The amazing story of Vanguard – Building a $A10 trillion mutual from a $1 billion fund company

14 December 2022

At the 2022 BCCM Leaders’ Summit, keynote speaker Jeremy Duffield (ex-CEO and Founder, Vanguard Australia) spoke about the remarkable vision and achievements of Jack Bogle and the mutual he founded, Vanguard. One of the major reasons behind Vanguard’s astonishing success is Jack’s commitment to mutuality and his belief that customers (who are also owners) should have access to investment products with low fees.

The amazing story of Vanguard – Building a $A10 trillion mutual from a $1 billion fund company

by Jeremy Duffield, presented at the BCCM Leaders’ Summit, 18 November 2022

The story of Jack Bogle, and his creation Vanguard’s remarkable rise, has to be one of the greatest business stories of the last 50 years. The company Jack Bogle founded, The Vanguard Group, has gone from being a $A1 billion traditional for-profit funds group in 1974 to today a $10 trillion dollar plus mutual mutual fund company, dominant in its field.

In doing so, Vanguard revolutionised the way investors invest by introducing and loudly advocating low cost diversified index funds. And transformed its industry by leading the way with cost reductions. It saved investors a fortune. According to Eric Balchunas, the author of The Bogle Effect, resulting cost savings have amounted to trillions of dollars. Warren Buffett said “Jack did more for American investors as a whole than any individual I’ve known,” noting that “a lot of Wall Street is devoted to charging a lot for nothing. He charged nothing to accomplish a huge amount.”

By dint of good luck, I was there in the midst of it, participant and observer, for much of the period when the foundations were built. I was so fortunate to work very closely with the key protagonists. My break came in 1979 as a 25-year-old Australian working for the Federal Reserve in research, on a speaker’s podium at a mutual fund conference in NYC to discuss money market funds. Vanguard’s Founder and CEO Jack Bogle came up to introduce himself; we had lunch and he asked me if I wanted to see how a real mutual fund company worked. He was looking for a new Assistant. That changed my life.

One billion to $10 trillion – just think about that for a minute – either in dollar terms – that’s growth in assets under management of over $10 trillion, or about three times the size of the Australian super fund industry.

It was only $US2.3b when I arrived in 1980 – 5 years after creation. Vanguard had 140 staff members and a budget of $6 million, and was the twelfth-largest firm in a tiny ($100 billion) industry. Virtually no one had ever heard of Vanguard.

It’s a funny chart, isn’t it. You can’t even see the assets of the 16 years I worked for the Group in the US before coming out to start Vanguard Australia. But those early years were the fastest percentage growth period. When I moved back to Australia in 1996, assets were $180b and when I left in 2010, they were about $2 trillion. So, the hugest dollar growth has occurred since then ­– that’s “the tyranny of compounding” Jack Bogle used to say – but the foundations were set earlier and that’s what I’m going to talk to you about.

I’m going to give you my take on this story – but to make it relevant to you, I will draw out the core lessons for mutuals, and ask what role being structured as a mutual played in Vanguard’s success and what else was necessary to drive the growth and success.

I’m delighted to be invited to make the speech as when I last tried to share the lessons from Vanguard’s mutual structure with Australian counterparts in the industry super fund sector in 2003, no one came. I had asked the then CEO of Vanguard, Jack Brennan, to prepare a speech on this topic for comparable Australian mutuals, the industry funds here in Melbourne. But no one attended the session. They didn’t care to know.

How did it all start?

It started with a corporate blow-up. A Big Bang, if you will. The genesis was in a for-profit mutual fund company (the Wellington Funds) run by Wellington Management Company. Jack Bogle, the CEO of Wellington Management Company, was fired in 1974 by the colleagues he’d brought on seven years earlier in his ill-fated (almost first) act as new CEO of Wellington – acquiring a growth-oriented money manager in Boston. Seven years later those Boston-based partners had the votes to kick him out – and they did in the midst of the turmoil of the bear market of 1973-74

Jack loved to say “he was fired with enthusiasm” and so he was – full of energy and desire to prove himself. His partners had underestimated the fact that Jack was still the chair of the Funds in the group. The independent directors of those funds, mostly Philadelphians loyal to Jack, kept him as chairman of the funds and told him to come up with a new plan.

