The Wall Street Culture that led to crash

It is always refreshing to read speeches of John Bogle (available on his blog). He has been questioning the practices in the financial sector for a very long time. His name should also feature in the names of all those people who predicted this crisis. His idea has always been that the people in the financial industry have forgotten that they need to serve the people and instead are just working for themselves. As he is from Vanguard, his severe criticism is always targeted at Mutual Funds.

I was reading his recent speech where he once again raises the same issues:

Relying on Adam Smith’s “invisible hand,” through which our own self-interest is said to advance the interests of our communities, our society had come to rely less on strict regulation to govern conduct in the field of free enterprise—in commerce, business, and finance—and to rely more on open competition and free markets to create prosperity and well-being, and to add value to our society.

But that self-interest got out of hand, and it spread to the very core of our national culture. Simply put, we became what has been called a “bottom line” society, one in which progress and success are largely measured in monetary terms. But our society, I think, is measuring the wrong bottom line: not only money over achievement, but form over substance; prestige over virtue; charisma over character; the ephemeral over the enduring; even mammon over God. Dollars have become the coin of the new realm, and unchecked market forces totally overwhelmed traditional standards of professional conduct, developed over centuries.

He quotes speeches from some people really long ago who had commented on the same issues which are bothering us right now. Why were the warning ignored? Perhaps Simon Johnson comes closest to explaining the events.

He says the society has moved from being an ownership society to agency society where managers have become more powerful than the owners, Speculation has gained wisdom over investments and how mutual funds continue to milk investors by charging high expenses. Here are some points on MF industry:

Example: the average expense ratio of the ten largest funds of 1960 rose from 0.51 percent to 0.96 percent in 2008, an increase of 88 percent. (Wellington Fund was the only fund whose expense ratio declined. Excluding Wellington, the increase was 104 percent.)

Three of the largest advisers, for example, charge an average fee rate of 0.08 percent of assets to their pension clients and 0.61 percent to their funds, resulting in annual fees of just $600,000 for the pension fund and $56 million for the comparable mutual fund

Vanguard’s lowcosts are legendary, by far the lowest in the field. Last year, over all, our operating expense ratio came to 0.20 percent of average assets, compared to 1.30 percent for the average mutual fund. That 1.1 percentage point saving, applied to one trillion of assets, now gives our shareholders an average savings of $11 billion annually. Do low costs matter? Of course they do! As the world of investing is at last beginning to understand, low costs are the single most reliable indicator of superior fund performance.

Shocking numbers really.

I just calculated the average expense ratio of all diversified equity funds in India and it is 2.14%. I am wondering whether the expense ratios have fallen or declined over the years. Looking at the way MF managers are paid in India (see this as well)  it should only be rising. Moreover, we hardly have any discussion in India over MF expenses. There is hardly any reporting of returns after netting expenses. There is hardly any advertisement for passive funds/index funds. The tracking error of index funds I am told is quite high which also is not understood. It is much better to be distributor of the funds (see this as well) or be an institutional investor.

We need someone like Bogle to help us know more  about India’s MF industry.


4 Responses to “The Wall Street Culture that led to crash”

  1. Tirath Says:

    Hedge funds are said to be expensive and charge ‘high’ fees. When I read that a typical hedge fund charges 2% of invst. plus 20% of gains – I thought that this is much lower than PMS services that we have – which in fact are quite dumb and narrow minded as long only funds.
    reg. MFs – I find it hilarious when Bogle says – 0.96% is high when I know that most equity investors still pay the entry load inspite of the new ‘direct investment’ option plus the hidden expenses that you rightly mentioned.
    I believe it has to do with maturity of the market.
    When we say that Reliance MF has an AUM of 18-20 Billion $ – it is still small compared to global MFs.

    Another note here is for debt funds which charge as high as 1.5% as expenses. Relative to how passive they really are – not to mention how limited their avenues for investments are – it is an appallingly high ratio.

  2. Who did it? Markets or Government? « Mostly Economics Says:

    […] be blamed. The financial oligarchy framework is equally powerful to explain the events (also read John Bogle’s view). Possibly related posts: (automatically generated)Fed handling of subprime crisisAre we recreating […]

  3. Libertarian Paternalism happening in India and US « Mostly Economics Says:

    […] form of LP from SEBI. I have bragged in numerous posts how mutual funds in India(see this one, see US case) are actually a distributor’s fund with most benefits going to a distributor than an […]

  4. Primer on Wall Street Pay « Mostly Economics Says:

    […] The highly paid executives call their country/region financial system efficient and continue to make so much money. Both are inconsistent. If markets are efficient, you cannot be making that kind of money. One could understand if few people made that kind of money. All cannot. There is something wrong with the system and is getting dysfunctional as Paul Woolley calls it. Or wall street culture that only pays itself as Bogle has been saying for so long. […]

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