserved for hypocrites and people who meddled with his creation.) At RIABiz, we depend on the marketing dollars of several mutual fund companies, so we have mixed emotions on that point. But we have clarity about the fact that we like people who fully speak their mind, gracefully and impoliticly, if you will. Two sources we respect deeply, Pat Allen and Burton Greenwald, have leapt to Vanguard’s defense in this article. The story’s balance is there, except with regard to our favorable bias toward ornery old sages.

John Bogle blasted the company he helped build — The Vanguard Group Inc. — for becoming a marketing machine, arguing that when marketing becomes a spending priority that nothing good comes of it.

Yet the industry patrician made his point in a way that did not come across as self-righteous with some self-deprecation.

“Every time I did something for marketing reasons, it was going to be on the long list of things I shouldn’t have done. I’ve done too many things for marketing reasons,” Bogle said Thursday speaking at Chicago’s McCormick Place at the annual Morningstar Inc. conference.

Bogle, who co-founded Vanguard and is seen as an industry icon, also didn’t back away from his views, which triggered controversy on the recent Public Broadcasting Service special about the retirement crisis. People felt he was too hard on the fund and 401(k) industries and too easy on consumers and plan sponsors. See: Why the industry needs to accept some blame for 'flaws’ in PBS Frontline’s 'Retirement Gamble’.

Though his remarks followed a familiar pattern with other speeches and interviews he does around the country, his words carried an additional oomph for being delivered to an audience chock full of mutual fund marketers and the advisors who eagerly purchase their products. See: Eavesdropping on the Tiburon CEO Summit: A cross-advisory channel power crowd converges on Wall Street Ritz-Carlton.

Among the ducks in his shooting gallery were: executive compensation, political donations and decisions mutual fund managers make that aren’t geared toward shareholders — such as spending for expensive advertising that says you watch every penny on behalf of investors.

Adding wattage to Bogle’s electrical storm was a very game Don Phillips, a Morningstar, Inc. managing director, who seemed to revel in asking Bogle the hard questions and putting him on the spot about his well-publicized disputes with Vanguard. “To what degree does it pain you to be estranged from current present management?” Phillips asked Bogle point blank. See: Jack Bogle steps aside as senior standards chairman at Advizent.

Bogle replied: “They have a problem. Here’s this old guy who keeps saying what he thinks. Would he just shut the …” and Bogle coyly trailed off.

It’s not me, it’s you

Bogle also joked about his dispute with Vanguard, saying: “People say to me, 'I understand you disagree with Vanguard.’ Absolutely not. I’d never do that. Vanguard disagrees with me. I’ve been in this position for too long and I’m too old to speak vigorously in a position I don’t believe fundamentally about. It gets me in trouble. I never know what Vanguard’s position is in these things. I think it’s important to have someone like me around for this business. You have to stand for what you stand for.”

Emily White, a spokeswoman with Vanguard, says that one of her company’s positions is that Bogle left Vanguard in 1996 and no longer speaks for the company.

“He’s very influential in the industry and [since he left] we’ve grown significantly and we’ve invested more in things like technology, ad development and marketing. It’s a very measured approach as with everything we do.”

White also maintained that shareholders are always the company’s priority when making decisions. “Our shareholders are the crux of everything we do. We hold that to the highest standard.” See: Three RIA citizen journalists file dispatches from the TD Ameritrade conference.

Of course, not everyone is clear whether shareholder interest and investor interest are one and the same when it comes to Vanguard.

Marketing only leads to trouble

One of Bogle’s chief beefs with Vanguard is the company’s aggressive marketing efforts. He spoke more about the problems with marketing in financial firms later in a press conference.

“I’m fundamentally opposed to marketing in a financial business,” Bogle said in the press conference. “The way I look at it — you should define marketing. What do people want? It’s fine if you are selling a product like Wonder Bread, but I never looked at Vanguard as a product-seller. I don’t like the idea of here’s a product, and let’s make another product. Products are fine and marketing is fine, but I think we should be offering products that you can buy and hold your whole life. How many funds can you hold for a lifetime?” See: The marketing naughty and nice list.

Times they are a changing

Burt Greenwald, a Philadelphia-based fund consultant who has known Bogle for many years, thinks Vanguard didn’t have a choice but to respond to heightened use of intermediaries in recent years by getting into the marketing game more vigorously.

“The overall distribution equation has changed so dramatically in the mutual fund industry since the time that Jack Bogle was an operating executive,” he says. He points out that chief executives following Bogle have recognized the changes in the industry and have responded with more-aggressive marketing plans.

“The fundamental approach has changed,” Greenwald says. “You can’t go direct, at least not effectively, and Bogle has always been critical of intermediaries.”

Greenwald says there’s no question that Bogle and current Vanguard executives have the best intentions. “I don’t want to criticize Bogle and I don’t want to criticize Vanguard. I think what Vanguard is doing is a reflection of major changes that have occurred over the last 10 to 15 years.”

Easy target

Pat Allen, principal of Rock the Boat Marketing, who attended the Morningstar conference, believes marketing has evolved since Bogle was building Vanguard years ago. “Today marketers understand that the best, long-term approach is to align with customers and what’s in their best interests,” she says.

She points out that Bogle is certainly an industry icon, but that marketing is often an easy punching bag. “People like to deride marketing as a catch-all for something aggressively promotional and something that people want to run the other way, screaming from,” she says. “The way I think of marketing is in more contemporary terms, which is in its role of leading engagement with customers, of bringing them closer.”

Breaking up hard to do

Bogle spoke about his early days creating Vanguard with fondness. “This is a company filled with a remarkable story of luck, chance, fights, battles and every one of them I enjoyed. I didn’t enjoy them. I loved them. I love a good fight.”

He concedes that some in the industry may think it’s time for him to get out of the ring and stop sparring with the industry, but he’s not planning to do that anytime soon.