Much to the Boston partners’ dismay, Jack came up with a plan to take the Wellington Funds “mutual” – to have the Funds own the operating company, which would become Vanguard. The board would only agree to let Vanguard do the administration of the Funds to start, so Jack became the CEO of a 27-person fund accounting and registry company— a very humble beginning indeed – while Wellington Management company remained the fund’s adviser, albeit on an arm’s length basis.

Okay, so do you get the mutual structure? The clients own shares (or units) in Vanguard funds; the Funds own Vanguard, and Vanguard operates at cost — no profit — solely acting in the interests of its clients, the shareholders. Jack said “my goal was to create an enterprise that was only of the shareholder,,by the shareholder and for the shareholder.” When he says “shareholder”, think “client”, as the fund shareholders are Vanguard’s clients. So, the whole concept of Vanguard starts with the client.

A modest beginning indeed – administration only. But as I said, Jack was “fired with enthusiasm.” He was still on fire when I met him five years later. He was just determined to make something substantial out of this crisis. In Vanguard’s early years Jack took some additional extraordinary bold steps – and the significance of one would only become apparent much later. All changes were made to realise his dream of a truly client-centred mutual mutual fund organisation.

Remarkably, he abandoned the traditional fund distribution system of selling through brokers and paying them 8.5% upfront commissions which was the industry norm. He’d take the company “no load” (no commission) direct to consumers. Vanguard would essentially never pay for distribution again. He hired external investment managers to run new funds so as not to be so reliant on Wellington.

But most importantly, he created the world’s first publicly available stock market index fund. It was launched in 1976 in an underwriting by brokers but only raised $11 million, not the $250 million they had sought. It was called First Index Investment Trust.

The new fund, which would track the US S&P 500 Index, was laughed at by most of the investment community. The idea of matching the market average and keeping costs low was anathema to the industry. “Who wants to be average?” they’d say. “That’s UnAmerican.” The fund was disparaged as “Bogle’s Folly.” It was very slow to have any impact but eventually index fund leadership would prove decisive in Vanguard’s success.

Indexing was at the heart of the coherent common sense investment philosophy Jack Bogle developed and preached to retail investors: low-cost diversified indexing, hold for the long term, eschew market timing, don’t speculate, have reasonable expectations, let the markets do their work.

Over the next four decades of his life, Jack would raise indexing’s profile and presence by being the most articulate spokesman for low-cost diversified passive investing. He found a thousand ways to tell the story, and though he didn’t have a competitor in the retail index fund space for 10 years, indexing would go on to become a tens of trillions of dollars business representing some 40+% of mutual fund industry assets. It would spawn the Exchange Traded Fund business. And it would drive down costs dramatically throughout the entire funds management industry.

Jack’s initiatives were followed by dramatic growth

The breathtaking thing about that growth is that it’s all been organic: all created without acquisition, created with no paid distribution, created with limited marketing expenditure and mostly dependent on word-of-mouth endorsement from clients and strong press support. The growth happened for 20+ years without access to financial adviser distribution since after dropping commissions and bad-mouthing advisers for many years, Jack had given up that channel. It’s amazing his Vanguard successors were able to revive it so that Vanguard is now the leader in adviser distribution – all without paying a cent in commissions.

What explains Vanguard’s remarkable growth?

First, how important was the mutual structure? It was huge. Gus Sauter, Vanguard’s long term Chief Investment Officer, is quoted as saying “the ownership structure is 100% the reason for Vanguard’s success.” And Jack Bogle himself said “well, in my mind there’s no question that the mutual structure is the founding block. The basic block.”

