He spent an hour on Tom Ashbrook’s show, On Point.

Op-Ed Response from Readers, and Mr. Bogle’s Reply

Six Lessons for Investors

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

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.

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.)

First, their proposed system is in fact far more complex. Now, fund shareholders receive from each fund they own a single tax statement providing the information required on the tax return. Under the new system, investors would have to report the amount and date of each share purchase, worry about wash sales, and post multiple gains (or losses) on their returns. What is more, the conversion from the old system to the new would require the complex recreation of prior data of perhaps hundreds of individual purchases and liquidations in each account. Finally, relying on the accuracy of cost information from investors when they sell their holdings of individual stocks has already proven difficult for the Internal Revenue Service to enforce; in the case of mutual funds, it would be even more difficult.

Second, their article completely ignores the fact that traditional open-end funds can easily provide the same tax deferral as do exchange-traded funds. So far, all (or virtually all) ETFs are index funds, providing returns that parallel those of the underlying market indexes, and are barely, if at all, more tax-efficient than regular index funds, many of which are operated at extremely low cost, yet free of the brokerage commissions on purchasing ETFs. Neither Vanguard’s 500 Index Fund and Total Stock Market Index Fund, for example, have paid capital gains distributions since 1999, with annual distributions averaging less than 0.5 percent of asset value during the preceding five years.

The authors also ignore the availability of tax-managed traditional funds for taxable investors. Again, Vanguard’s five tax-managed funds, in nearly 50 cumulative years of operation, have yet to realize a single capital gain distribution, all the while providing superior pre-tax returns, and truly stunning after-tax returns (outpacing, on average, 92 percent of their peers over the past decade).

The real problem is not with the tax code, but (unrecognized by the authors) with the mutual fund managers themselves. They turn over their fund portfolios at a stunning average rate of 91 percent per year—a holding period of barely 13-months for the average stock in their portfolios, reflecting a trading strategy that is far more akin to short-term speculation than long-term investing.

Unsurprisingly, because of all those execution costs, high fund turnover is clearly associated with low fund performance. During the past decade, for example, the highest-turnover quartile of funds (165 percent annually) provided an annual pre-tax return of just 9.8 percent, while the lowest-turnover quartile (13 percent) returned 11.5 percent, an advantage of 1.7 percent per year—a cumulative extra profit of nearly 30 percent. What is more, the high-turnover quartile of funds took nearly 30 percent more risk (standard deviation of 20.6 percent vs. 16.2 percent).

Looking at risk-adjusted returns, then, the low-turnover funds earned 11.6 percent per year compared to just 8.9 percent for their high-turnover cousins. Result: $10,000 invested ten years ago grew by $20,000 vs. $13,300—a 50 percent enhancement in profit even before taxes are considered. After taxes, the enhancement in cumulative profit approached 100 percent, a difference that is truly astonishing.

Like the mutual fund industry that is now vigorously campaigning to change the tax law, Professors Fama and French simply ignore the economic realities described in this letter. It is not the tax code that needs changing; it is the “short-termism” exhibited by the vast majority of mutual fund managers, and the short-sightedness of mutual fund shareholders who refuse, out of naiveté or even ignorance, to look after their own economic interests. “The fault, dear Brutus, is not in our tax code, but in ourselves.”

John C. Bogle

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.

I confess I looked at this year’s program before I made my decision. And I’m only truly sorry to miss Morgan Stanley’s Steve Roach, whose persistent gloomy warnings about the global economy have yet to come home to roost. And I’m kinda sorry to miss the apparently impassioned defense of speculating in today’s financial markets (“Beyond Short-Termism: Not on my Watch”), which I hope — but doubt — is an attack on my attack on the folly of short-term speculation in my new book. To say nothing of “Hedge Fund Fairy Tales,” although that can hardly be covered adequately in the allotted hour. The sessions “Happiness is . . . ,” “The Trust Deficit,” and “Transforming Neurotic Corporations” may also have been interesting.

