Are the Interests of the Nation and the Investing Public Best Served by Accepting a Mutual Fund Industry Consigned to “A Permanent Morass”? John C. Bogle Founder, The Vanguard Group Remarks before the Financial Markets Conference Sea Island, GA April 16, 2004

The Investment Company Act of 1940 Mutual Funds: Are vested with “a national public interest and the interest of investors.” Must be “managed and operated in the best interests of their shareholders, rather than in the interests of advisers, under- writers, or others.” 2.

The Public Interest and the Interest of Investors Require that Funds Provide: A sound repository for long-term investing. An efficient medium for accumulating funds for retirement. A contribution to the proper functioning of our capital markets. Constructive participation in corporate governance. Full and fair disclosure of risks, returns, and costs. Stewardship of shareholder assets that is independent, conflict-free, and empowered. 3.

That is Not How Fund Organizations Operate Today “In practice, a mutual fund is a (corporate) shell... another consumer product.” There is “one and only one reasonable objective (for a fund advisor), to maximize its own profit.” 4.

Let’s Look at the Record The mutual fund industry has moved from a major focus on stewardship to an overpowering focus on salesmanship. Marketing and asset gathering have supplanted prudent investing as the industry’s highest value. 5. In the Past Half-Century:

How Has the Industry Changed? Let Me Count the (Seven) Ways 6.

International Specialized Once Funds Were Bought to be Held, Now They’re Bought to be Sold Large-Cap Blend Number of Equity Funds 66 9 Specialized Total 3,59975 Other Div. Equity1,952 7.

2. Once Funds Were Managed by Investment Committees, Now by Portfolio Managers Management Mode 1950: Almost Entirely Investment Committees 2003:Investment Committee - 0 (?) Management Team funds Single Portfolio Manager - 2,917 funds 8.

3. Once Mutual Funds Were Long-Term Investors, Now Short-Term Speculators Mutual Fund Portfolio Turnover 9.

Investor Turnover of Equity Fund Shares 4. Once Fund Investors Held for the Long-Term, Now Too Often Only for the Short-Term 10.

Equity Fund Expense Ratios 5a. Once Cheap, Now Funds Are Dear 11.

5b. Once Cheap, Now Funds Are Dear Estimated Total Expenses of Equity Funds 12. Turnover Costs Expense Fees Equity Fund Assets (Bil) $3.0 $17$24$79 $797$3,800 Asset Increase: 1,265 x Fee Increase: 1,620 x

6. Once Corporate Citizens, Now Funds are Corporate Dilettantes Fund Ownership of all U.S. Stock <2% 23% 13.

Ownership of Top 50 Fund Organizations PrivateFinancial Conglomerates International ConglomeratesMutual Major BrokeragesPublic, Independent Once A Private Profession, Now a Public Business 14.

The Cost Penalty 13.0% 10.3% 3.5% The Timing and Selection Penalty 15. Source: Dalbar, Lipper. How Well Have Funds Served Shareholders? Average Annual Return, % Market Return Fund Return Investor Return

Growth of an Investment Plan Over 40 Years 16. Ann. Return How Well Will Mutual Funds Serve Retirement Plans in the Future?

The Mutual Fund Scandals: The Symptom of our Structural “Agency” Disease, Not the Cause Remedies: 4 p.m. cutoff 2% redemption fees Disclosure of costs, incentives Will help, but only at the margin. Root Cause: A failure to honor the 1940 Act requirement that funds be managed solely in the interests of shareholders. 17.

Optimal Solution (Not a “Silver Bullet”) Reform Fund Governance by Empowering the Mutual Fund Board of Directors. 1. Require an independent chairman. 2. Allow only one interested director on the board. (Why any? Remember the duty of loyalty, and that “no man can serve two masters.”) 3. Provide the board with objective, unbiased information. Large complexes: Board gets its own staff. Small fund groups: Board uses consultant. 4. Federal fiduciary duty statute. (Add “nine little words.”) “Directors shall have a fiduciary duty to assure that funds are managed and operated in the best interests of their shareholders, rather than in the interests of advisers, underwriters, or others.” 18.