I’d say the investment business as an industry is almost ideally suited to a mutual structure. Asset management generally requires low amounts of financial capital to establish, and it’s a business with a high percentage of fixed costs, where the (high priced) investment talent can be amortized across larger asset bases. Sure, there are variable costs in administration and marketing, but economies can be gained there too.

So, if the normal profit margins of asset management companies run in the 30-40% range, the opportunity for a mutually structured fund management company to undercut the competition by operating at cost are substantial. And if you can undercut the costs of competitors you can likely outperform them. And that’s what investors want — the best net of cost performance they can get. After all there are three dimensions of asset management: risk, return and costs – and the only one you can know for sure in advance is costs. Or as Jack Bogle would often say, in “investments you get what you don’t pay for.”

The payoff for Vanguard clients from the mutual structure has been enormous. As assets have ballooned over the decades, largely fixed costs have been spread over a much wider asset base. Expense ratios have come down to an incredible extent.

Costs have declined steadily, from annual expense ratios of 64bps in 1980 to just 8 bps today, or a decline of 88%! All while services and quality of services have widened out unbelievably and improved dramatically.

I think of it as an extra nearly 40-100 basis points per year in the pockets of Vanguard investors rather than the fund management company. And the word got out, aided by the Great Communicator, Jack Bogle. It created a virtual cycle: lower costs led to better net performance, which results in clients doing better and telling their friends and family about Vanguard and investing more in Vanguard, which helps to spread the costs against a bigger asset base leading to lower costs and better performance, and on and on.

But being mutual wasn’t enough. What else drove that extraordinary growth?

Well first, I’ve got to admit the outstanding and prolonged tailwinds from the generational bull market which began in 1982 and continued into the 2020s (maybe over now with inflation kicking up again). There’s an old saying that “you never want to confuse genius with luck and a bull market.” It’s been an extraordinary era for asset management. The S&P 500 has grown from a low of 102 in 1982 to 3800 today. The era of reducing and then exceptionally low interest rates lifted many boats in funds management. So it’s been a great industry to work in.

But granting the favourable conditions, Vanguard crushed it against peers in asset management rising from #12 in the fund industry to be #1 in the mutual fund industry in the US, from a market share less than 5% to a remarkable market share in the high 20% – 29% at last count. So, what else drove Vanguard to the front of the pack?

Leadership — there is no question Bogle’s visionary leadership made a huge difference. Paul Keating has been quoted as saying “leadership equals imagination plus courage.” Jack certainly lived up to that and much more.

He really brought a whole, comprehensive philosophy of investing to the task of leading Vanguard and our burgeoning investor base. He designed Vanguard to live the investment philosophy he believed in. He believed in and promoted “common sense” investing, focusing on sensible diversified investment portfolios operated at low costs – index funds and active funds so long as they were low cost – and long term holdings not short term speculation. He had a profound scepticism for what active management could reliably provide. He eschewed market timing, saying in his 50 years in the investment business, he’d never known anyone who’d successfully timed markets and didn’t know anyone who knew anyone who had successfully timed markets. Much better in his view to buy a low-cost portfolio and hold it for the long term. Stay the course was his motto.

“The winning formula for investing is owning the entire stock marketing through an index fund, and then doing nothing. Just stay the course.” Jack Bogle

He built the company around those beliefs, and when critics would say “Jack, you just make these arguments – such as for indexing or low costs – because that’s what Vanguard does”, he’d say no, the company does those things because I believe that’s the way to invest.

Innovation – his imagination also took Vanguard into product and marketplace innovation. The 1980s and 1990s saw a slew of new products introduced to the marketplace – especially as Vanguard expanded its index fund line-up to cater to different portfolio needs.

Vanguard also was an early mover in the individual and corporate retirement market, which had been liberalized via new tax rules making corporate 401k plans – like super funds – a major savings vehicle for employees in America. From a cold start in 1981, Vanguard became a leader in corporate retirement plans.

