The Inside Story of How Wellington and Vanguard Became Partners
In an excerpt from his most recent book, Charles Ellis writes about one of the founding tales of the asset management industry — and why it still matters.
Last year, Greenwich Associates founder Charles Ellis published “Inside Vanguard: Leadership Secrets From the Company That Continues to Rewrite the Rules of the Investing Business.” In a new introduction written for Institutional Investor to accompany an excerpt from his book, Ellis lays out how Vanguard Founder Jack Bogle unwittingly pushed Bob Doran, head of Wellington, into challenging conventional wisdom and remaking the firm. The changes set the stage for an iconic asset management partnership that continues to endure.
Half a century ago, Wellington Management was in grave trouble. In a vengeful battle, Jack Bogle of Vanguard had cut the fees paid to its primary investment manager, the market was down substantially, and the shares of publicly owned Wellington were at an all-time low. Prospects were grim.
At the time, everybody thought the secret for success in the institutional market was to have a clear identity as a growth or value manager — or small-cap or large-cap manager — and to keep all portfolio managers and analysts concentrated entirely on that core style. This strategy, of course, ran the risk that that one focus might be out of sync with the market. The other even more troubling risk: success would add assets to a point where it would be harder and harder for the ‘true believer’ firm to deliver superior performance.
Today, Wellington Management, privately-owned by its professionals, is one of the world’s largest and most successful investment companies. The transformation of Wellington has always centered on a culture of professional respect and responsibility. And it all goes back to a memo by the firm’s then leader, Bob Doran, and his belief that even in its darkest era, Wellington could transform itself.
Doran made his case that priority number one would be serving clients, followed by priority number two: what was best for the firm itself.
Wellington would be structured around three dimensions, starting with a superb research organization of analysts who would not be subordinate to portfolio managers. Perhaps even more importantly, analysts would be able to have long careers at the firm, including partnerships, as stellar industry experts.
Doran wanted portfolio managers to be markedly different from those at leading competitors. They would not “sing the same tune” or “march to the same drummer.” Portfolio managers could thrive in careers based on all sorts of investments. But they had to excel at their chosen style, whether in high-yield or high-grade bonds; U.S. or global; growth or value stocks; or long-only strategies or hedge funds.
The third component of Wellington’s strategy would be a group of unusually capable senior relationship managers, superior to what other competitors could offer. These professionals would “belong” to each of their clients’ senior executives and would custom tailor an optimal portfolio of specialist portfolio managers.
Next, Wellington organized itself into an unusual three-part structure that ran counter to the well-accepted framework. “Everyone knew” that the only way to succeed in the institutional investment business was to focus on one style, build an organization around a few charismatic portfolio managers, and support them with analysts who, if successful, would aspire to become managers themselves. Then conventional wisdom had it that you needed a few sales people who would strive to get their firm into the finals — at which the hero portfolio managers would make the crucial presentation. If the firm won an account, the portfolio manager would be the primary person meeting regularly with the client while sales would arrange meetings and handle routine service requests.
Doran developed a very different kind of organization with three main parts, all filled by partner-track professionals who worked in a “big tent” structure. The unifying factor would be consistent professional excellence.
While any one style of investing might reach its capacity, the entire Wellington organization would always have the ability to manage more and more assets without suffering from performance problems.
Before this innovation in organization had been proven, Doran and his co-leader, Nick Thorndike, recognized that the major decline in Wellington’s share price was an opportunity to take the firm private by forming a partnership and making a tender offer. The risks were obvious, but so were the opportunities.
The partnership was unusual. When most partnerships paid departing partners only at book value, the Wellington partnership paid out from earnings over multiple years. This fit nicely with the concept of Client over Firm over Individual that Doran preached as the key to long-term success.
As Wellington gained strength, so did Vanguard. With the “Bogle Wars” over, the two organizations rebuilt their constructive partnership and today, Vanguard is Wellington’s largest client and Wellington is Vanguard’s largest manager to the great benefit of both organizations.
