Mutual fund structures
One of John Bogle’s most unique achievements is the creation of the organizational structure of The Vanguard Group. It is common for both Bogle and Vanguard to refer to the company as a “mutual” mutual fund company, since the investment management company is owned by the individual Vanguard mutual funds and provides services to the funds at cost. The figure to the right sums up an argument for favoring a mutual structure: cost savings result in increased returns to investors.
While mutual forms of organization have existed for other businesses in the financial sector, Vanguard is the sole representative of this form of organization in the mutual fund industry. It should also be noted that while mutual companies in the insurance,1 savings bank,2 and stock exchange 3 industries have a long history, a growing majority of these mutual firms have demutualized and become standard corporations.
The Vanguard funds ownership stake in the management company is verified in the audited financial statements of each fund and revealed in the fund’s annual and semi-annual reports. The fund’s capital investment in the management company is listed in the “Other Investments and Liabilities” segment of the “Statement of Net Assets” section of the report. Thus, for example, Vanguard’s largest mutual fund, the Vanguard Total Stock Market index fund, has the following listing in the 2017 annual report:
| Investment in Vanguard | $36,381,000 |
A footnote informs us that this capital investment represents 0.01% of the fund’s net assets and 7.56% of Vanguard’s capitalization. Furthermore, the fund can be assessed a maximum contribution of 0.40% of net asset value at Vanguard Group’s request.4 Currently, all Vanguard funds (with the exception of fund-of-funds which are not assessed a capitalization contribution) contribute 0.01% of fund assets to The Vanguard Group Inc. capitalization.
Vanguard Group book value
The capital investment in Vanguard by a fund, along with its percentage investment in the management company allows us to come up with an estimated book value for The Vanguard Group. Based on a large sample of Vanguard funds (50+), The Vanguard Group Inc. has, as of fiscal year 2017, an approximate $250,000,000 book value.5 This is historical cost value and is not marked to market.
How does this compare to the market capitalization of three respected publicly owned market competitors? The following table provides the stock market capitalization of Blackrock Inc.,6 Charles Schwab Inc.,7 and T. Rowe Price, Inc.8
| Company | Market cap |
| Blackrock Inc. | $86,765,000,000 |
| Charles Schwab Inc. | $70,865,000,000 |
| T Rowe Price Inc. | $26,970,000,000 |
From one perspective the juxtaposition of public-owned versus mutual-owned valuation is concrete evidence of John Bogle’s inversion of the ownership pyramid. The “non-profit” management company is many times smaller than the funds it services. In tangible, financial terms, a total loss of the Vanguard Group’s value, due to bankruptcy or government edict, would mean a loss of 0.01% of the mutual fund shareholder’s net asset value in the funds.
Viewed from a different angle, the stock market capitalization of similar financial firms suggests a range of potential marked-to-market value of Vanguard Group Inc. should the company demutualize or be sold.
Demutualizing?
In the short term, the possibility that Vanguard will elect to demutualize is virtually nil. One doubts that the firm would take this step while its founder and architect, John Bogle is alive. Furthermore, the mutual structure is planted in the firm’s charters and permeates management culture, as evidenced by the following statement from incoming CEO, Tim Buckley.
CEO Tim Buckley
Question: Will Vanguard change it’s fund-owned structure?
“Not on my watch. Sorry. It’s who Vanguard is.
We are structurally owned by our client. In demutualizing (as with mutual insurers who convert to stock ownership), your owners benefit. But they already own the company!
You have to be willing not to be a billionaire. What is your strategic differentiation? As soon as Vanguard isn’t mutual, you have to have outside shareholders. You have to pay someone else. You have to have a (profit) margin. Instead of zero. It would undermine the strategic purpose of Vanguard. If we demutualize, you can kill the company. It’s not going to happen.” – CEO Tim Buckley in an interview. 9
Finally, there exists a concrete fundamental factor that favors Vanguard retaining its current structure. The motivation that drives stock market exchanges to demutualize is the desire to compete and expand in the global marketplace. Insurance companies and savings banks demutualize for greater efficiency in management, and perhaps most importantly, to gain access to capital investment.
As mentioned earlier, Vanguard mutual funds capitalize the management company by devoting 0.01% of fund assets to the capital account. The service agreement allows the management company access, upon request, to receive 0.40% of net assets. A forty-fold increase in capitalization gives the management company access to 10 billion dollars of book value capital.
Over the very long term
What structure Vanguard may select far into the future, assuming the company still exists at that point in time, is impossible to predict. Change is an inevitable part of life.
From our 2018 vantage point let us look at the state of the investment world five, six, seven, and eight decades back. This would cover the period from the late 1930’s to the late 1960’s.
At the beginning of this period, mutual funds were a mere drop in the financial intermediation bucket. The first US open end mutual fund, Massachusetts Investors Trust, was created on March 21, 1924. Only a handful of funds existed when the The Investment Company Act of 1940 was signed into law, setting the structure and regulatory framework for registered investment companies.
During this entire period there we no individual retirement accounts, no corporate 401-k defined contribution plan. Money market funds, municipal bond funds, and index funds did not exist. Vanguard did not exist.
The typical individual investor during this period would likely invest through a full service brokerage wirehouse account holding individual stocks and bonds, supplemented with commissioned loaded mutual funds.
Now allow us to turn the screw and attempt to envision the investment world five, six, seven, and eight decades into the future, when today’s toddlers scampering across Millennial living room carpets will be grandparents and great grandparents.
All we can safely assume is that the regulatory regime, the retirement system, the investment intermediation system will all evolve and differ, perhaps markedly, from today’s conditions.
Notes
1 Erhemjamts, Otgontsetseg and Leverty, J. Tyler, The Demise of the Mutual Organizational Form: An Investigation of the Life Insurance Industry (February 24, 2010). Journal of Money, Credit and Banking, Forthcoming.
2 Girotti, Mattia and Meade, Richard, U.S. Savings Banks’ Demutualization and Depositor Welfare (July 26, 2017).
3 Ramos, Sofia Brito, Why Do Stock Exchanges Demutualize and Go Public? (March 13, 2006). Swiss Finance Institute Research Paper No. 06-10.
4 Codified in Vanguard’s Fifth Amended and Restated Funds’ Service Agreement.
5 Book value is calculated on Vanguard Inc. capitalization google spreadsheet.
6 BlackRock, Inc. (BLK) as of March 2, 2018.
7 The Charles Schwab Corporation (SCHW) as of March 2, 2018.
8 T. Rowe Price Group, Inc. (TROW) as of March 2, 2018.
9 Joseph N. DiStefano, New CEO Tim Buckley: To run Vanguard, ‘you have to be willing not to be a billionaire’ The Inquirer, November 7,2017.
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