Confession being good for the soul, the session I’ll really be sorry to miss is “All You Ever Wanted to Know about Relationships — But Were Afraid to Ask,” a rare three-hour session that vastly exceeds the customary one hour-limit. Here, psychologist Dagmar O’Connor will tell what I’m certain will be a capacity audience why “relationships and sexuality may be the only universal part of human life,” and give us “tools to overcome old problems and keep desire flowing.” We can all learn, can’t we? (Even though I’ll soon be 77, I’ll celebrate my 10th anniversary as a heart-transplant recipient on Feb. 21. The heart is actually now 35.)

Speaking of CEOs, the Forum exults that among its select horde of 2,340 participants are a record 735 chief executives, chairmen and CFOs, “the highest figure of corporate leaders ever.” With all due respect, I won’t miss glad-handing most of them. They get paid as if they’re solely responsible for their firms’ success, and even if they fail, they get handsome rewards. In 2004, their compensation rose another 39% to 475 times that of the average worker — the guys and gals who get out of bed every morning and do their jobs, with never a ride on the corporate jet whose cost is paid 60% by shareholders and 40% by taxpayers. Truth be told, most CEOs I’ve met are greatly overrated. But I don’t complain; I may have been the most overrated of all.

So sorry, Bono, I can’t be with you for lunch. Sorry, other Michael Jordan, that I won’t hear the latest on EDS. Sorry, David Stern, that I can’t shoot some hoops with you. Sorry, Jacques Rogge, that I won’t learn more about “the impact of sports in the world.” And sorry, Jean Claude and Christo, but please know that I took my whole family to “The Gates” and loved it.

But I already knew, as I suspect everyone there knew, that “China, India, [are] Key to the Future,” CNN’s headline about Chancellor Merkel’s speech. And I didn’t need to fly to Davos to learn that “plumbers, construction workers, and electricians” will still be needed in the global economy of the future. With 226 sessions, I would have had to miss at least 200 anyway.

Deep down, however, I may just be jealous. Perhaps if I call President Clinton I can hitch a ride on his jet, arriving late tomorrow afternoon for a closing panel with Forum founder Klaus Schwab. Then I’d have avoided all the foolish, self-righteous show-biz baloney, but be able to assure my pals: “Yes, I was at Davos, 2006.”

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.

The 9% ownership stake held by financial institutions in 1950 crossed the 50% mark in 1983, and now totals 68% of all stocks. It is hard to imagine that our earlier society dominated by individual stock ownership will ever return.

Of course individual investors remain major participants in the stock market, but now do so largely through mutual funds and public and private pension plans. But such participation lacks the traditional attributes of ownership such as selection of individual stocks and engagement in the process of corporate governance.

But aren’t our financial institutions owners of stocks? Not really. They are owners in name, but in fact are agents with a duty to act on behalf of their principals, including our mutual fund owners and beneficiaries of our retirement plans. Today’s agency-dominated investment society is overwhelmingly composed of those two groups of underlying owners.

At first, the march toward institutionalization was led by pension plans. Holding less than 1% of all stocks in 1950, they shot up to 19% in 1980 and 27% in 1989-95, only to ebb to today’s level of 21%. Growth in mutual-fund ownership, on the other hand, was stagnant in the early years, holding at 3% in 1950 and 1980 alike, rising to just 8% by 1990. Since then, fund ownership of stocks has risen relentlessly to a record high of 28% currently.

Within the pension segment, public plans are holding steady while private pension plans are gradually receding. But the secular decline in defined-benefit pension plans has been matched by an offsetting rise in defined-contribution thrift and savings plans in which mutual funds are the major component. So today’s dominant stock ownership by mutual funds seems destined for continued growth.

Institutional investing is now largely the business of giants. America’s 100 largest money managers alone now hold 58% of all stocks. When such a relative handful of professional managers substantially displaces a diffuse group of tens of millions of inchoate individual investors, one might have expected the managers to more aggressively assert their rights of stock ownership and demand more enlightened corporate governance focused on shareholder interests. With few notable exceptions, however (some state and local pension plans, unions, and TIAA-CREF), our institutional investors have refrained from active participation in corporate affairs.