“Sometimes, the creator gets lost in the shuffle in other people’s egos. And, it’s OK. That’s life. There’s no way to change it. You just have good humor and smile and accept that things have changed. I still feel very good about what we created at Vanguard.”

Blows at mutual fund industry

On a roll, Bogle hit the retirement industry in the United States hard, too.

“The retirement system in the U.S. is facing three train wrecks, all of which have to be fixed,” he says. “You’ve got to do something before it gets here.”

He spoke about the constant underfunding of Social Security and maintains that it could be fixed pretty easily if the politics could be pushed aside. “Simple things end up being completely controversial,” he says. “You become a little cynical when you’re in the business as long as I am. The reality is there’s a fair way to adjust the cost of living. I could solve this problem in five minutes if you could take the politics out of it.”

Defined-contribution plans, which he pointed out began as thrift savings plans, are also a giant problem. “We’ve taken a thrift plan and turned it into a retirement plan. To make it a real retirement plan, you’ve got to do things.” See: Blog battle: Vanguard 401(k) principal and president of 401(k)-tracker have it out over the Internet.

Bogle criticized the government for continuing to let participants withdraw from these accounts and ultimately hurt their long-term retirement savings. He says rules need to be better defined to prevent that.

People don’t count Social Security as an asset

The industry as a whole forgets how important Social Security is as an asset to clients, Bogle observed. For instance, he says, when investors are reviewing their portfolios, they don’t factor in the ever-important Social Security income payments. By adding in Social Security income, he maintains that investors may have more flexibility with their retirement accounts.

“For about 90% to 95% of investors, their retirement account is not their entire asset base if they counted on Social Security,” Bogle says. “Social security is another asset base.”

Focus on stream of income

Bogle maintains that investors and advisors need to stop focusing so much on an account’s value and focus more on the stream of income.

“You need to look at the stream of income,” he says. “If Social Security pays you $25,000, then you need to look at the other side of income to produce your income. As long as checks come, you shouldn’t care how big or little the account is, as long as the checks keep coming.”

Bogle continued: “You have to focus on dividend checks, and social security checks will also continue to grow,” he said. “As long as you go to the mailbox and you continue to pull out the fund envelope and the government envelope, that’s all that should matter to you in retirement. I think we’ve got to change the mental attitude and not give away so much to money managers who have trouble earning it.”

Dividends count

Advisor Cathy Curtis of Curtis Financial Planning was at the conference, and she agrees with Bogle’s opinion about helping retirees allocate part of their portfolio to dividend-paying stocks. See: What three highly wired financial advisors have to teach us about social media.

“The yield, plus potential for price appreciation, are perfect for a retiree investor profile,” says Curtis. “Yes, there will be volatility, but there can be in bonds as well, as seen in the last couple of weeks. Simple truth is, the longer we live, the more money we will need,” she says. “And we’re all living longer. Investing too conservatively in retirement isn’t a good strategy unless, of course, one is lucky enough to have enough saved where taking risk isn’t necessary.”

Bogle also spoke about how he feels the money market fund system needs to be overhauled.

“The probability of something bad happening in the market is tiny, but the consequences are very dire. I think we still must act. I’ve had a lover’s quarrel with the fund industry for the last 65 years. They don’t want to get down to the truth. I don’t think we should compromise.”


Mentioned in this article:

Morningstar, Inc.
TAMP
Top Executive: Joe Mansueto



Share your thoughts and opinions with the author or other readers.

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Jeff McClure said:

June 14, 2013 — 7:22 PM UTC

when John Bogle gets sanctimonious I cannot help but remember the many speeches he gave as the Chairman of the Vanguard Group. During the late 1990s he commonly claimed that all a person needed for a secure retirement was a low-cost S&P 500 Index fund. At the time Vanguard had just passed Fidelity in the race for biggest fund. That winner was their Vanguard 500 Index fund. Anyone who followed his very non-fiduciary advice back then paid a very high price. To the best of my knowledge he has never acknowledged that he was wrong.

Mr. Bogle coined the term, “The S&P 500 outperforms 85% of mutual funds.” If ever there was a list of misleading statements that has to to be near the top of the list. In fact, out of 311 large cap blend funds with 10 or more years in business, the Vanguard 500 Index fund (VFINX) is number 135 in performance for 120 months according to Morningstar Principia. Looking at that number over a long period, VFINX hovers around the 50th percentile. Stating the truth that by investing in a low cost 500 Index fund an investor historically has done better than about half of the large-cap blend funds doesn’t exactly match with the 85% statement.

Were Mr. Bogle one of those “intermediaries” he so despises, he would have been subject to disciplinary action for making such an unbalanced, promissory, and misleading statement over and over again. Worse, he was inadvertently outed as a major hedge fund investor in the early 2000s but the SEC. He was the one that said everyone should use indexing because active management was useless and too expensive. At the same time he apparently was paying 2.5% management fees plus 20% of gains to be a major investor in a hedge fund.

I will be glad to listen to his wisdom when he admits that he mislead the public and was an out and out hypocrite while he was at the head of Vanguard.

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LCD said:

June 15, 2013 — 12:05 PM UTC

Well I guess that says it. Bogle is the one who misled the public and is the hypocrite. Aren’t we all lucky for the rest of the industry for their integrity and always being forthright. What a mess we’d have if they were all like Bogle.

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Jamie Dimon said:

June 17, 2013 — 7:45 PM UTC

“At RIABiz, we depend on the marketing dollars of several mutual fund companies, so we have mixed emotions on that point.”

“Mixed emotions”, lol.

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Jeff McClure said:

June 18, 2013 — 3:29 PM UTC

The difference is that the mutual fund companies that are clearly in the profit mode are just that. I don’t expect Best Buy to suggest I go to Lowe’s, or, heaven forbid, Ace Hardware. On the other hand when a company and its leader make a claim to be solely acting in the best interests of their mutual fund shareholders, and then give conflicted and factually incorrect advice in public forums, I would expect a mea culpa.

