“Yes, Virginia”: The compensation question
In a post last month, I mentioned the skepticism we hear from time to time about Vanguard’s client-owned, at-cost structure.
In brief, under this novel structure the various Vanguard mutual funds own the operating company—The Vanguard Group, Inc.—that exists to serve those funds. No other owner pulls a profit from the operating company.
It’s clear from your comments that skepticism still abounds, along with a fair amount of curiosity, and even a good portion of gratitude for Vanguard’s unique client-owned structure. In this post, I’ll respond to some of those questions and comments.
Executive compensation
About one in four comments focused on the compensation of Vanguard executives.
“How much does CEO McNabb make . . . How about the compensation packages for the Directors . . . How about the top 100 compensated employees.”
Although I know this response won’t satisfy those concerned about compensation, Vanguard’s view is simple: We don’t disclose the compensation earned by any crew member. We believe that compensation matters deserve the same privacy protections that we provide to shareholders and their account information.
So how do you know Vanguard’s executives aren’t enriching themselves at your expense?
You have to rely on your elected representatives: The eight independent directors of Vanguard’s board, who together comprise the board’s compensation committee. One key part of their job is to review and determine each year the compensation of senior officers to ensure that compensation levels are fair, competitive, and most importantly, designed with the best interests of fund shareholders in mind. These board members all are Vanguard investors, too, and they take their responsibility to fellow shareholders quite seriously.
Stewardship: The proof is in the pudding
You may not like having to rely on others to determine what’s “fair.” But I think it’s reasonable to suggest that the proof of good stewardship is in the pudding:
- Vanguard has existed for 35 years, and the average expense ratio for our mutual funds has declined substantially over that span—from 0.89% in 1975 to about 0.20% in 2010. Over that same period, the average expense ratio for all mutual funds throughout our industry has risen slightly—from 1.08% to 1.19%. All compensation for Vanguard’s crew, directors, and senior leaders is part of our funds’ expense ratios, and incentives are based on various factors, including long-term fund performance, service quality, and controlling our operating costs.
- Through the years, Vanguard’s officers and fund trustees have on numerous occasions closed or restricted purchases into various funds when they believed cash inflows might cause those funds’ performance to suffer. Turning away business probably isn’t something you’d associate with a “growth at all costs” mentality.
- Vanguard has a long track record of alerting investors to the risks of investing—not merely highlighting the potential rewards. We don’t run advertisements touting the returns of a hot fund. All of this is entirely consistent with a client-owned company with a long-term investment philosophy that puts clients’ interests first.
As a former journalist, I understand the keen interest in how much various individuals make—whether in business, government, sports, or entertainment. Each investor has to decide whether executive compensation is vital information for making an investment decision, and how much weight to give to other fundamentals—the total cost paid for the investment, taxes, objectives and risks, and long-term performance.
Will Vanguard’s structure change?
“What could happen to change this corporate structure,” asked one reader. “What assurance is there that this ship will not change course?”
I went straight to the boss on this one. When I asked Bill McNabb, our chairman and chief executive officer, if there’s any chance of a change in course, he said simply: “No way.”
Managing investment risks
A few readers asked how Vanguard’s investment analysts and portfolio managers try to avoid the kinds of securities that blew up during the credit crisis.
As one wrote: “What keeps the people who do research for the bond funds, and those who run them, from buying dangerous instruments?”
Besides the experience and skill they bring to bear, investment analysts and portfolio managers also have an advantage that stems from Vanguard’s client-owned, at-cost structure. The fact that our fund expense ratios are generally well below those of competing funds allows our investment professionals to position the funds more conservatively, giving up some potential yield on riskier investments while still seeking to provide very competitive yields.
Vanguard’s advertising
Some readers asked about our advertising expenditures and how we determine whether to spend money on advertising.
The short answer is that we don’t spend anything on advertising unless we believe it will benefit our clients over time by attracting clients whose assets will help us to continue reducing expense ratios. The long answer? Well, that was in an earlier post.
A word in self defense
Speaking of expense ratios, I should address one more minor thread in response to the post.
A few readers took swipes at a comment posted on the blog on March 27, which itself was a reply to a March 25 comment. The March 27 comment equated an expense ratio of 0.25% to “one-quarter of 1 cent for every hundred dollars under management.” Some folks assumed I had written the response.
