Thursday, June 11, 2009

The Battle for the Soul of Capitalism: John Bogle

The firmament of the financial services industry is brighttly lit with many brilliant stars. Most of these are stars because they made unimaginable amounts of money investing for themselves, or for their firms. There are very (very) few that are stars because they truly made the average investor richer. There are even fewer that can claim to have truly made a difference to the long term well being of the average investor. In my mind, John Bogle is one of these super stars.

Bogle's most direct contribution to the investing world of course is that he founded and was the CEO of Vanguard. In that capacity, he created the very first index mutual fund. If there was ever a competition for putting money in people's pockets, you could go ahead and retire the trophy after this one.
That said, the other equally valuable role Bogle has played in the world of investing is that of being the 'conscience of the industry'. With his unimpeachable personal code of conduct and integrity, an unrelenting moral compass, and the depth of knowledge to truly understand the inner workings of the industry, Bogle has long been the speaker of unpleasant truths about the financial industry. There are some that consider him too idealistic, pesky, grumpy and frankly a pain in the you-know-what. But in my mind, Bogle's moral stature is only further enhanced by such complaining.

The extravagantly named The Battle for the Soul of Capitalism was published on the heels of the dot com bust, and the corporate scandals of Enron, Worldcom, Anderson and the like. Much of the arguments put forth by Bogle in the book though, are equally pertinent today.

The central thesis of the book is this: Capitalism if a great system that has created inordinate wealth over the centuries. But in recent decades, the integrity of the capitalist system has been severely corrupted and compromised. With ever greater diffusion of corporate ownership, we have transitioned from "owners' capitalism" to "managers' capitalism". Managers, instead of being mere agents in their enterprise, are now running corporations primarily to optimize to their self-interest.

Bogle looks at three variants of the same problem - the corporate world, the financial world and the Mutual Fund world. He lays out his case for how in each of these, the managers have taken over control, and how decision making has moved fundamentally away from optimizing for the owners' long term interest.

In looking at the underlying reasons behind the changing face of capitalism, Bogle does not pull any punches. This isn't by any means a populist treatise that is out to tell you how the big gun in the corner office is to blame for all ills and the little guy down Main St is faultless. No sir! One of the major gripes Bogle has is against the owners of companies (the average shareholders) themselves, and their utter lack of concern about how their companies are run. Direct owners, claims Bogle, have moved far from the position of their predecessors, and are no longer long term owners but short term speculators. They couldn't care less if decisions being made by management are not in their long term interest. Then there is all the intermediation which diffuses ownership beyond recognition. 50 years ago, direct shareholders owned almost all of the shares in the US stock markets. Today financial institutions (MFs, Pension Funds, Hedge Funds etc) own close to two-thirds of the market cap. And even these institutions are being run more and more for short term speculative returns rather than true long term value creation. Finally, there are the other gatekeepers in the process of ownership (particularly company directors) who are supposed to represent the owners' interests. These directors, of late, have been smart enough to see which side of their bread is buttered. Net result - the company belongs to the owner only in name. It is actually run for the betterment of the management in charge. As Bogle states, 'When we have strong managers, weak directors, and passive owners, don't be surprised when the looting begins'.

Bogle meticulously (though somewhat repetitiously) lays out his case. He then lays out very specific solutions to solving the problems. The Battle for the Soul of Capitalism is a manifesto for enlightened ownership of companies. It is an expose of many of the ills of the current face of capitalism in America. It is a call to a moral higher ground by a man I consider to be an investment sage. Though slightly difficult and somewhat bombastic, I believe this book is a must read for investors and for anyone who hopes to be a truly value creating executive of a public company.

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