John Bogle’s ongoing claims to be for low-cost index investing and denigrating any and all forms of professional investment management other than indexing is starkly at odds with his behavior for his personal wealth. Were he a registered investment adviser, his conflicts of interest would be fraudulent. My complaint is not that he invests where he wants, but that he created and creates unbalanced and misleading sets of numbers that rather obviously seem to be directed toward getting business for the company that pays him, all while claiming to be objective and the mutual fund investor’s best friend.

We are a fee-only IA firm, and I am the President and Chief Investment Officer. I, indeed, am displeased with the hidden fees and misleading numbers from the retail broker-oriented funds, but I recognize commercial speech for what it is. We use several Vanguard funds routinely, but I can say with a great deal of evidence to support my claim that there are actively managed funds that have very consistently done better in their asset class than the comparable index fund at Vanguard. Were John Bogle what he claims to be, a seeker of truth and an advocate for the average fund investor, I believe he would have a very different presentation.

I have had clients, particularly in the late 1990s, who took all their money and charged off to follow the Prophet Bogle. They did exactly what he said to do in his speeches and went all in to the Vanguard 500 Index Fund. Instead of being retired today, they are still trying to earn a living working at jobs they hate. Some were unable to pay for their children’s college. Those people recognized a fund advertisement for what it was, but they trusted the frugal and honest John Bogle who became and stayed wealthy doing the opposite of what he was preaching.

John Bogle cheapened and damaged the credibility of the investment fiduciary community. He was a pretend fiduciary, not bound by the rules that govern the rest of us. Alan Greenspan made some errors too, but he has “fessed-up” and taken responsibility. Mr. Bogle should do the same rather than bask in his glory. He has never, to the best of my knowledge, admitted publicly just how wrong he was about his advice when he stated repeatedly in the late 1990s that, “All the typical investor needs is a low cost S&P 500 index fund to retire comfortably.”

For whatever it is worth, the PIMCO executives have done the same thing with their endless denigration of the stock market while espousing the virtue of bond investing. In August of 2002 and again in March of 2009, Bill Gross very publicly strongly advised that “It is not too late to get out of the market.” warning that the worst was yet to come. Those who followed his advice were the losers, but where is his admission that he was flat wrong?

No, Bogle is not the only sinner, but those who claim to speak solely for the small, individual investor and claim to be his or her advocate in the face of rampant evil fund managers, have a much higher standard to which they must be held. It saddens me to see Bogle and Gross feted like kings and prophets. Intentionally or not, they speak to enrich themselves, not the investing public.

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Mac said:

August 3, 2013 — 5:33 PM UTC

Jeff, your posts are misleading, and they come across like like a misdirected vendetta. Sounds like you’ve misunderstood Bogle’s advice over the years. I guarantee he never said “all you need is the 500 index to retire comfortably”, except in the context of discussing the equity portion of a portfolio. Though even there, Bogle has suggested a total US market index more often, since its more diversified. (But the two are so highly correlated that you can take your pick.) Anyway, I’m guessing you are sophisticated enough to know that Bogle has preached asset allocation and risk control from day one (that is, maintaining a proper mix of equity and fixed income for ones risk tolerance and time horizon.) Something to consider for any future posts you choose to make: No one is going to take a rant about hypocrisy and deception seriously if the rant is based on a misleading premise.

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Jeff McClure said:

August 5, 2013 — 3:01 PM UTC

Mac,

While I never heard Mr. Bogle speak, I certainly had to counter clients who read articles in which he was quoted, and read interviews in which he did, rather directly, state that all an investor whose goal was a secure retirement needed was a “S&P 500 Index fund.” I had clients who left well allocated portfolios in the late 1990s to buy into Vanguard’s “500 Index Fund” because of Mr. Bogle’s reported and published statements, echoed and amplified by a host of publishing pundits.

As you can well guess, those investors were devastated in the market decline from 2000 to 2002, and having lost faith in the system, generally bailed out at the worst possible time. Yes, I have read articles, interviews, and quotes from Mr. Bogle in the years since in which he advocated asset allocation and touted the total index funds, but his statements during the stock bubble of the late 1990s were very real, and I have never found any evidence of a mea culpa.

I personally know investors who were clearly and publicly mislead by Mr. Bogle’s statements. That he was, at the very same time as he touted low-cost index funds as the prime means of investing, while at the same time invested most of his personal portfolio in high-cost hedge funds is another simple fact. As a fiduciary investment-adviser I would be guilty of fraud for doing the same thing.

Yet another example, which certainly has a mountain of evidence, is his oft repeated statement that “the S&P 500 has outperformed over 85% of mutual funds.” Even if one gives that the most generous of definitions, it was only true for about four years in the late 1990s. Even that definition had to include bond-funds to be accurate. In the vast majority of time periods extending three years or more, the S&P 500 hovers around the mid point of all large-cap blend funds tracked by Morningstar. More, if one generates a capital-weighted list of large-cap blend funds, the Index drops, quite consistently, well below the mid-point for five or more year time-frames.

The fact is that a person like myself who is held to the fiduciary standard could not go about making such claims about a portfolio managed by the company I headed, but he did. He was in error, as we all have been from time to time, but he has never apologized for those errors.

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Jeff McClure said:

August 5, 2013 — 5:26 PM UTC

Mac,

If I may, I would like to provide an interesting reference. In “The John C. Bogle Reader” by John C. Bogle, in figure 5.6, he demonstrates that of the funds he illustrates, all with a 25 year or greater audited history, 65 funds underperformed the Wilshire 5000, while 136 funds had a better performance over the previous 25 years as of 2008. In his book, “Common Sense on Mutual Funds” published in 1999, he states that “in the long run, only one of every five actively managed funds is apt to outpace the market index.” He goes on to state that the “Standard & Poor’s 500 Index has outpaced a stunning 96% of all mutual funds. The more representative all-market Wilshire 5000 Equity Index has outpaced 86% of those funds.”