What explains the passivity of these institutions that in fact hold effective control over corporate America? First, too many of our financial agents have their own interests to serve, often conflicting with the interests of their investor-principals. It is a truism that principals are likely to watch over their own money with far more care than they take in watching over the assets entrusted to them as the agents of others. When there are many masters to serve, it is the master who pays the servant whose interests are most likely placed front and center.

Corporate pension plans, for example, are controlled by the same executives whose compensation is based on the earnings they report to shareholders. During the 1990s, they arbitrarily raised their projections of future pension plan returns, enhancing operating earnings to meet “guidance” targets, even as interest rates tumbled and prospective returns eroded.

Similarly, mutual fund managers are compensated by separate corporations seeking to maximize the return on their own capital (i.e., to enhance their own wealth), in direct conflict with their duty to maximize the returns on the capital entrusted to them by their fund shareholders. The excessive advisory fees, expenses, hefty sales loads, and huge commissions on portfolio transactions paid to brokers in return for their sales support consumed something like 45% of the real returns earned on fund portfolios during the past two decades.

Second, unlike their predecessors in the 1950s and 1960s, today’s financial institutions are now focused on modern investment strategies that emphasize short-term speculation in evanescent stock prices, rather than traditional long-term investing based on durable intrinsic corporate values. From 1950 to 1965, for example, equity mutual funds turned over their portfolios at an average rate of 17% per year; in 1990-2005, the turnover rate averaged 91% per year. The old own-a-stock industry could hardly afford to take for granted effective corporate governance in the interest of shareholders; the new rent-a-stock industry has little reason to care.

To further complicate matters, today’s typical giant private financial institution—managing both pension plans and mutual funds—faces serious conflicts in its exercise of the rights and responsibilities of ownership. When a proxy proposal is opposed by the management of a corporate client, the money manager is unlikely to vote in its favor. It is not surprising, then, that, governance activists among large private money managers are conspicuous not merely by their scarcity, but by their absence.

And it gets worse. Today, it is difficult to separate the owners from the owned. Through its defined-benefit pension plans, corporations own 12% of all stocks, and dominate another 11% through defined-contribution savings plans. What is more, most of our largest money managers are themselves now owned by giant financial conglomerates. Arguably, this circularity of ownership allows corporate America to control itself.

The problems created by this new and conflicted world of financial intermediation are hardly trivial. Excessive return projections for pension plans have played a major role in creating the current shortfall of $600 billion private pension plan liabilities relative to plan assets. The shortfall in public plans has been estimated at $1.2 trillion, bringing the total deficit to $1.8 trillion, and rising.

Individual retirement savings are also at dangerously low levels. Only 22% of our workers participate in 401(k) savings plans and only 10% in IRAs. (About 9% have both.) Despite having had a quarter-century-plus to build assets in these tax-sheltered plans, investors have accumulated balances of but $33,600 and $26,900 per participant respectively, a trivial fraction of what would be required for a decent retirement.

With today’s agency society arrogating to itself far too large a share of market returns, the outlook for future individual retirement savings is dire. Consider that a young citizen entering the work force today has an investment horizon of at least 60 years. If, for example, the stock market were to earn an average nominal return of 8% per year, $1,000 invested today would then be worth $101,000—the magic of compounding returns.

But if our financial system consumes 2.5 percentage points annually of that total return—a conservative estimate of today’s reality—that $1,000, growing now at 5.5% net, would be worth just $25,000—a minuscule 25% of the accumulation that could have been obtained simply by owning the stock market itself. The magic of compounding returns, it turns out, is simply overwhelmed by the tyranny of compounding costs at today’s exorbitant levels.

The serious shortfalls in retirement reserves that represent the backbone of the nation’s savings have arisen importantly because our manager-agents have placed their own interests ahead of the interests of the investor-principals they are duty-bound to serve. Our financial institutions have failed to exercise the rights and responsibilities of corporate citizenship; to adequately fund pension reserves; and to deliver to fund shareholders their fair share of the returns generated by the financial markets themselves.

Why? Largely because the radical change from an ownership society dominated by individual investors to an intermediation society dominated by professional money managers and corporations has not been accompanied by the development of an ethical, regulatory, and legal environment that requires trustees and fiduciaries, as agents, to act solely and exclusively in the interests of their principals.

