• [WEBCAST] Raoul Pal & Neil Howe: A Sobering U.S. Economic Reality Check

    Prepare your portfolio for “big picture” paradigm shifts with Real Vision co-founder Raoul Pal and Demography analyst Neil Howe. Watch the replay from this webcast.

“The motivations of those who seek the rewards earned by engaging in commerce and finance struck the imagination of no less a man than Adam Smith as something grand and beautiful and noble, well worth the toil and anxiety."
- Jack Bogle, Founder of Vanguard Group

“Good people do not need laws to tell them to act responsibly, while bad people will find a way around the laws.”

Since we are located on the fringe of Yale’s campus in New Haven, CT, the Yale Daily News (“YDN”) tends to be one of the many daily newspapers our research team reads every week. It is the United States’ oldest college daily newspaper (although the Harvard Crimson disputes that claim) and has been the starting place for many successful journalistic careers, including Henry Luce, William F. Buckley, John Hersey, Pete Axthelm, and Dana Millbank, to name a few. From our perspective, it is worth reading because it offers a view into the current mindset of college students.

On December 4th, 2008, we picked up a copy of the YDN and a headline on the front page article read, “A Job on Wall Street: Are you Crazy?” The insinuation being that not only were jobs tougher to come by on Wall Street, but, and not surprisingly, the allure of such jobs had faded meaningfully. This was reinforced by a recent talk Keith gave to a group of students who were emphatic in their disdain for finance and the said “leaders” that run these major financial and investment banking firms. Smart, motivated graduating seniors want to be proud of their emerging careers and that pride begins with picking an industry that has integrity and respect.

The events last week relating to the fraud of Bernie Madoff’s hedge funds obviously even further tarnish the financial industry. We discussed Madoff this week on our portal, so won’t rehash the facts again, but the extent of the fraud is breathtaking and is estimated, in some reports, at over $50 billion. Ironically, while Madoff was not a household name, both he and his firm were considered long time leaders in the financial industry.

As a slight digression, not everyone bought into Madoff’s returns. We reread a May 2001 article from Mar/Hedge this weekend , which was entitled, “Madoff tops charts; skeptics ask how”. This is a major publication in the hedge fund industry and a must read for anyone allocating capital to hedge funds. According to the article, from June 1989 to February 2001 “it (Madoff’s fund) would rank as the best performing fund for the period on a risk adjusted basis, with a Sharpe ratio of 3.4 and a standard deviation of 3.0%.” The returns appeared to be too good to be true, and were.

As I reflected on Madoff this weekend (admittedly, many of the details are yet to come), I found it incredibly difficult to understand how a man could live his entire life under such a fraudulent scheme. Not only did he cheat his friends, close associates, but, ultimately, his own sons turned him in. In my mind, it would be better to be destitute and unknown than to live an entire life based on a lie, but, of course, Madoff thought otherwise.

The unfortunate implications of the Madoff fraud are that confidence in the “old boy” financial services industry will deteriorate further. While mistrust in the leadership of the industry is certainly well founded, I do think it is important for us to value the Madoff situation appropriately as his actions appear be an outlier, even for a terribly conflicted and compromised industry. While reading this morning, I a read article online by psychologist Juliann Mitchell about sociopaths and she wrote:

“It is typical for sociopaths to engage in illegal or deceitful behaviors. Compulsive lying is the norm. Guilt and remorse are not in their vocabulary. All sociopaths are incapable of feeling sorrow or sadness for their wrongdoings and destructive behaviors. Any tears you might see are for themselves. “I am crying because I got caught, not because I am sorry for anything I have said or done.”

Madoff was clearly a sociopath and, therefore, in a league of his own.

As the Madoff scandal and the failed leadership of Investment Banking Inc. are leading to a crisis of confidence in the financial industry and creating real doubts by our leaders of tomorrow, it becomes even more important to highlight that there are many great leaders in finance. These are people that have built long and successful careers on the pillars of integrity, transparency, and trust. One such person is Jack Bogle, the founder of the Vanguard Group.

John Clifton “Jack” Bogle was born on May 8, 1929 in Verona, New Jersey. Bogle went to Princeton University and while at Princeton happened upon an article in Fortune about the emerging mutual fund industry. Eager to write a thesis about a topic that had not been widely studied, Bogle wrote a successful thesis about the industry and was awarded with a job at Wellington Management, where he worked for the next 23 years and ultimately became CEO. Bogle left Wellington in 1973 and founded Vanguard in 1974.

The rest, as they say, is history. Vanguard today manages over $1.3 trillion and is the largest pure no-load mutual fund company in the world.

In a 2003 speech at the Harvard Club of Boston, Bogle said:
“The extensive study of the industry (in his 1951 senior thesis at Princeton) that followed led me to four conclusions: One, that mutual funds should be managed in the most “efficient, honest, and economical way possible: and that fund sales charges and management should be reduced. Two, mutual funds should not lead the public to the “expectation of miracles from management,” since funds could “make no claim to superiority over the (unmanaged) market averages.” Three, that the “principal function (of funds) is the management of their investment portfolios” – the trusteeship of investor assets-focusing on the performance of the corporation . . . (not on) the short-term public appraisal of the value of the share (of stock).” And four, that “the prime responsibility” of funds “must be to their shareholders”, to serve the individual investor and the institutional investor alike.”

These are fairly basic principles that embody transparency, accountability, and putting the client first. Bogle developed these principles as a senior at Princeton over 50 years ago and has managed his businesses based on them ever since.

The quotes from Plato and Bogle at the start are meant to emphasize two points. First, capitalism and the pursuit of profits can very much be a noble endeavor. Secondly, bad people exist and they will find ways around our laws. Careers like Bogle’s tell me one thing, incredible profits and success can be found within the framework ethical conduct and, in fact, and a long term legacy is almost impossible without that ethical foundation. We need to encourage our leaders of tomorrow to study the careers of people like Bogle, so they will realize that there is much to be proud of in the investment management industry.
Biographer Richard Slater described Bogle’s life as “evolutionary, iconoclastic and uncompromisingly committed to the founding principles of putting the interests of the investor first . . .” There is clearly a vacuum of leadership in the financial and money management industry at the moment. While the lack of credible role models justifiably concerns the leaders of tomorrow, this leadership vacuum will also create opportunities for people to lead themselves, to define “The New Reality”, and to aspire to become the next generation’s Jack Bogles.

Daryl G. Jones
Managing Director
111 Whitney Avenue
New Haven, CT 06