In the “Reader” (published in 2008) he has reduced his historical performance claim for the equity index fund’s superiority from the outpace 80% of managed funds to “match or exceed 50 to 60%.” Note here too that his figures include all funds, eliminating survivorship bias. If he had gone a simple step further and examined large-cap blend funds that have existed under consistent management for at least 10 years, and then weighted them by capitalization, he would have noted that a very large percentage, well in excess of his upper boundary of 60% of actively managed funds “outpace.”

Mr. Bogle, in his published speeches, has commonly warned investors that they are delusional if they believe they can find the “5% of funds that will outpace an index.” Even his Vanguard total Stock Market fund (VTSMX) is only in the 29th percentile among its peers at 15 years. Note that on the Morningstar report for that same period, the average Large Blend fund has an average annual total net return of 5.05% while the S&P 500 Index total return was 4.76%. That is the other side of the story that balances Mr. Bogle’s claims. Had he at any point acknowledged that from the time he published his “Common Sense” book, the average Large Blend fund has actually outperformed the S&P 500 Index, I would be applauding him.

Indeed deep in his books he includes the nuanced advocacy of asset allocation, but in his public comment during the 1990s, he consistently states that “85% of funds underperform the market” in his rather blatant advocacy of “S&P 500 Index funds.” At that point the largest fund in the market was the Vanguard 500 Index fund, and none other than John C. Bogle was the CEO of Vanguard. I have searched high a low and cannot find a single reference in the late 1990s to Mr. Bogle publicly advocating that an investor limit his or her exposure to the S&P 500, and more critically, to the large-cap growth stocks that by that time had come to dominate that index.

Does any of this suggest that I am against lower costs? in a word, “No.” I also recognize that in some asset classes Vanguard’s equity funds have a clearly superior long-term return. I do find it interesting that in a careful quantitative analysis, Vanguard’s best risk-adjusted returns are found in funds they offer which have multiple active management firms and little evidence of indexing.

John Bogle has has contributed a lot of good things to the knowledge of investing, but his nearly unqualified advocacy of equity index funds in the 1990s was, in my opinion, self-serving, unbalanced, and misleading. Those advocating the use of value funds combined with intermediate-term bonds got run over by the stampede to low-cost S&P 500 Index funds, notably including Harry Markowitz who was fired by Nomura because his value fund failed to match the S&P 500 Index. John Bogle threw gasoline on that fire, even as he, both in his book, and in public interviews and speeches, glorified the “triumph of the equity-index fund,” followed with comments about the intrinsic superiority of his invention, “the S&P 500 Index fund.” Yes, deep in the dense prose of his book, he included a caveat about the dangers of the market and some investor’s needs to balance their approach, but sprinkled all through his 1999 book are assurances that if one is a true investor, one will achieve vastly superior returns by holding a market index equity fund.

Indeed I do get upset when a person who has the majority of his personal wealth invested in high-cost hedge funds publicly touts an investment strategy that both runs counter to his personal strategy and winds up doing severe damage to trusting investors. I was not particularly injured by individual defections to equity indexing as a central strategy, but they were. Meanwhile, Bogle is treated like an infallible prophet by the news media, and I have yet to hear the hard questions put to him about his public advocacy of his S&P 500 fund in the 90s.

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Mac said:

August 13, 2013 — 4:35 AM UTC

Jeff, your reference to figure 5.6 is confusing. 5.6 shows pre-cost performance. Investors don’t get pre-cost returns. Why don’t you talk about figure 5.5, which shows performance after costs are deducted? It shows that about 85% of active funds underperformed the Wilshire 5000 Index.

Anyway, it is true that for the specific 15 year period you seem most concerned about, the 500 Index Fund falls right in the middle of the pack of funds categorized by Morningstar as large blend. (For now, we’ll leave aside the fact that the fund outperformed the M* large blend category over the most recent 3, 5, 10 year periods and for periods beyond 15 years.)

But your numbers don’t tell the whole story. Since M* doesn’t include closed or merged funds in its data, and since funds that close or merge are typically chronic underperformers, it’s well known that the M* category average return is inflated. (I know you know this).

One study on survivor bias estimated that M* the large cap blend category return is inflated by 1.9% per year. Compound that 1.9% over 15 years and you can conservatively assume that 70% of funds in the style category either underperformed 500 index fund or simply didn’t survive. And again this is over a specific 15 year period with starting and ending dates of your choice. Over most other periods the number would be closer 80-90%. (According to M*, $10,000 invested in The 500 Index Fund in 1976 would have grown to $453,179 compared with $409,777 for the large blend category average. And that’s with 37 years of compounded survivor bias cooked in! )

OK, next: M* style category performance also does not account for sales charges. So now we’ll push the large blend underperformance number up to 75%. For now, I’ll leave out the issue of after-tax returns (index funds are much more tax efficient) and pretend that everybody puts their actively managed funds in tax protected accounts only.

So now we see that over your favorite 15 year time period , investors had about a 25% chance of identifying, buying and holding a fund that outperformed the 500 Index Fund.

I should also mention that you would have been happy to extract an additional 1% per year in advisory fees from your clients accounts for each of those 15 years (in return for your best attempts to pick one of the few funds that actually survived and outperformed).

Of course even if you picked the right fund over your favorite 15 year period (or any other period), your 1% advisory fee would have erased any pre-cost alpha you might have delivered (and then some), leaving your clients with a net performance not even equal to Bogles’ evil creation. Now I see why you don’t like the 500 Index Fund!

Of course, if we ran that whole scenario through again (over your favorite 15 year time period) this time using Bogle’s other creation (VTSMX), the results would make your case look that much worse!

So the point is this: if you’re trying to convince people that index funds are bad for investors, or that Bogle has somehow done the average investor a disservice, all your work is still ahead of you.