In addition, we have developed a whole patchwork of tax-deferred retirement programs—Social Security, corporate and public pensions, deferred compensation plans, 401(k)s, 403(b)s, individual IRAs, and Roth IRAs—and are now considering the addition of Personal Savings Accounts to the list. We need to undertake a careful appraisal of this complex and often costly mix, and work to develop an integrated retirement system that will enhance the nation’s savings.

The overarching need is for a clearly enforced public policy that honors the interests of our citizen-investors and puts these beneficiaries in the driver’s seat where they belong. It is high time for the appointment of a blue-ribbon federal commission to examine these issues and make appropriate policy recommendations to resolve them. The ownership society is over. The agency (or intermediation) society is not working as it should. We urgently need a truly enlightened fiduciary society. The sooner the better.

“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.”

U.S. Supreme Court Justice Harlan Fiske Stone wrote those words in 1934. Today, they could have been as easily written by New York State’s crusading attorney general Eliot Spitzer. At first almost alone, he turned the spotlight on the unprincipled conduct of too many financial intermediaries during the recent era.

His campaign to eliminate conflicts of interest between service providers and their clients began with Wall Street investment bankers in 2001, spread to mutual fund managers in 2003, and last month enveloped insurance brokers. While it would be unfair to tarnish the entire financial field with the brush wielded by the attorney general, the misconduct was not only rife, but practiced by some of the oldest, largest and once most respected firms in each of those fields.

The practices he attacked were open secrets to industry insiders, indeed often accepted as the normal way of doing business. On Wall Street, for example, it was hardly unusual for analysts to publish glowing “research” reports on stocks of companies that they believed were junk, often with the objective of puffing initial public offerings or winning investment-banking clients.

In the mutual fund industry, managers enriched their own coffers by aiding and abetting short-term speculators in fund shares to engage in widespread market-timing and time-zone trading, at the dollar-for-dollar expense of their long-term owners. In insurance brokerage, bid-rigging and contingent commissions — “preferred service agreements” — were used to force insurance companies to pay rebates to brokers as a quid pro quo for winning the business.

These pervasive examples of conflicts of interest in the financial services field are violations of the public trust. Trustees who accept the responsibility for other people’s money have a fiduciary duty to place the client’s interest ahead of their own, and those who handle money for others no less so. “Put the client first,” an obvious rule for any business, takes on a whole new imperative in the profession of handling other people’s money. Why? Because the value provided to clients in the financial field is measured largely in dollars and cents.

Unlike consumer products such as food, television sets, automobiles and perfume, for example, whose value is measured as much by satisfaction and style as by intrinsic worth, the value of a financial service — the performance of a brokerage account, the investment return on a mutual fund, the amount covered by a homeowner’s policy, the face amount of a life insurance policy — can be precisely measured in dollars and cents. And the cost of providing that service — the advisory fees and operating expenses, the policy premiums, the sales commissions — can be precisely measured in dollars and cents as well.

The fact that product cost directly impacts product value lies at the very heart of how well financial service firms serve their clients. Costs matter. So providing real, honest-to-God, dollars-and-cents value to our clients requires offering our financial services at fair, reasonable, and competitively determined prices. If our clients are to make the best possible choices within their budgets as they seek to protect their assets and property, fully disclosed pricing is essential.

As a result of that unique relationship between cost and value, the vast multitude of American families who have placed their trust in their financial service providers must be applauding Mr. Spitzer and his staff. But since fair and open competition in our system of free-market capitalism puts pressure on prices and profits alike, many, if not most, providers of those services are excoriating these determined regulators.

Much of their criticism has been based on the attorney general’s reliance on New York statutes adopted long ago, for rather different purposes. For brokers and fund managers, it was the Martin Act of 1924, a “Blue Sky” law originally designed to prosecute the “bucket shops” that were rife in the early part of the century. For insurance brokers, it was the Donnelly Act of 1893, a “Baby Sherman” antitrust act designed to block collusion and price-fixing.

