Part V

THE PRINCETON THESIS

AS I RE-READ MY thesis “The Economic Role of the Investment Company,” from cover to cover, three things struck me. First, it wasn't too bad! While the quality of the writing was hardly first-rate, it seemed quite serviceable and comprehensible, especially considering that I was a not-particularly-mature young man but 21 years of age, and that it was my first major writing project. The organization seemed about right too, and the research—in a field where data were scarce—remarkably complete.^* I'm not sure that I would place the thesis in the high honors category, but I surely reveled in that outcome all those years ago.

In retrospect, I wish that I had done more research on the extent of the mutual fund industry's success in serving investors, and, in particular, that I had evaluated fund investment performance more comprehensively. First, I accepted at face value the industry's claim that, as cited in my thesis, “the attainment of objectives is proof of good management,” and ignored the perhaps inevitable vagueness of most funds’ goals. (It's difficult to refute a claim, as made by one fund that I cited in the thesis, of having provided “reasonable dividends, profits without undue speculation, and conservation of capital,” worthy as those objectives are.) But the kind of comparative data we take for granted today were then almost three decades away. I did present some data comparing the returns of a few funds with the Standard & Poor's (then) 90-Stock Average, and found those funds’ records satisfactory. But I nonetheless concluded that “funds can make no claim to superiority over the market averages.” I leave to wiser heads the judgment of whether that was a harbinger of my founding, a quarter-century later, of the first market index mutual fund, modeled on the (by then) S&P 500 Stock Index.

Second, I was surprised by my high hopes for the growth of this then embryonic industry. Just what was the Securities and Exchange Commission thinking when it called the growth of this tiny $2.5 billion industry, “the most important single development in the financial history of the United States during the last 50 years,” as quoted at the start of my thesis? In fact, the industry was almost irrelevant in 1950, dwarfed by the $63 billion life insurance industry, the $58 billion in U.S. savings bonds, and the $56 billion in bank and savings deposits. Further, mutual funds then owned but 1% of the shares of America's corporations, even as I urged the industry not to “refrain from exerting its influence … on corporate policy.” In fact, my thesis applauded the SEC's desire that funds serve “the useful role of representative of the great number of inarticulate and ineffective individual investors.” But to no avail. While funds now own some 24% of all U.S. corporate shares, they remain to this day largely passive investors.

It goes almost without saying that I could not have even imagined the coming increase in aggregate stock, bond, and money market fund assets to $6.5 trillion, representing a 50-year compound annual growth rate of 17% in an economy growing, in nominal terms, at only one-third that rate. Nor did I imagine the change in the financial markets that lay ahead: Since I wrote my thesis, the aggregate value of U.S. stocks has increased from $75 billion in 1950 to $17 trillion today, a similar, if slightly lower, growth rate than that of mutual fund assets. Further, the investment character of the industry has changed. Equity mutual funds were income producers in 1950, and, as I duly noted that in my thesis, stocks were then yielding 6.63%, corporate bonds 2.96%, and prime commercial paper 1.48%. Today, the spread has been turned upside down and it is bonds that produce income. Stocks presently yield 1.1%, bonds 7.5%, and prime commercial paper 6.2%. Clearly, the investment climate is different—at least for the moment.

Most important of all, a third aspect of my thesis delighted me. On page after page, my youthful idealism speaks out, calling over and over again for the primacy of the interests of the mutual fund shareholder. At the very opening of my thesis, I get right to the point: Mutual funds must not “in any way subordinate the interests of their shareholders to their other economic roles. Their prime responsibility must always be to their shareholders” (italics added). Shortly thereafter, “there is some indication that costs are too high,” and concluding, “future industry growth can be maximized by concentration on a reduction of sales charges and management fees.” (As it happened, fees have actually soared to far higher levels. Again, so much for my advice!) Still later, “fund influence on corporate policy … should always be in the best interest of shareholders, not the special interests” of the fund's managers. Yet today the passive governance policies of most funds hardly serve their shareholders.

My conclusion powerfully reaffirms the ideals I hold to this day: Mutual funds should serve—“the needs of both individual and institutional investors … serve them in the most efficient, honest, and economical way possible. … Providing advantages to the investor … is the function around which all others are satellite. … The principal function of investment companies is the management of their investment portfolios. Everything else is incidental. … Other roles must be discarded if they interfere in any way with the interests of the investors.” And the very last sentence of my thesis sets forth the optimum economic role of mutual funds: “To contribute to the growth of the economy, and to enable individual as well as institutional investors to have a share in this growth.”

In the light of 50 years in this industry, I would add to that ringing peroration but a single word: “fair.” Now, far more than in 1949, when I began to write my thesis, mutual fund investors deserve not only a share, but a fair share of the returns generated in the financial markets. Not only a fair share, but a fair shake!