Another thing to note and something I’ll concede: I would not be at all surprised to see active funds as a group do somewhat better vs the indexes then they have in past. Why? Not because they are getting better at beating the market. Its because industry wide expense ratios have come down significantly in recent years. And why have they come down? Because they’ve been forced to compete on cost with index funds.

So ironically, to the extent that active funds suck less in aggregate going forward… you can thank Jack Bogle.

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Mac said:

August 13, 2013 — 3:03 PM UTC

Jeff, you said: “ I have searched high a low and cannot find a single reference in the late 1990s to Mr. Bogle publicly advocating that an investor limit his or her exposure to the S&P 500, and more critically, to the large-cap growth stocks that by that time had come to dominate that index.”

It took me about 30 seconds to find a speech by Jack Bogle from the late 1990s in which he: a) warns that stocks, (SPECIFICALLY large caps ) were overvalued and b) reiterated his beliefs about asset allocation — specifically that those near retirement should have more in bonds than stocks. (Here’s the link: https://personal.vanguard.com/bogle_site/lib/sp19970717.html). I could find countless other examples from that period, but then I’d be doing research for you that you should have done for yourself.

In addition, Bogle’s most popular book Common Sense on Mutual Funds from the late 90s (which apparently you have a copy of ) devotes the entire 3rd chapter to asset allocation. Indeed, one of the most important concepts supporting the idea of indexing is that 90+% of portfolio return variation can be accounted for by asset allocation alone. In other words, the asset classes you invest in drive your returns and risk, not individual investment selection. In his book , Bogle refers to the studies that have established this.

So my question for you is: Is it really Jack Bogle’s fault that you and your clients missed his discussions of asset allocation? Is it his fault that you or your clients “lost faith” and bailed out of the markets at the wrong time because you missed the part of his advice where he says buy the whole market and hold it FOREVER.? I’ve never heard a more worn out record than Jack Bogle on then idea of sticking with your asset allocation in the midst of market volatility. It may have fallen on deaf ears with respect to you or your clients, but Bogle must have uttered the phrase, “stay the course” ten thousand times since the late 1970s. So it sounds like you and your clients were waiting for the consummate buy and hold investor (Bogle) to give you market timing advice on when to bail from then 1990s stock run-up. When it never came, you rode the market down and foolishly sold low, and then felt silly when the market came back (like it always does). And then you blamed Bogle. Never mind that your clients near retirement never should have been 100% in the stock market to begin with.

As for your idea that Jack Bogle promotes index funds to line his own pockets… this is laughable. Bogle started a company that to this day is the only mutually owned fund company in the U.S. For all Vanguard’s success , not one fund company has adopted a similar ownership structure. Why? Because there’s relatively little money in it. Why do you think Vanguards fund fees are so low? It’s because the funds are managed at cost. The at-cost structure requires any profits go toward lowering fund fees, as opposed to lining the pockets of executives. Do you read Morningstar commentary? They’ve had countless articles that explain this. If Bogle was interested in getting filthy rich, he easily could have turned Vanguard private, or took it public, or sold it. He did none of these.

As for your claim that Bogle invests “most of his money in hedge funds”: Would you provide a link to whatever SEC document you are apparently privy to? To show that he has or did have “most” of his money in hedge funds, I’m assuming you can show a) what his net worth is/was, and b) how much he invested in the hedge fund. If you can’t do that, then you probably would have been better off spreading that particular falsehood anonymously.

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LCD said:

August 13, 2013 — 3:41 PM UTC

Mac,
You have been extremely diligent in your responses to Jeff and for that we all thank you. Like you I have never heard or seen any of the things that Jeff attributes to Bogle. To support your points, all of which I agee with, I recently read that 3900 funds have closed or merged since 2009 alone, which from my way of thinking makes the surviorship bias huge in recent performance statistics. I also heard this amusing quote “ to say that active mutal funds have fallen out of favor in academic finance is like saying that leeches have fallen out of favor in medicine.
Jeff any more blood letting you’d like to share with us?

LCD

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Jeff McClure said:

August 13, 2013 — 5:39 PM UTC

Mac,

My point was that members of the public who carefully listened to Mr. Bogle in the late 1990s took his advice in many cases, and many suffered from that advice. His speeches and interviews back then were not balanced or even particularly accurate.

As far as the numbers are concerned, if you go to Morningstar’s category returns for Large Cap Blend, 15 years, as of the end of July, 2013, the 15 year average annual return (which includes all funds that existed in the 15 year period, eliminating survivorship bias) is 4.95%. The Vanguard 500 Index Fund (VFNIX) for the same period has a net return of 4.58%.

Those are simple facts. The total return of VFNIX is determined in exactly the same manner as the category return. If there is an error in the method Morningstar uses to determine returns, then the error is present in both figures.

By any analytical method of which I am aware, those two numbers state that the Vanguard investor class S&P 500 index fund over the last 15 years slightly underperformed the average large capitalization blend fund. A person can use heuristic reasoning to come up with very nearly any number, but heuristic reasoning is fairly notorious for producing less than optimal results. Yes, the Vanguard Extended Market Fund did better, but its category is the Mid-Cap Blend, and in that category it is in the 64th percentile.

I recently have had several reviews with our clients who have been with us for extended periods of time. One of the repeating characteristics of those reviews recently is that those clients have experienced long-term average annual returns that are very close to the expected return in their investment policy statements. While I certainly make no claim to be able to beat or match any index, in some of those cases the IPS expected return was near or even above the actual S&P 500 return for the period we were examining. The combination of asset classes we used, supported by the funds we selected in those asset classes, gave us a return net of fees.

I do not claim to be a genius, but I do have some understanding of investing, having been relatively successful as a professional over these past 30 years. I also understand Dr. Joseph Juran’s methodology for manager selection. Fund managers are just that, managers. I have no clue as to how to pick a fund based on anything other than selecting the best, most consistent managers, using Juran’s methodology.