Even if it has not been used for 100 years, however, a law is a law. Consider our United States Constitution, ratified 217 years ago and still standing today as a monument to our commitment to “protect the general welfare.” Mr. Spitzer’s aggressive pursuit of the public interest seems entirely appropriate under state law, and wholly consistent with that national commitment as well.

The description of the attorney general as “politically ambitious” may well be accurate. But doubtless most capable state attorneys general are “governor-ambitious,” even as most capable journalists are “Pulitzer-ambitious,” and scientists “Nobel-laureate-ambitious.” Bless them! And when we describe our businessmen and entrepreneurs as ambitious to build firms and create economic value, it’s usually meant as a compliment. Mr. Spitzer is entitled to the same treatment.

While the “Spitzer effect” focuses directly on the scandals of the era, it also points to our need to attend to the forces that have driven them. Vast changes have taken place in the structure of the financial services field. Once dominated by a series of free-standing and largely privately held professional firms, it is now dominated by giant business conglomerates whose interests span a variety of wide-ranging services which themselves often entail conflicts — commercial and investment banking; stock brokerage and mutual funds; insurance and consulting, a list that only scratches the surface.

Of course, the officers and directors of these financial titans have a fiduciary duty to serve the shareholders of their own firms. But they also have a directly conflicting duty to serve another master: the shareholders of the mutual funds they control; the holders of their insurance policies; the customers of their brokerages.

Mr. Spitzer has revealed how badly that balance has been distorted. When the chief executive of one of the nation’s largest banks announces his goal of doubling the 7% share of the bank’s revenues provided by the asset management group by “cross selling,” he sets into motion a chain of events whose outcome is almost foreordained. Managers roll up their sleeves and try to make it happen. Witness this series of e-mails at one firm: “Market timing . . . is very disruptive to the portfolio managers and operations of the fund. (However) your call from the sales side . . . I don’t want to turn away $10-$20 million . . . it’s in our best interests (increased profitability to the firm).”

In taking constructive action to restore that balance, Mr. Spitzer and his counterparts in other states have been joined by state securities regulators and the Securities and Exchange Commission. Many of the “bad apples” that have betrayed the public trust have been indicted, fined and penalized. But that’s not enough. It’s the responsibility of the “good apples” that remain to put their own character on the line, beginning with the recognition that the financial services barrel that holds all those apples — good and bad alike — is badly in need of repair.

It’s high time that our financial leaders acknowledge the mistakes and faults of the recent era and establish “best practices” that preserve, protect, and defend the interests of their customers and clients. But not only to serve them. To serve themselves. Without maintaining its character — operating with integrity, responsible conduct, and service to others before service to self — no financial service firm can achieve long-term success.

It will not be easy. As Demosthenes warned us two-and-a-half millennia ago, “Nothing is easier than self-deceit. For what each man wishes, that he also believes to be true.” Admitting mistakes requires character; so does introspection; so does changing the status quo; so does courage. But if our financial service leaders who do have character — and there are many of them — accept responsibility for what has happened, we can begin to take the necessary steps to restore the nobility of fiduciary duty to its pre-eminent place on our priority list.

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.

What is “strange” about the law, however, is not that it effectively ratified the pre-1940 Act standard that clearly separated the fund corporation from the management corporation that it employs to provide it with the administrative, investment advisory and distribution services it requires to exist. Rather, what is strange is that the Act failed to establish a structure that would facilitate the realization of its noble purpose: Put the fund investor first.

Last month, a courageous Securities and Exchange Commission took the first major step in accomplishing that goal, adopting a rule that requires the chairman of a fund’s board of directors to be unaffiliated with — essentially, independent of — the management company.

It will take time for fund investors to benefit from that requirement. But standing alone, it is not enough to redress the existing structure in which the manager controls the fund, dictating the contractual terms under which it provides all of the services the fund requires in order to exist. It will also take further restructuring in fund governance.

An ideal governance structure requires, first, a far heavier representation of independent directors, and the new SEC rule requires that at least 75% of a board be independent, another forward step. Second, since individual fund directors often simultaneously oversee as many as 100 to 300 separate mutual funds in a given group, fund directors need an independent staff to provide to the board unbiased information that includes analysis of the investment returns, risks, management fees, expense ratios and capital flows for each of the funds in the complex. (The new rule authorizes, but does not require, such a staff.)

