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Tuesday, August 05, 2003 9:09:17 PM
"4. Turnover Goes Through the Roof
Together, the coming of more aggressive funds, the burgeoning emphasis on short-term performance, and the move from investment committees to portfolio managers had a profound impact on mutual fund investment strategies—most obviously in soaring portfolio turnover. M.I.T. and the other funds described in that Fortune article didn't even talk about long-term investing. They just did it, simply because that's what trusteeship is all about. But over the next half-century that basic tenet was turned on its head, and short-term speculation became the order of the day.
Not that the long-term focus didn't resist change. Indeed, between 1950 and 1965, it was a rare year when fund portfolio turnover much exceeded 16%, meaning that the average fund held its average stock for an average of about six years. But turnover then rose steadily and surely and
fund managers now turn their portfolios over at an astonishing average annual rate of 110%(!). Result: Compared to that earlier six-year standard that prevailed for so long, the average stock is now held for just eleven months.
The contrast is stunning. At 16% turnover, a $1 billion fund sells $160 million of stocks in a given year and then reinvests the $160 million in other stocks, $320 million in all. At 110%, a $1 billion fund sells and then buys a total of $2.2 billion of stocks each year—nearly seven times as much. Even with lower unit transaction costs, it's hard to imagine that such turnover levels aren't a major drain on shareholder assets.
Let me be clear: If a six-year holding period can be characterized as long-term investment and if an eleven-month holding period can be characterized as short-term speculation, mutual fund managers today are not investors. We are speculators. When I say that this industry has moved from investment to speculation, I do not use the word "speculation" lightly. Indeed, in my thesis I used Lord Keynes' terminology, contrasting speculation ("forecasting the psychology of the market") with enterprise ("forecasting the prospective yield of an asset"). I concluded that as funds grew they would move away from speculation and toward enterprise (which I called "investment"), focusing, not on the price of the share, but on the value of the corporation. As a result, I concluded, fund managers would supply the stock market "with a demand for securities that is steady, sophisticated, enlightened, and analytic." I was dead wrong. We are no longer stock owners. We are stock traders, as far away as we can possibly be from investing for investment icon Warren Buffett's favorite holding period: Forever.
5. High Stock Turnover Leads to Low Corporate Responsibility
Whatever the consequences of this high portfolio turnover are for the shareholders of the funds, it has had dire consequences for the governance of our nation's corporations. In 1949, Fortune wrote, "one of the pet ideas (of M.I.T.'s Griswold) is that the mutual fund is the ideal champion of . . . the small stockholder in conversations with corporate management, needling corporations on dividend policies, blocking mergers, and pitching in on proxy fights." And in my ancient thesis that examined the economic role of mutual funds, I devoted a full chapter to their role "as an influence on corporate management." Mr. Griswold was not alone in his activism, and I noted with approval the SEC's 1940 call on mutual funds to serve as "the useful role of representatives of the great number of inarticulate and ineffective individual investors in corporations in which funds are interested."
It was not to be. Just as the early hope I expressed that funds would continue to invest for the long term went aborning, so did my hope that funds would observe their responsibilities of corporate citizenship. Of course the two are hardly unrelated: A fund that acts as a trader, focusing on the price of a share and holding a stock for but eleven months, may not even own the shares when the time comes to vote them at the corporation's next annual meeting. By contrast, a fund that acts as an owner, focusing on the long-term value of the enterprise, has little choice but to regard the governance of the corporation as of surpassing importance.
While funds owned but two percent of the shares of all U.S. corporations a half-century ago, today, they own 23 percent. They could wield a potent "big stick," but, with few exceptions, they have failed to do so. As a result of their long passivity and lassitude on corporate governance issues, we fund managers bear no small share of the responsibility for the ethical failures in corporate governance and accounting oversight that were among the major forces creating the recent stock market bubble and the bear market that followed. It is hard to see anything but good arising when this industry at last returns to its roots and assumes its responsibilities of corporate citizenship."
http://www.vanguard.com/bogle_site/sp20030114.html
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