We have clients who started with us three decades ago with monthly investments and are now financially independent. We have others who entrusted us with their retirement funds 15 or more years ago who are still living on the income in a relatively comfortable fashion. Another thing that popped up in a recent review was that while the portfolio had underperformed the Index by one percent per year since 2008, the bear market of 2008-2009 was reflected in that portfolio by a 28% decline rather than the 49% (end of month numbers) decline in the Index.

I don’t question the value of using index funds. We do use them when we cannot find superior management with an open fund available in the market. What I object to is the blatant statement that the Index outperforms 85% of funds, thereby one should use an S&P 500 Index fund (or a total market fund).

Yes, indeed, I make a living. My income is, I am confident, an insignificant fraction of what Mr. Bogle earned or earns today. My, and my firm’s total income is also an insignificant fraction of the money our clients have made. While any statement of our clients’ average return is inappropriate, suffice to say that DALBAR publishes a report regularly of the average return earned by self-directed mutual fund investors, and from that I believe we do add a great deal of value to our clients’ net worth.

One more point, for some reason when we come to the end of the year and note our assets under management, our total revenue does not add up to 1% of that number. Since you seem to be assured of our fee level, perhaps you can explain that discrepancy?

I do not object to Vanguard, or index funds. I am sensitive to public statements by much touted “experts” that have caused people who follow them to make serious and damaging errors. When there is a clear conflict of interest inherent in those statements and no apology follows, then I question the source. If an “expert” issues a caveat and the reader or listener ignores it, then it is on their head, but when no caveat is issued, it is on the speaker or writer.

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Mac said:

August 15, 2013 — 8:07 PM UTC

Jeff,

You said: “ if you go to Morningstar’s category returns for Large Cap Blend, 15 years, as of the end of July, 2013, the 15 year average annual return (which includes all funds that existed in the 15 year period, eliminating survivorship bias) is 4.95%. “

Yes, the 4.95% figure is correct. Your interpretation of what that number represents is not correct. It does not include “all funds that existed in the 15 year period.” It only includes funds that survived to the END of the 15 year period.

Jeff, you said: “Those are simple facts.”

No, those aren’t the simple facts. Again, Morningstar’s figures do not account for survivorship bias. Morningstar DOES, however, keep data on funds that didn’t survive. But you have to download and/or analyze that data separately.

Jeff, you said: “The total return of VFNIX is determined in exactly the same manner as the category return.”

Yes, except that one is the average annual net return of a single fund, and the other is the average annual net return of a category of funds that survived for an entire 15 year period. The category return does NOT include funds that did not survive to the end of that 15 year period. (This is the very definition of survivorship bias).

Jeff , you said, “ If there is an error in the method Morningstar uses to determine returns, then the error is present in both figures.”

There is no error. The calculation is correct. You just seem to misunderstand WHAT is being calculated. It’s not a minor point. If you’re still not clear, see above.

You said: “What I object to is the blatant statement that the Index outperforms 85% of funds, thereby one should use an S&P 500 Index fund (or a total market fund).”

Over the very long term, that 85% figure is pretty much dead on for equity funds, once you account for loads and survivorship bias. For bond funds it’s more like 95% to 98%. I tried to explain why , but you seem to be in denial about survivorship bias, among other things . Jeff, the dead/closed funds that you choose to ignore were very real options that very real people chose in an attempt to beat the market. Just because Morningstar doesn’t include them in their category averages doesn’t mean they didn’t exist.

You said, “when we come to the end of the year and note our assets under management, our total revenue does not add up to 1% of that number. Since you seem to be assured of our fee level, perhaps you can explain that discrepancy?”

You’re right, I don’t have access to your year-end statements. Feel free to swap out the 1% I used in my example and replace it with the 0.95% or 0.85%, or whatever it is you charge your clients. It doesn’t affect my point, which is that your fees make the very long odds of achieving market outperformance that much longer.

Jeff, I don’t fault you for using active funds or for misunderstanding survivorship bias. I’m just not sure why you thought you could go off on such a misguided, ill-informed rant without having someone call you out on it.

I do fault you for making easily disprovable statements about Bogle’s investment advice — and even more — for spreading falsehoods that have bordered on libel, with no evidence to back them up. (Where is your link that shows Bogle invests most of his money in hedge funds? )

You’re so intent on getting mea culpas from other people — Why don’t you step up, set an example, and offer your own?

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Jeff McClure said:

August 15, 2013 — 9:48 PM UTC

Mac,

I have no prejudice for or against index funds. Prejudice has no business in a fiduciary’s mind. Moreover I do understand survivorship bias. I would like to quote from Morningstar’s definition of “Category Averages” as published in the July, 2013 edition of Principia Mutual Funds Advanced:

“Morningstar category averages measure how a category performed over a specific time period while correcting for the effects of survivorship-bias, recently-incepted funds and category changes. Bias category averages do not capture these effects.

Survivorship bias is the tendency for mutual funds to be excluded from a database or study because they no longer exist. This can happen when a fund is liquidated or merged into another fund. When a fund liquidates, the holdings are sold and the proceeds are distributed to the shareholders. The fund ceases to exist and its historical performance is no longer considered in the calculation of bias category averages. When a fund merges with an existing fund, the ‘surviving’ fund into which the fund merged keeps its historical performance, and going forward from the merger point the two funds will exist as one. The prior history of the fund that merged is no longer taken into consideration in the calculation of bias category averages. Because of this survivorship-bias effect, bias category averages tend to skew higher than if those ‘extinct’ funds were included in the historical population. Morningstar category averages address the effect of survivorship-bias by including obsolete funds in the population for calculating the category average during the historical months when those funds were alive.

A related effect occurs when recently-incepted funds or share classes are excluded from category averages due to limited performance availability. When a bias category average is calculated for a specific time period, only those funds with a complete history will be considered. For example, a fund with 58 months of performance history will be used in the calculation of one-year and three-year trailing bias category averages but will not be used in the calculation of five-year or 10-year trailing bias category averages because it does not have the complete performance history. Recently-incepted funds often cause bias category averages to skew lower than if those newly-incepted funds were included in the historical population. Morningstar category averages address the effect of recently-incepted funds by including them in the population for calculating the category average during the months when those funds were alive.”