Vanguard was, however, a late entrant into Exchange Traded Funds – a new format for the index mutual fund, even though Jack was offered the opportunity to be the first provider in the early 1990s when the inventor brought the idea first to Vanguard. Jack thought the ETF a dangerous contender/competitor to the traditional index mutual fund. He was afraid that the ETF, while innocent and a fine vehicle in itself, would be abused and corrupted by vendors encouraging short term trading. The vendors would make the money and not the investors. He was right to be concerned.

So, it was left to Jack’s successors to make a late start into the ETF market. Despite that, aided by the low costs enabled by the mutual structure, Vanguard quickly became a leader in the marketplace. Vanguard emphasised the diversified index funds better suited to long term holdings – rather than more speculative, narrower vehicles, and ETFs have become an essential part of the Vanguard product suite.

Also critical to Vanguard’s growth was its ability to win client trust.

Mutual funds are an intangible product – tough for consumers to get their heads around. So, it was critical to establish brand identity and trust amongst consumers. Bogle was the man for that. He was a glorious communicator, always writing client letters with homespun, common-sense wisdom and honesty. He was a brilliant speaker, whip-smart, with a sonorous voice and a gift for expression and storytelling. Late in his executive career he started writing his first book on common-sense investing. After his executive career he spent another 20 years writing a dozen books, 19 financial journal articles and giving countless speeches and TV interviews. I’ve never seen anyone create such a brilliant and impactful second act post-executive career.

Trust and a long-term investment philosophy were essential to the other driver of Vanguard’s growth success: retaining clients. I think most people in the asset management industry undervalue the importance of client retention as a driver of success in the industry. But Vanguard was able to have dramatically stronger client loyalty, evidenced in lower client turnover, and lower redemption rates.

In fact, for decades Vanguard had redemption ratios that were 10% a year lower than industry competitors. Imagine this: say you’ve got a $100 billion fund business and you’ve got 20% per year redemption rate. You need to sell $20 billion per year just to break even with your redemptions. Whereas Vanguard with a redemption rate 10% less, would only have to sell $10 billion in new units to break even. That advantage just compounds year over year.

Now, let me also state that I think business acumen and winning culture were essential to the mix of things that made Vanguard a success.

Most histories of Vanguard rely on the Jack Bogle legend – and that’s fair enough up to a point. There have been five or six books about Vanguard’s growth and they all remind me of a story about US President Teddy Roosevelt. Before he became president, he took a Colonel’s position in the Spanish American war and fought in Cuba. When he returned, he wrote a book called The Rough Riders. On reviewing it, one of the famous muckraker journalists of the time quipped that based on Teddy’s account, which always placed himself at the centre of the action, it should have been called Alone in Cuba.

Vanguard histories tend to have this same shortcoming. But underneath the usual story told about Jack Bogle’s product innovation and visionary leadership, I think there’s an amazing management story to be told about how the growth was enabled and a winning team created.

In the early days of the 1980s, we were a bit of a management basket case, struggling with growing pains. Sometimes we were on the verge of operational disasters such in 1985 when we were growing so fast and we couldn’t answer the phones or process the applications coming in on a timely basis. We had lots of problems, were technologically unsophisticated, and had a team that wasn’t functioning as a top team. What we needed was operational management skills and a stronger technology backbone.

That’s why I often think about Vanguard, not as the House that Bogle Built, as author Lewis Braham called it, but as the House That Jack Built (photo). Every great visionary leader needs a great operating and team-focused executive to pull it all together. And Jack Bogle’s was Jack Brennan. These two made a great pair at the top while Jack Bogle was chairman and CEO. Jack Brennan was a superb President of the company and went on to become an excellent CEO for Vanguard for 12 years after Jack Bogle stood down in anticipation of his life-saving heart transplant in 1996.

