John C. Bogle is without a doubt one of the most listened-to experts on mutual funds in the world. And he should be. Having created the massive Vanguard fund complex and written eight books on the topic, the depth of his knowledge is unmatched.
Bogle was maybe the first, and has consistently remained for decades, a staunch advocate for low cost mutual fund investing. Friday in the Wall Street Journal, he weighed in on Morningstar’s recent findings that low cost is the best predictor of a mutual fund’s outperformance, better than its own star system.
Bogle takes Morningstar’s study as a jumping off point. He goes on to show that even Morngingstar’s conclusions likely understate the advantage of low-cost fund investing.
For one thing, he notes, less expensive funds tend to last longer, making them better candidates for long-term investing, and their track record more valuable. Mutual fund analysis is greatly hampered by “survivor bias” — the fact that poor performing funds are generally closed or merged into others and so the performance record of the good ones outlasts that of the weaklings. Bogle sites Morningstar’s own data finding that the most expensive funds have a 57% survival rate over the past five years. The cheapest have an 81% rate.
He goes on to layer in some disheartening evidence that funds could be a lot cheaper than they are.
According to data Vanguard has collected from the Investment Company Institute (2009) and Wiesenberger (1960), the expense ratio of the average equity fund weighted by fund assets has risen to 0.86% in 2009 from 0.54% in 1960, an increase of 59%.
Despite the modest decline in the expense ratio reported by the Investment Company Institute since 1990—to 0.86% from 1%—total fees paid by equity fund investors continued to soar, rising to $42.7 billion from $2.3 billion. That quantum increase refutes the notion, put forth by so many industry participants, that fund expenses are declining.
During this half-century, industry data show that equity fund assets have burgeoned to $5 trillion from $10 billion, a 500-fold increase. But fund costs rose at a far faster rate—to more than $42 billion from $50 million, a near 800-fold leap. Conclusion: The huge economies of scale available in managing other people’s money have largely been arrogated by fund managers to their own benefit rather than to the benefit of fund shareholders.
The Vanguard founder notes that while expenses as a percentage of equity-fund assets have moved down since the early 1990s, that is not the only metric we should be looking at. As a percentage of dividend income, these expenses have soared, he notes, and that’s a big hit to long-term returns.
According to data we’ve collected at Vanguard’s Bogle Financial Markets Research Center, fund expenses consumed 19.5% of equity-fund dividend income in 1990 (about the same as in 1960). As dividend yields fell, that ratio then doubled to 38.5% in 2009, after reaching an astonishing high of 51% in 2000.
Consider that confiscation of dividend income in the context of the fact that dividend yields have accounted for one-half of the long-term return on stocks—four percentage points of the 8% total. Fund expenses, then, are now consuming almost 40% of that major contributor to stock market returns. With that enormous erosion of income, the average equity fund, according to Morningstar, currently delivers a puny dividend yield of just 1% to its shareowners.
“Fund costs, against all logic, continue to rise, to the clear detriment of fund investors,” concludes the eminence gris of fund investing.