Bogle’s Corner

January 01, 2004

In a speech I delivered in the autumn of 1996, I warned that the "spirit of trusteeship, professional competence and discipline, and a focus on the long term, are rapidly losing their role as the driving force-in the long run, the life force of this industry." Today, the three principal points I made seem almost prescient:

• "The industry's traditional focus on trusteeship, implying placing the interest of fund shareholders as our highest priority and charging a reasonable price for our services, is being supplanted by a focus on asset-gathering-on distribution-as we worship at the shrine of the Great God Market Share, the exorbitant cost of which is borne by our own fund shareholders.

• "The industry's traditional focus on professional competence and discipline has moved from long-term investment to what is really speculation, with rapid turnover in our investment portfolios (averaging almost 100% per year!), funds concentrating on ever-narrowing segments of the stock market, and far too many gunslinger portfolio managers.

• "And the industry's traditional focus on the eminent suitability of mutual funds for long-term investors is quickly becoming a focus on investing in fund portfolios for the short term (a second level of speculation) and, even more baneful, a focus on enticing fund shareholders to use their mutual funds as vehicles for rapid switching, either for the purpose of market timing or for the purpose of jumping on the bandwagon of the latest hot fund (and that's called speculation, too)."

Shocked, Shocked

What we now know, of course, is that the consequences of these three baneful trends have come home to roost in the most painful sort of way: in damage done to the pocketbooks of the shareholders who placed their trust in mutual funds.

The recent market timing scandals are but a midget manifestation of the problem. But the industry's response can be best characterized by a classic line spoken by the police chief in the film Casablanca, Claude Rains: "I am shocked, shocked to find (timing) going on here." We've already been told that the misdeeds are akin to "parking at a meter and not paying. Nobody is being bankrupted by this." And we'll doubtless be told (if we haven't already been told) that these breaches of f i d u c i a ry duty are attributable to only "a few bad apples." Although as these scandals continue to come to light, we may need to liberalize our definition of "few."

Even as the spotlight that shined on the specific acts that brought notoriety to corporate America's bad apples-the Ken Lays, the Dennis Kozlowskis, the Sam Waksals, the Jack Welches, the Richard Scrushys, to name just a few-illuminated all the nibbling around the edges of proper and ethical conduct that, absent the intrusive spotlight, could otherwise have persisted for another decade or more, so does the spotlight that shines on the scandals perpetuated by the bad apples of the mutual fund industry reflect the frequent willingness- nay, the eagerness-of fund managers to build their own profits at the expense of the fund owners whom they are honor bound to serve.

"It's an ill wind that blows no good." By illuminating the inherent conflict of interest between fund managers and fund investors, these scandals will ultimately prove a blessing for fund owners. This conflict is hardly a secret. Indeed in that very 1996 speech, I urged this industry to move to a system in which "the focus of mutual fund governance and control is s h i fted . . . to the directors and shareholders of the mutual funds themselves, and away from the executives and owners of mutual fund management companies (where it almost universally reposes today), who seek good fund performance to be sure, but also seek enormous personal gain."


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