INTRODUCTION

The Vanguard Adventure

The Vanguard adventure began nearly 50 years ago with almost nothing: a few dozen people, mostly clerks, doing the routine work of administering 11 mutual funds that were losing assets as investors continued to reduce their investments. Vanguard had no role in either selling or investing, the two main parts of the mutual fund business; for these, it was entirely dependent on the organization that had, after an increasingly bitter fight, terminated the man who was the tiny entity’s leader.

Today, Vanguard is the world’s largest and most widely admired mutual fund organization—larger than its three main competitors combined—as it serves over 30 million investors and over $8 trillion in assets. At the same time, it is also one of the most rapidly growing.

Along the way, Vanguard has changed the fund industry and is well positioned to continue driving the industry to change again and again in the years ahead.

If you are one of those 30 million entrusting their trillions of savings and investments to Vanguard—as do I, my wife, children, grandchildren and our church—you will find strong confirmation of your decision to take advantage of Vanguard’s low-cost, high-integrity commitment to advancing investment services. If you are new to Vanguard and its remarkable commitment to serve investors large and small, you will learn how its strengths developed—an all-American adventure story—and why it remains the investment industry’s main agent of change, to the great benefit of many millions of investors.

The expressed values and explicit behavior of individuals seldom become the core beliefs of large organizations, particularly over several decades fraught with turbulence and change. But as Vanguard’s adventure story unfolds, readers will see how the essence of Jack Bogle’s original beliefs became the enduring DNA of today’s Vanguard. They will see how a driven, creative, forceful entrepreneur, a self-described “small company guy,” was outgrown years ago by the managerial challenges of explosive growth, bringing the need to develop an unusually effective organizational system with the many different managers and teamwork. Without Jack Bogle’s creativity and unrelenting drive, Vanguard could never have been conceived, launched, or made successful in its early years. And it could never have reached the extraordinary success it has achieved without Jack Brennan’s taking over as CEO when he did, followed by the contributions of his successors Bill McNabb and Tim Buckley.

At Vanguard’s beginning, low fees were consistently the least important in a long list of the criteria by which investment managers were selected. But low fees became what Vanguard could offer to attract investors and their assets. Then, in an era of super-high interest rates, a new type of mutual fund was invented: money market mutual funds. These funds all invested in the same safe, short-term instruments: treasury bills, commercial paper, and the like. And since the funds were so much the same, one factor stood out: low fees. Low fees now mattered to investors. Focused on controlling operating costs, Vanguard had the industry’s lowest fees and swiftly captured substantial market share and assets.

Before long, Vanguard used that visible edge to extend into both taxable and municipal bond investing. Again, investors noticed, and Vanguard assets surged. As assets increased, Vanguard could and did continue reducing costs and fees. Then the same formula and more good luck propelled the firm into equity investing: Vanguard offered an equity fund managed by John Neff, who achieved impressive performance and low cost. Vanguard’s reputation rose among an increasingly appreciative and growing group of investors as it drove costs and fees lower and lower, while other mutual fund managers actually increased their fees.

Vanguard’s low-cost, low-fee strategy was made possible by its unique structure: Vanguard was and is a mutual mutual fund organization; Vanguard is owned by the Vanguard funds—and hence indirectly by the investors in those funds—so there is no divided loyalty and no need to reward owners with increasing profits the way other mutual fund organizations are designed to do.

A powerful “externality” created an opportunity for Vanguard to build an enormous business in exchange-traded funds (ETFs) and index funds: the world of “active” investment management has, over the past several decades, changed in many ways that make it harder and harder for active fund managers to outperform the indexes. Most fail.

Part of the change has been a Darwinian process of driving inferior managers out of the business, so only the better managers have survived and can still compete. Another part of the change has been an extraordinary increase in both the quality and the quantity of information available to all investment managers and the speed with which information is distributed to investors. All professional market participants have powerful computer systems and Bloomberg terminals with modes to access and analyze all sorts of information instantly.

Volume of trading has increased enormously and, importantly, the fraction of trading done by professional experts has increased from below 10 percent (by small bank trust departments when banking was limited to single states and America had over 14,000 banks) to over 90 percent (led by hedge funds and aggressive active managers). As a result, the experts must trade mostly with other experts, who all know almost all the same superb information, at almost the same time, and so are mighty hard to beat. Costs and fees matter a lot and have been increasingly difficult to overcome. One result is that, over the long term, 89 percent of actively managed funds fail to equal—let alone beat—their self-chosen target market.

This means that Vanguard’s index funds and ETFs have been able to grow enormously. In its array of actively managed funds, too, Vanguard’s ability to negotiate low fees with managers gives investors a compelling advantage. So does its experience in selecting and monitoring active managers. Low-cost offerings have also enabled Vanguard to build an enormous business as a manager of 401(k) funds, which increasingly dominate the retirement industry.

Looking ahead, simply slowing the rate of reductions in its already low fees enables Vanguard to make game-changing capital investments of over half a billion dollars year after year in new kinds of value-adding services it can deliver to present and future investors, as it continues to change the investment services industry again and again. The Vanguard adventure continues.