The March 3 issue of the Wall Street Journal included a letter to the editor from Mr. Bogle, in which he clarified some of the contentions made in a letter written in response to his February 9 opinion piece.

Text of letter in response to Mr. Bogle’s 2/9/07 article:

Contrary to Mr. Bogle’s belief, the first index fund was created by Barclays Global Investors (BGI) for institutional investors in 1971. As the world’s largest index manager and the global leader in ETFs, we have enabled investors to access our institutional indexing strength in their portfolios. We’ve responded to what investors and their financial advisers want today — better tax efficiency, flexibility in trading, increased transparency, and access to hard to reach markets that help them diversify their portfolios.

ETFs have attracted significant assets because they appeal to many different types of investors. The vast majority of ETF owners are buy-and-hold investors. On the other hand, about 90% of the ETF trading volume is done by institutional investors such as mutual funds and hedge funds for short-term exposure or to hedge risks. Importantly, this trading happens outside the fund at the stock exchanges; thus long-term ETF investors don’t subsidize the costs of active traders in ETFs.

Lee Kranefuss
CEO of iShares at Barclays Global Investors
San Francisco

Text of Mr. Bogle’s response to Mr. Kranefuss:

Among the responses to my Feb. 9 editorial-page commentary “‘Value’ Strategies” on exchange traded funds (Letters to the Editor, Feb. 24), one from Lee Kranefuss of Barclays Global Investors (BGI) contained errors:.

1. While he denies that I created the first index fund, I have claimed only that I created the first index mutual fund (now Vanguard 500 Index Fund), incorporated on Dec. 28, 1975.

2. BGI did not create the first index fund. The first pension account to use an index strategy was created by Wells Fargo Bank in 1971, acquired in 1996 by Barclays.

3. That index strategy was a failure. It relied on a price-weighted — not market-cap-weighted — index, and was thus overwhelmed by frequent trading and its attendant transaction costs.

4. In 1976, the year after the creation of Vanguard 500, the pension account finally switched to the cap-weighted S&P 500 as its tracking standard, and the strategy at last began to work.

Attempts to rewrite history — even in its seemingly arcane aspects — should not be attempted.

John C. Bogle
Founder
Vanguard Group

Mr. Bogle and Prof. Malkiel co-authored an op-ed that runs in today’s Wall Street Journal in defense of market capitalization-weighted indexing. They wrote, in part:

While we have witnessed many “new paradigms” over the years, none have persisted. The “concept” stocks of the Go-Go years in the 1960s came, and went. So did the “Nifty Fifty” era that soon followed. The “January Effect” of small-cap superiority came, and went. Option-income funds and “Government Plus” funds came, and went. High-tech stocks and “new economy” funds came as well, and the survivors remain far below their peaks. Intelligent investors should approach with extreme caution any claim that a “new paradigm” is here to stay. That’s not the way financial markets work.

The full piece is available here.

The February 25, 2006 issue of the Wall Street Journal carried an op-ed piece by Eugene Fama and and Ken French (here, for subscribers). Their article inspired me to submit a letter to the editor, which was, for better or worse, never published by the Journal. I’m pleased to have the opportunity to share it with you here:

To the Editor of the Wall Street Journal:

While I greatly respect the major contributions that Professors Fama and French have made to modern portfolio theory, I take strong exception to their recommendation to change the tax code so that mutual fund investors pay taxes only as gains are realized when they sell their shares, rather than be subject to taxes paid as their funds realize gains on their underlying portfolios. (“Keep it Simple,” February 25, 2006.)

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This year I’ve decided not to call the pilot, pop on to Vanguard’s G-4 and jet to Davos. Partly because we don’t “do” corporate airplanes. Partly because I’ve never been important enough to receive an invitation to the perennial World Economic Conference. But mostly because what was once truly a global economic conference has become a “happening,” a magnet for the rich and famous — including business stars and Hollywood starlets — to see and be seen, sort of like walking on that red carpet to the Oscars.

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The amazing disappearance of the individual stockholder as the backbone of the U.S. stock market has been one of the least recognized but most profound trends of the last half-century. As shown in the chart nearby, direct ownership of stocks by American households has declined from 91% in 1950 to just 32% today.

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“Most of the mistakes and major faults of the financial era that has just drawn to a close will be ascribed to the failure to observe the fiduciary principle, the precept as old as holy writ, that `no man can serve two masters’ . . . . Those who serve nominally as trustees but consider only last the interests of those whose funds they command suggests how far we have ignored the necessary implications of the principle.”

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Recently described on these pages as “a strange law enacted in 1940,” the Investment Company Act is the foundation of the modern mutual-fund industry. It requires that funds be “organized, operated, and managed” in the interests of fund shareholders, rather than in the interests of their managers and distributors.

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The rapidly cascading mutual fund scandals have brought unwelcome attention to 11 major firms that manage about $1 trillion. For an industry that only six months ago was bragging that “We’ve never had a major scandal,” it’s been an astonishingly rapid comeuppance. Yet who could have imagined that the fund managers who aided and abetted the pervasive market-timing scandal would be brought to the bar of justice by “Blue Sky” laws? For most members of the financial establishment, these laws had been consigned to the dustbin of market history.

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Well-deserved attention has been focused on the $140 million compensation package received by Richard Grasso, the recently departed chairman of the New York Stock Exchange. Undoubtedly there will now be significant changes at the NYSE Board. But the real question is why that Board, with representatives from the most sophisticated firms on Wall Street, agreed to pay its chairman such a rich compensation package. There is only one conclusion: He was worth the money.

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Congress is now considering legislation that would strengthen the independence of mutual-fund boards of directors from fund managers and require cost disclosures to mutual-fund investors. Both measures would serve to increase the share of financial-market returns that fund investors earn.

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