Almost since its founding in 1975 by the late great John Bogle, I have held the Vanguard Group, the giant of mutual funds, in the highest regard.
Vanguard's mission was to provide investors with the lowest possible cost of services and to behave in a highly ethical manner. Unlike other mutual fund companies, the company has been structured as a non-profit organization (all profits go to investors, not to external shareholders) and has consistently offered extremely low-cost, high-quality investment services, causing competitors to cut costs.
Perhaps because there are no outside shareholders to maximize share value, Vanguard was also the most reliable source of unbiased financial information and research. While other companies, sometimes outrageously, tend to do their research and the information they provide (often it's just a selling point), Vanguard stands out as credible.
But even the best companies make mistakes. Unfortunately, Vanguard makes a big one.
Bogle, like me, supported a financial transaction tax (FTT) to throw sand into the wheels of excessive and potentially harmful speculative trading. Radio frequency trading currently accounts for more than half of the US securities business.
In contrast, there is little or no radio frequency trading in Hong Kong, the third largest stock market in the world, as a two-way stamp duty (purchases and sales) of 0.1% is levied on trading in Hong Kong. This had no noticeable negative impact on Hong Kong's market or economy, which the conservative Heritage Foundation categorized as the freest in the world.
Unlike Bogle, Vanguard's current management is against a financial transaction tax. Vanguard's argument may be of reasonable interest, but the research Vanguard has put forward to support this position is not at all reasonable.
This research reads like a polemic. The headline reads: "Main Street investors in danger – a financial transaction tax would harm everyday savers."
This is the same sham argument that other potential US financial industry protectors have spoken out against any restrictions in the industry. In fact, it's obviously wrong. High-frequency speculative traders would be heavily affected by the tax, but main street investors would hardly be affected.
However, Vanguard's one-page research document highlights "the needs of American families." These "hardships," according to the Vanguard document, would reduce the value of an initial investment of $ 10,000 after 20 years by 19%.
Vanguard's conclusion, however, was a huge 1.09% reduction in an investor's annual return due to the financial transaction tax. (Although Vanguard does not say this, I assume that this refers to the financial transaction tax currently proposed in Congress under the Wall Street Tax Act.) In order to make this assumption, the company had to take a closer look at the Base Vanguard's graph on an equity portfolio 100% invested in an actively managed small cap equity fund.
Vanguard would never recommend that investors invest more than 10% -20% of their money in such a fund. An investor who invests his entire equity portfolio in the Vanguard Strategic Small-Cap Equity Fund, for example
VSTCX, + 0.51%
I would have an undiversified, relatively expensive and high-turnover portfolio – the opposite of what Vanguard generally recommends.
In addition, it is difficult to understand how Vanguard could have come to the 1.09% annual income reduction tax. Vanguard Strategic Small-Cap Equity had an annual turnover rate of 67% at the end of September 2019. The direct impact of the 0.1% financial transaction tax on securities purchases can therefore only be 0.067% per year.
How did Vanguard get the other 1.2% to conclude that the impact of the FTT on the active small cap fund would be 1.09%?
Answer from Vanguard
In his honor, Vanguard has faithfully answered my questions about this investigation, although they have not yet answered repeated questions regarding the methodology and assumptions with which they determined the value of 1.09%.
However, Charles Kurtz, a Vanguard public relations specialist, emailed me after I submitted my complaint about this investigation to them and we exchanged several emails saying that they were currently playing the piece revise, “to illustrate the impact of different levels of a financial transaction tax on additional fund types. “Kurtz also gave me Vanguard's preliminary considerations about this investigation. In particular, he sent me estimates of the impact of the tax on funds other than the active small cap fund.
According to Kurtz's email for a large cap index fund like Vanguard's flagship products (and the largest funds) – Total Market Index Fund
VTSMX, + 0.20%
and S&P 500 Index Fund
VFINX, + 0.19%
) – Vanguard calculated that the tax would only affect 0.044%, less than one twentieth of the estimated impact of 1.09% on an active small-cap fund.
Together, these large-cap funds have assets in excess of $ 1 trillion. Vanguard would have no authority whatsoever to recommend an investor to invest 100% of its equity in any of these funds. In contrast, Vanguard's active small-cap fund has assets of only $ 1.4 billion – and it is recommended not to include more than a small portion of an investor's portfolio.
Why did Vanguard highlight this fund? Mr. Kurtz didn't tell me – I suspect he doesn't know why. In addition, I disagree with Vanguard's 0.044% estimate for the large cap index fund and I believe it should be much lower. However, since I do not know which methodology and assumptions Vanguard used to arrive at their estimate, I cannot rate them directly.
I welcome and look forward to the update of Vanguard's research results. But damage was done. Vanguard's biased, publicly available results, which were achieved using unknown methods and only for a small, actively trading fund, have already been highlighted by interested financial industry organizations to support their refusal to accept the FTT.
The danger for Vanguard is that it appears to be just a specialist in the financial industry, of which there are so many who make false arguments to prevent any regulation or taxation of the industry. This was not an inheritance from Vanguard. The advocacy of the financial industry should never be a special plea.
I look forward to Vanguard revising this study. I think it will be much less biased.
Michael Edesess is Chief Investment Strategist at software company Plynty for mobile financial planning and research assistant at the EDHEC Risk Institute. He is the author of "The Big Investment Lie" and co-author of "The 3 Simple Rules of Investment".
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