Third, this structure must be buttressed by a statutory standard of fiduciary duty added to the 1940 Act requiring directors to assure that funds are, yes, “organized, operated, and managed” in the interests of their owners. Such a standard should also provide guidelines for aiding directors in carrying out their trusteeship responsibilities.

The fund industry and its lobbyists vigorously argue that mutual funds need no such independent oversight. “Trust us,” say the managers, “we’ll do what’s right because our reputation is at stake.” And, as the recent scandals have shown, reputation risk is hardly to be ignored. Investors have pulled more than $100 billion out of the funds whose managers have betrayed their shareholder’s trust. But these scandals represent only the tip of the iceberg in which the interests of fund owners are subservient to those of fund managers.

In the mutual-fund industry, relying solely on market forces has proved to be a weak remedy for bad behavior. As asset-gathering replaced prudent management as the industry’s prime focus, fund expenses rose and nearly 500 new, largely speculative, “new economy” funds were organized and offered at the recent bubble’s peak. The fund failure rate soared, with some 1,900 equity funds disappearing in the last decade alone, lost in the dustbin of history, often merged with other, better performing funds, under the same management.

If one accepts the idea that mutual funds are just another consumer product, and that consumers once burned — their hard-earned retirement savings devastated — will be twice shy, the present industry structure, although it hardly meets the statutory goal, is fine. But if one believes that the stewardship responsibility for other people’s money is a sacred trust, it is high time for structural reform in the fund industry. For by allowing funds to be organized, operated and managed in the interests of their management companies rather than their owners, the fund industry has defied the principles of the 1940 Act.

Few have taken the trouble to examine the heavy penalties that managers have extracted from the returns earned by fund investors. During the past decade, for example, while the stock market has returned an average of 11.1% per year, the average equity fund has delivered just 8.6% — a 2.5 percentage-point shortfall roughly equivalent to the drain of the heavy sales charges, management fees and operating expenses, and portfolio turnover costs it incurred. (The notorious tax inefficiency of funds would extract several additional percentage points.)

To make matters worse, the returns earned by the average equity fund investor fell far short of that already unacceptably low net return achieved by the average fund. A recent comparison of the shareholder (dollar-weighted) returns of the 100 largest equity funds with the average fund (time-weighted) returns would have reduced that 8.6% figure to just 6.2%. To understand the enormity of that shortfall, consider that an 11.1% return on $10,000, compounded over 10 years, grows by $18,650, while a 6.2% return grows by just $8,250 — an astonishing shortfall of 56% in accumulated capital.

A recent study sponsored by industry giant Fidelity Management — which has a huge economic stake in maintaining the status quo that produced that grotesque shortfall — purported to show that funds with affiliated chairmen produced better performance for their owners, and with lower costs. But the study was badly flawed. By simply redefining the categories, one discovers that the study actually showed that the 889 funds run by banks and brokers provided by far the worst returns. The 1,326 other funds with affiliated chairmen provided returns that were somewhat better, but virtually identical to the results produced by the 89 other funds with independent chairmen.

Moreover, at the top of the Fidelity list — by a wide margin — were the 75 funds that do not allow even a single representative of their investment adviser to serve on their boards. (Full disclosure: All of these funds are members of the Vanguard Group, which I organized and which is still operated and managed on an at-cost basis by a management company owned by the funds themselves.)

It’s only a matter of time — although, human nature and inertia being what they are, doubtless a long time — before a second fund organization recognizes that such a structure is one obvious response to the 1940 Act’s original principles. So the developing new standards that have now begun with a more independent board structure hardly end there.

Capitalism ought to be about capturing the benefits of equity investment for those who put up the capital and take the risks. The record makes it impossible for fund managers to assert that they have achieved that goal for our 91 million citizens who own mutual funds. It is high time to put their interests front and center, rather than allowing the self-interest of fund managers to prevail. It’s all about giving the shareowner a fair shake.