As II readers likely know, the lessons learned by Vanguard and Wellington are lessons well worth examination by every investment organization.
Chapter 12: Partners Again
Unlikely as it would have seemed at the fraught time of Bogle’s war with Wellington nearly 25 years before, Wellington, led by Bob Doran, and Vanguard, led by Jack Brennan, began to develop a strong symbiotic relationship. Today their relationship is dynamic, collegial, and extraordinarily beneficial to both. In one of the most successful large-scale working relationships in the investment world, Vanguard is again Wellington’s largest business relationship and Wellington is Vanguard’s largest too.
Back at the nadir of their relationship, when Bogle was determined to hurt Wellington while building up Vanguard, the situation facing Doran and his colleagues at Wellington was grim. At Vanguard board meetings, Bogle always had a documented argument for reducing the fees paid to Wellington or for switching from Wellington to another manager, and his directors almost always felt obliged to go along. Bogle was at war, determined to “press on regardless” to spur Vanguard’s growth and prominence — particularly at the expense of Wellington. He took the profitable business away, but there was never a complete break. Wellington continued to have many teams managing many Vanguard mutual funds.
It would have been a great time for Wellington to make a major acquisition to offset those Bogle-driven losses of assets and earnings. A potential home run deal suddenly presented itself in 1976. The SEC, concerned about conflicts of interest when brokers controlled captive asset managers, gave securities firms with investment management subsidiaries just two years to divest those units. This meant that stockbroker Donaldson, Lufkin & Jenrette had to divest its highly profitable subsidiary Alliance Capital Management. That presented an ideal opportunity for Peter Vermilye, who was both CEO and chief investment officer of Alliance Capital. While Alliance and its owner, DLJ, were headquartered in New York City, Vermilye had established his own office in Boston. He resided in nearby Manchester-by-the-Sea and did not enjoy commuting to New York City. The perfect solution for Vermilye was clear: Alliance Capital could merge with Wellington and he would lead the buildup of Wellington’s pension business from a base in Boston.
Negotiations quickly began with Doran and Vermilye playing the key roles. They got along well. Vermilye had a slightly intimidating way of going silent for long moments during a discussion. Doran soon found himself doing the same.
Suddenly, what had appeared to be an easy win-win combination hit a serious pothole when the SEC began an investigation of the commission rates charged to Alliance Capital by its broker-owner, DLJ. The risk of a major fine, potential lawsuits, or both — and the loss of big accounts that might be expected to follow — could have caused a serious loss of business and even thrown Alliance Capital into the red. Had the SEC inquiry quietly evaporated, as it eventually did, the combination would have been a formidable solution to the profitability problems then facing Wellington. However, some of Wellington’s partners were concerned because, in a private partnership, any loss would get charged against the personal accounts of the partners. Key partners saw no reason to embrace a possible large loss. So they insisted DLJ indemnify Wellington against any such loss. DLJ refused.
At Wellington, the recollection is that the Wellington partners, led by John Neff, the risk-focused investor, were prepared to vote against the merger, so Doran called Dick Jenrette with the news. At DLJ, the recollection was that partner Harold Newman went to Jenrette, pleading that he not sell DLJ’s “crown jewel” to Wellington, so Jenrette decided not to sell. Either way, the New York Times reported the impasse the next day, and the Wellington-Alliance merger was, at the last minute, called off. There was to be no quick, easy solution for Wellington to Bogle’s continuing siege against its assets and revenues. Meanwhile, Vanguard was losing assets as investors redeemed shares of the old, out-of-fashion and underperforming Wellington Fund.
About then, the Massachusetts Institute of Technology’s endowment, long managed by the Colonial mutual fund group, decided to establish a new investment-manager relationship. After screening many firms, MIT invited Wellington to compete to become the new investment manager. The plan was to link MIT with a strong investment research and portfolio management team at one of Boston’s major firms. At the time, both Harvard and Yale had sole-manager relationships with Boston-based investment firms: State Street Research & Management and Endowment Management & Research.