There’s a great book to be written on how Jack Brennan reset Vanguard’s operating rhythms and rebuilt management team capability. Brennan was a great coach, finding the right people, getting rid of the people who weren’t making the grade, putting people in the right places, moving them around to train and develop them, getting them working on the right things. He also helped us move from being graded a “gentleman’s C” in technology in the late 1980s to a top 100 technology company by the end of the 1990s – and an early innovator and leader in internet adoption. The internet would pay off handsomely for Vanguard which went from a call-centre dominated service model to a web-based delivery model.

Jack Brennan also made sure the team was well catered for, bringing in top HR resources, and cultivating a winning attitude devoted to continual improvement. He took us through multiple phases in improving operational excellence, from Total Quality Management to six sigma and beyond. He never accepted that being low cost meant low quality. Instead, he insisted we had to be the lowest cost and the top-quality provider. He was all about “focus and discipline.” He liked to say we could be “confident but never complacent.” He was always pushing us to get better.

I think a standout feature of Vanguard as a mutual is that it was always led by exceptionally competitive people. They wanted to lead a winning team and succeed on behalf of clients. These guys – Jack Bogle and Jack Brennan and their successors under whom most of the dollar growth was achieved– wanted to win. And were restless and driven towards that outcome in the way that leaders of top sports teams are. And they would create a passionate team culture –many have called it a “cult”. Jack Bogle had always called Vanguard’s staff “crew,” never “employees,” not just because Vanguard was named after Nelson’s flagship at the Battle of the Nile but because he wanted people to work as a team for a purpose.

And the crew were raised on a winning attitude filled with common purpose focused around clients, clear vision and fueled by successes won. From my own experience, I’d say there’s nothing quite like the joy of being part of a winning team working successfully with great shared purpose. Glory days!

Coming to Australia

It was my privilege to bring this great story out to Australia, and come home, in 1996, as a one-man band, or first apostle if you will, starting Vanguard’s first international office here in Melbourne. It took me seven years to convince Vanguard to go international, after returning from an extended Harvard Management Program the Jacks sent me to in 1988. Here I was surrounded by a bunch of international executives and found the passion to take the Vanguard mission offshore. I finally convinced them in 1995 with the identification of the opportunity developing in Australia because of compulsory superannuation contributions. Compulsory super made it a no-brainer.

Who would they send? That had always been one of the objections to the prior plans for the UK and Canada and other countries. “Send me,” I said. Let me go home, watch the footy again and raise my teenagers in much more sensible Australia. See what we can do taking the mission to an international market and build a broader international business from there.

And they said yes, and that’s what we did.

The mission in Australia was simple – bring low-cost indexing to a market where there was almost no indexing and start in the institutional super fund market (because that’s where the money was) and move into retail and adviser channels. As in the US there was a huge amount of skepticism but we were able to build a significant share of an indexing sector that grew in a quickly growing superannuation driven marketplace. The business has continued to grow rapidly under my successors after 2010.

Of course, in Australia, there are a number of admirable mutual investment management organisations – known as industry funds and they’ve been very successful. Jack Bogle would have thought this was great. He’d always wanted there to be other mutuals in the US as that would create a better industry. He often thought of himself as a failure because no one had followed him into a mutual structure. He’d say “you can’t be a leader if you don’t have followers.”

I hope you’ve enjoyed hearing the story of Vanguard’s early growth as much as I’ve enjoyed retelling it. The story should give mutuals and cooperatives everywhere confidence and inspiration to see what can be done with a purpose-filled mission and a structure that supports it, how it’s possible to get teams aligned around that mission and focus on building the team and the capability to execute the opportunity to the best of your ability. It still takes management nous and determination, and a bit of luck – being in the right place at the right time – never hurts.

I wish you the best of luck in your own fine endeavours.

To discover more about the remarkable man, Jack Bogle, see The Bogle Effect by Eric Balchunas, another keynote speaker at the BCCM 2022 Leaders’ Summit.

For more BCCM Leaders’ Summit news, visit our Summit wrap-up.