You seem to believe that the Morningstar Categories have survivorship bias because they only report the returns of funds that survived for the full period. Morningstar claims that they do account for those funds. It would seem that either Morningstar is making a false claim or you have erred. Mac, I have been a Morningstar subscriber from day one and have tracked their methodology all the way. They DO include the dearly departed in their calculations. You are certainly welcome to contact them on that. I have. I have visited their headquarters in Chicago and queried them about that very fact.

Let me quote again the critical sentence: “Morningstar category averages address the effect of survivorship-bias by including obsolete funds in the population for calculating the category average during the historical months when those funds were alive.”

I am quite sincerely sorry that I did not clip that article I read in the Wall Street Journal about John Bogle’s hedge fund investment ten or twelve years ago, when I was still reading the paper version. My memory may be in error as I do not have the evidence, but I recall reading that the SEC inadvertently had posted John Bogle’s personal holdings on its web site, but that it removed them the next day. The article went on to state that a substantial part of his holdings were in a hedge fund. In light of the fact that his son, John C. Bogle Jr. started Bogle Investment Management about that time, it would not have been too surprising to find that he participated, and according to my memory that is what it appeared he was doing.

Notably, Bogle Small Cap Growth has a ten year average annual net rate of return of 9.87%, and has an alpha of 3.65 for that period vs the Morningstar Small Core Index. I am going to make a sincere effort to find that article, but I do not have it on hand.

I want to make something else clear. I appreciate about 95% of what John Bogle, Sr. has to say. We work very, very hard to keep expenses down. As far as fees are concerned, Vanguard’s fees are low, but they still charge fees, and did when John Bogle was CEO. They also hire sub-managers who charge fees. It could easily be argued that they should keep all their management in house and only use index funds, but instead, under John Bogle’s leadership, started sub-managed funds which use active managers. Wellington and Windsor funds have been outstanding performers, but they are anything but index funds. Vanguard Selected Value is one of my favorites, but is not an index fund and is managed by Barrow, Hanley, Mewhinny & Strauss LLC.

If indexing is the only way to go and active management cannot be chosen with any hope of beating indexing, then why did John C. Bogle Sr. select those active mangers, who, by the way, have beaten their respective indexes, net of fees, on a risk adjusted basis? Selected Value, for example, had 19 year a standard deviation of 15.68 versus the Russel Mid Cap Index ETF at 17.96%, yet turned in a better mean!

I agree with his decision to use active management from high quality management firms. I just can’t find a way to reconcile that decision with his loud proclamations that indexing is the only way to go.

Jeff

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Jeff McClure said:

August 15, 2013 — 10:10 PM UTC

Mac,

O.K., I am getting close. Financial Advisor Magazine, January 1, 2001. John Bogle Jr. states that his father encouraged him to start a quantitative investment management firm. He does not disclose who his first investor(s) were, nor where he got his seed money, but the start dates coincide with the article I remember seeing.

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Jeff McClure said:

August 15, 2013 — 11:10 PM UTC

Mac,

Still closing in on the article, but thought I would share this one with you.

New York Times, Business Day, Funds Watch: May 31, 1998.

The article reports that because of the reorganization of the Vanguard Funds into a Delaware Trust, the directors of the fund group had to disclose their holdings in the group. John C. Bogle, the founder and CEO of Vanguard Funds, had 34% of his invested money in index funds, but the rest of it was in actively managed funds. The article quotes Daniel P. Wiener, editor of the Independent Adviser for Vanguard Investors, as stating that Mr. Bogle does not walk the walk but “sort of crawls the walk.”

Frankly, I think his choices of funds reported in the article were excellent, but remember this is the same gentleman that was, at that moment, making speeches, giving interviews, and proclaiming that index funds were the only rational choice.

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Mac said:

August 22, 2013 — 5:16 PM UTC

Jeff, I looked online for the document you said you copied from, and did not find it.

However, adding dead fund returns back to snapshot periods from the past (e.g., calendar years, etc.) wouldn’t address the bias issue.

Here’s what Morningstar said last month about their trailing return data ( I skipped the trip to Chicago, and just went to their website):

“Rankings based on trailing performance are not survivorship-bias-free, meaning they do not include funds that no longer exist.”

Here’s the article: http://www.morningstar.in/posts/16895/making-sense-of-survivorship-bias.aspx

Yes, Morningstar’s data does suffer from survivor bias. So I’ll reiterate my original point.

If you remember , in your first anti-John Bogle rant, you complained that VFINX only “hovers around the 50th percentile”.

If VFINX is ranked in the 50th percentile of surviving fund trailing returns, then you can easily assume that 70% of the funds available over those 15 years either underperformed VFINX or simply did not survive.

Factor in loads and after-tax returns, and you can conservatively estimate that 85% of funds either underperformed VFINX, or did not survive.

And VTSMX did even better, since it was in the 29th percentile in the survivor biased rankings (over those 15 years).

Granted, if all you want to do is compare the relative performance of surviving funds, then Morningstar’s data bias isn’t important. However, if you want to assess the historical likelihood of having chosen an investment that not only remained open but also outperformed, then accounting for survivor bias is critical.

Given that the vast majority of dead funds are, were, and will be poorly performing active funds, it means that the already favorable odds of succeeding with an index strategy become that much more favorable versus an active strategy over time.

I find it curious that a fiduciary who claims to not let bias enter his mind, and who claims to have “tracked Morningstar’s methodology from day one”, would choose to burry his head in the sand when it comes to survivor bias.

That said, my issue isn’t with active funds, or your analysis of them. If you think you can beat the market consistently enough to justify the additional nearly 1% in fees you extract from your clients every year, then that’s between you and your clients, and I wish you luck.

