06 November 2011

Occupy My Wallet: Moving Money Off Wall Street

If you're really ticked off at Wall Street, you've got some options: Grab your sleeping bag and head to the nearest protest site, or do something that actually pinches the big bankers' bottom line

By Lewis Braham | Bloomberg | Nov 5, 2011
Financial Disobedience
A man dressed as an "evil banker" stands with other Occupy Wall Street protesters. Photographer: Leon Neal/AFP/Getty Images

The second choice may be the smarter one. While Occupy Wall Street protests are colorful and make for good sound bites, what major bankers and money managers really care about are their pocketbooks, and pain in that department is most likely to get them rethinking their ways.

Activists at websites such as MoveYourMoneyProject.org recommend that savers switch from banks to credit unions, but there’s another alternative few are talking about. It's buying and holding low-cost index funds, rather than investing in the actively managed mutual funds and other products sold by the big banks and financial services firms. The beauty of such a "revolt" is that it deprives the Street of profits and saves investors money at the same time.

John Bogle, founder of the Vanguard Group and the first index mutual fund, doesn’t necessarily support the protesters. He does, however, think their anger toward Wall Street is justified and that indexing could be an effective means of boycotting the Street’s most speculative firms. “Indexing fulfills the Adam Smith-ian argument that if you do best for yourself, you will serve society well,” Bogle says. “The implication of that is if many more people indexed, there’d be much less trading in the market, and that’s good because it's costly. There’d also be much less big payoffs to investment managers, and that’s good for the returns earned by investors and good for our society, too.”

For instance, Vanguard’s Total Stock Market Index Fund has an expense ratio of 0.07 percent for its admiral share class. (The fund has a minimum investment of $10,000.) That compares with 1.12 percent for the average large-cap blend fund, according to Morningstar. So if you put $10,000 into the index fund, only $7 a year goes to the manager, compared with $112 for the average fund. Moreover, the fund has an average holding period for each of its stocks of 33 years, so very few trading commissions are being generated. By contrast, the average domestic equity fund has a holding period of a little over a year. The Vanguard fund has beaten 83 percent of its peers in its fund category over the past decade.

While saving a $105 a year in management fees and a few dollars more in trading commissions may not seem like a lot, collectively the costs are huge. According to "The Cost of Active Investing," a 2008 study by Dartmouth economic professor Kenneth French, the annual all-in management and trading costs for actively managed mutual funds, hedge funds, and other institutional investors rose from $7 billion in 1980 to $101.8 billion in 2006. If every portfolio were indexed instead, French estimates that the total annual cost would be $8.9 billion.

Vanguard’s funds have an added appeal to investors who support the Occupy Wall Street movement. The company is run at cost, similar to a nonprofit organization. Although the company has its own rather complex bonus system, the absence of the profit motive at the firm ensures no massive issuance of stock options or mammoth paydays. Vanguard is owned by and run for shareholders, much like a mutual insurance company.

And yet by some measures Vanguard fails in one crucial area. That is in how it votes on shareholder proposals to restrict executive compensation at companies it invests in. An annual study published by AFSCME, a union for public service employees, analyzes how the largest fund companies vote on such proposals. Of 26 fund families, Vanguard ranked the worst and was labeled a “pay enabler” for the 2010 proxy season, voting 98 percent of the time against proposals to constrain executive pay. (Not that other big fund shops fared much better. Vanguard’s largest competitors, Fidelity and American Funds, voted in excess of 95 percent of the time against shareholder proposals.)

Bogle argues that poorly designed compensation schemes encouraged the speculation that caused the last two financial crises. By promising big paydays to executives for hitting a quarterly earnings number or short-term stock price, compensation committees encouraged chief executives to take excessive risks, he says.

So why would Vanguard vote against proposals to limit such pay? “If Vanguard wants to manage the 401(k)s of large corporations, it doesn’t want to offend their CEOs by voting to rein in their compensation,” argues Lisa Lindsley, AFSCME’s director of capital strategies. Bogle agrees. “The three lowest voters for shareholder proposals in the AFSCME report are the three biggest providers of defined contribution plans [i.e., 401(k) plans],” he says. "Vanguard says 'We're much more active than you think because we talked to 400 managements last year [privately] and we get them to change what they're doing.' But at some point you've got to say here is the data and failing any other explanation, the data is telling us the truth."

Glenn Booraem, a member of Vanguard’s proxy oversight committee, characterizes the AFSCME analysis as too simplistic. He says Vanguard works behind the scenes to ensure that executives are compensated appropriately. “AFSCME’s got this very black and white view that all management proposals on compensation are bad and all shareholder proposals are good,” he says. “I think that is a terribly simplistic view of governance. We’ve taken the perspective that we don’t want to be in the position of micromanaging the minutia of specific compensation practices.”

Activist shareholders may feel differently. Those dissatisfied could switch to a socially conscious fund shop that takes a more activist approach. “During the 2010 and 2011 proxy voting seasons, we voted 84 percent of the time against management resolutions to increaseexecutive compensation,” says Julie Gorte, senior vice-president for sustainable investing at Pax World Funds, a socially responsible fund company in Portsmouth, N.H. “It’s a reflection of our belief that executive compensation should be what it isn’t. It should be fair, it should be performance based, it should compensate managers for long-term performance rather than what happened in the last 10 minutes, and it should be transparent.”

The fees on Pax World funds are far higher than those at Vanguard, however. The retail shares of the Pax World Growth stock fund have a 1.29 percent expense ratio. That’s 18 times more expensive than the Vanguard Total Stock Market index fund. Until there are more equitable fee structures at socially responsible funds, buying an index fund may be the only “Adam Smith-ian” solution for activist investors, other than investing in individual stocks and voting on shareholder resolutions themselves. Of course, you can always go the sleeping-bag route.

(Lewis Braham is a freelance writer based in Pittsburgh.)
To contact the editor responsible for this story: Suzanne Woolley at swoolley2@bloomberg.net

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