One commenter wrote: “But seriously, I just hope the people at Vanguard who are actually managing my money are somewhat better at math than those who do planning & development.”
Another wrote: “It is astounding that he (Craig Stock), who is supposed to understand the arithmetic of money matters, should state that 0.25% is equivalent to ¼ cent per $100. . . . Stock was off by a factor of 100, and yet he has not come back with anything by way of a mea culpa.”
First, I issued no mea culpa for a simple reason: I didn’t post the comment with the error in arithmetic. One of the blog’s readers made the mistake, apparently miscarrying a decimal point.
Second, although I didn’t make the error, I am quite willing to concede that Vanguard’s portfolio managers and investment analysts are better at math than I am. That’s one more reason that I’m glad they’re managing all of my own investments!
Notes:
- All investments are subject to risk. Investments in bond funds are subject to interest rate, credit, and inflation risk.
- Vanguard provides services to the Vanguard funds at-cost.
- “Client-owned” means clients own the funds and the funds own Vanguard.
- Sources for the expense ratio data cited above: Vanguard and Lipper Inc. Data as of March 31, 2010.
Thank you for sharing this information.
Great!
I’m very disappointed in Vanguard’s complete unwillingness to disclose ANY information about executive compensation, for the following reasons:
1. You could disclose average compensation levels for a category of senior executives or directors, while keeping any individual’s compensation private. That would at least give us shareholder-owners some sense of how much we are paying you.
2. Public companies are required to disclose compensation information for certain senior executives — in theory so that shareholders have transparency on the issue, and can use their voices to serve as a check on excessive compensation. We, as Vanguard mutual fund holders, should support those requirements — we benefit from them, especially if institutional shareholders like Vanguard use their leverage to reduce excessive compensation. (By the way, Vanguard disappoints on this also — I believe you rarely if ever have said a word about the clearly excessive compensation paid by some companies within your mutual fund portfolios.) Anyway, would be in the interests of Vanguard’s shareholder-owners if Vanguard lead by example — with transparent and reasonable executive comp. policies. Instead, Vangaurd basically tells its owners that executive comp. is ‘none of your business’.
3. The secrecy on executive comp. which you seek to justify runs counter to everything Vanguard is supposed to stand for: putting your shareholder-owners first; and minimizing costs in every way possible.
You’re like my old Wise Uncle. And perhaps better at math than you get credit for.
Well said, Mr. Stock! Thank you for putting our interests first!
Do you have any interest in replying to the question I posed in your “Yes, Virginia” posting on March 30, 2010 at 1:42 am:
How would Vanguard’s unusual ownership structure affect things if the Prime Money Market Fund were at risk of breaking the buck? When other mutual fund sponsors have a money market fund at risk of breaking the buck, they have put up their own funds so as not to risk the bad rep of breaking the buck. I assume those moneys come from the mutual fund sponsor’s corporate equity. But with Vanguard’s structure, where is there capital available to bail out the money market fund?
I am amazed at all the micro managers out there. Ask yourself two questions. Am I satisfied with the returns of the Vanguards funds I own? Are the expense ratios below the average of the industry? If the answers are yes, why would you care about individual compensation?
Since Vanguard is client owned, am I not entitled to know how much my executives and managers are paid. After all it is my expense fees that pay their salaries. When you own something you usually have the right to know what your money is used for. I like and appreciate that Vanguard is client owned, but that secrecy regarding compensation of its executives doesn’t seem right. What is there to hide if everything is fair and square? We hear a lot about the word transparency these days. I wish Vanguard would be in the vanguard on that issue.
To be truly TRANSPARENT Vanguard should disclose the compensation of it’s top managers.
All investor owned corporations in the country do this.
So, why not Vanguard, an investor owned, not do the same?
Vanguard does itself no favors by not disclosing what it pays it’s managers.
This single fact is about the only thing I find wrong with Vanguard.
Hey, the companies Vanguard buys stock disclose comp, so why not Vanguard?
That’s an outrage.
If they really are working in our interest, then disclosing executive compensation is not only a no-brainer, it should have been a first order of business!
I can see no valid ‘privacy’ or other excuse for such hubris; more appropriate for the robber barons who created the financial crisis we are still in, than for the stewards of our investments.