I do, however, take issue with the unbalanced, uninformed, and blatantly dishonest statements you’ve made about John Bogle and the investment advice he’s provided over the years.

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Mac said:

August 22, 2013 — 6:03 PM UTC

Jeff — As for Bogle investing in active funds: I know you only brought it up to distract from your dishonest hedge fund claim (still waiting for your mea culpa), but still, it made me yawn…

Bogle has talked about his portfolio in his books and interviews for decades. It’s consistent with the active/passive Vanguard fund line-up that Bogle helped develop. Bogle even offers advice for how to pick an active fund in the book he wrote (that you apparently own)... Did you miss that part?

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Jeff McClure said:

August 22, 2013 — 7:52 PM UTC

Mac,

The quote I posted was from Morningstar’s Principia published definitions. I did not use the fund ranking that Morningstar posts for each fund. Rather, I used the overall Morningstar Principia Category data. Category returns in Morningstar publications are not survivorship biased (see my previous quote). Individual long term fund rankings, as you noted are. In this case we are then talking about two different measures.

I have listed here the URL for the article with the references to John Bogle having most of his money in actively managed accounts. That is not a sin, as those were excellent funds at Vanguard. He was the CEO of Vanguard when they signed up Wellington and a host of other active mangers. He invested most of his money in those actively managed funds rather than the index funds. Here is the URL for the article:

http://www.nytimes.com/1998/05/31/business/funds-watch-an-unusual-window-into-vanguard.html

I have no objection to any of that. What I do object to is the media’s failure to ever ask him about that issue. I happen to agree that if one attempts to predict the future performance of a mutual fund with no other data than the past performance, the odds are stacked to the negative. On the other hand, there are managers who have persisted in long term performance that is in excess of their respective, appropriate index. As of the end of July, the Morningstar Category, Large Blend, had a 15 year average annual total return of 4.95%. Vanguard 500 Index Inv (VFINX) has an average of 4.58% for the same period. Now, I do not claim to be a mathematician, although I did get an “A” in each of the master’s courses I attended on securities analysis, but when a fund’s average annual return for a given period of time is below the average of all the similar funds that existed during that period, then anyone making the claim that the noted fund outperformed 85% of all funds, has a heck of a burden of proof.

Again, I refer you to Morningstar’s published Category definition, not a reference to a blog about fund ranking. In that blog, by the way, you will note that the author states that some Morningstar historical fund performance data is subject to bias and others are not. According to their published definition of Category Returns, that is not.

Here I will gladly acknowledge that when the Vanguard Total Stock Market Index is measured against the Category “Large Blend”, its 5.33% average is superior to that category average. Now whether your heuristic argument gets rid of the 30% of funds that reportedly outperformed that fund is another question. I do know that the funds that fail tend to have an extremely tiny fund capitalization, so their failure commonly has a very small effect on the overall return earned by the average investor.

In my experience the majority of investors have been using their defined contribution retirement plans as their main investment vehicle. It is vanishingly rare to find a total market index fund in a 401(k). Even in our local medical center’s plan, which is administered by Vanguard, the broad market index fund is their S&P 500 offering.

My point was and is that John Bogle, while he had the majority of his personal investments in managed funds, reportedly proclaimed that a low-cost S&P 500 Index fund “outperforms” 85% of all mutual funds and that the only rational course for the small investor was to use such a fund. More, his speeches about bond funds in the late 1990s were, as far as I can tell from the archives, consistently negative. I have been able to find repeatedly in his archived speeches where he rather clearly states that the ideal for an individual investor is to own a single fund, and that should be a low-cost, broad-market, index fund.

If I may, I would like to quote from his keynote speech to the Boston Globe Money Matters Conference, October 16, 1999: “The simplest of all approaches to equity investors, then, is to invest solely in the shares of a single, all-market equity index fund—just one fund. It is a good plan. And it works.”

Now if I, as a fiduciary, were to make such a statement to one of my clients, and they followed that advice, I would be at great liability for presenting “false and unbalanced” information.

My question, again, is Why has Mr. Bogle not been asked the hard questions?” Why did he have the majority of his money invested in actively managed funds while he preached that investors should only hold indexed funds?

And, by the way Mac, you may note that with the exception of the article on hedge fund investment, I have been able to find a reference for every statement I have made. We may have a difference of opinion, but I am not a liar. I would really like to see a peer reviewed study documenting that an S&P 500 (or total market index) fund has outperformed 85% of its peers over a trailing long-term period. The burden of proof is on the person making the statement. Very notably, in Mr. Bogle’s archived speeches I find that what he is reported there to have said was that during the late 1990s the Vanguard 500 fund outperformed 85% of active funds, but that during other extended periods of time it only outperformed about 22% of funds.

Mac, I hope to end this here. I have read more Bogle speeches in the past few weeks than in the many years I have been in this business. I have noted the number of times Mr. Bogle stated that owning actively managed funds is a good idea (and they were many). My memory was refreshed as to the origin of the nine guidelines for choosing an active manager that I use. It was from one of John Bogle’s speeches. I have also read again and again in his opening remarks before the body of his speeches that he suggested a combination of bonds and stocks. Of course, he then commonly went on to castigate bond funds rather thoroughly!

Apparently Mr. Bogle in his formal remarks as they are recorded at Vanguard did include cautionary statements about asset allocation. Unfortunately, when the media reported his remarks statements similar to the ones quoted above were what made the headlines. It is also notable that I cannot find any evidence that he made an attempt to counter those headlines. Perhaps he did and it was not recorded, but I cannot find it.

I did know good people who truly thought they were following his advice, and put quite literally all of their money in a single Vanguard Index fund. When the pain became too great in the early 2000s, they liquidated. That, in my opinion, as well as evidenced in many studies, is the biggest loss-risk factor. I can say that my clients, even given my far from perfect advice, have faired far, far better than the average mutual fund investor, and, at least according to DALBAR have done dramatically better than the average “do-it-yourself” no-load mutual fund investor.


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