MIT invited two other firms to compete. Wellington knew Fidelity would be its toughest challenge. “We are in the finals,” said Doran to the small team he had carefully chosen, “but being in the finals is not our objective. Our goal is to win! So every day each of us must make winning the MIT mandate our first priority. We’re going to meet every Monday to bring our best ideas together into action plans until we win this competition.” He added: “MIT wants no mistakes or any doubts or questions about their process. Our goal is to come through with more and better reasons for MIT to select Wellington than can be found to select anyone else. And remember, with all the turbulence caused by the Bogle difficulties, we are starting this race well behind our competition. So we have to catch up first, but we must win — or we could be on our way to going out of business. It’s that serious.”
The length of the search process — over a year — became a major advantage for Wellington. A short process would probably have led to an easy win for one of the other competitors. But the long search gave Wellington ample time to demonstrate its research strengths by parading its many expert analysts; to show the strength of its collegial professional culture; and to give Doran, by nature low key and soft spoken, the time to show how strong he would be as a leader of a professional organization. After a long year of top-priority focus on winning MIT, Wellington won in 1977.
Years later, Doran was told, “Wellington was the firm we thought we could go through tough times with.” In other words, as Doran had hoped, the key factor was Wellington’s culture. One of the major benefits for Wellington was that in competing for MIT, it had hammered out exactly what kind of firm it wanted to be over the long term, and this self-definition became the core of its proposition when competing for other business.
After the dark days, an extraordinary cluster of favorable business developments strengthened Wellington Management Company. A new kind of business came its way at just the right time. First, the directors of the OTC Fund went looking for a new investment manager and called on Wellington. Would it be willing to serve as a subadviser, responsible for investing a portion of OTC’s assets? An investment firm serving a subadviser was a new concept and would need the SEC’s approval, but after some discussion the appropriate answer became clear: this was a new kind of business and a great opportunity for Wellington.
Other organizations turned to Wellington for help. The Ohio State Teachers’ Retirement Fund made a flat-fee arrangement with Wellington. The Hartford Insurance Company came next. The Hartford wanted to build a major investment business. Strong in sales and client service and responsible for substantial mutual fund assets as well as its own portfolio, the company had concluded that it was not competitive in investing and would be wiser to contract with a strong investment specialist than to try to build competitive in-house capabilities. Would Wellington be interested in becoming a subadviser? A major business relationship soon developed.
Wellington was encouraged to develop a variety of new capabilities. These new services combined with a realization that subadvisory relationships — ironically, so comparable to its relationship with Vanguard — presented a major growth opportunity. Over the next several years, Wellington, the only investment manager pursuing this rapidly growing, long-term relationship business, turned investment subadvisory work into a major growth business.
As the world’s fastest-growing investment services organization, Vanguard has an expanding need for first-rate active investment management capacity and relies for much of that capacity on exceptional external managers. Wellington Management Company has developed a strong professional culture and is one of the world’s largest and most diversified organizations serving institutional investors worldwide. It serves as subadviser for several mutual fund groups but offers no retail mutual funds directly to consumers, so it’s glad to access the enormous individual investor market indirectly through Vanguard.
The table below lists many of the mutual funds the two organizations manage together and the assets of each fund. The scale of the relationship between the two organizations is huge and growing. In 2021 Wellington managed $450 billion for Vanguard — $158 billion in bonds and $292 billion in equities.
All’s well that ends well. But just how did two organizations go from a messy, painful divorce to a mutually beneficial working partnership? The story can be briefly told in personal terms. After Bogle was no longer working to take business away from Wellington, and specifically after the more collaborative Brennan became CEO, the leaders on both sides recognized that working out a joint solution was clearly in the best interests of both. Another part, as will be seen, was luck, good and bad. The key players were Brennan for Vanguard and Bob Doran and Duncan McFarland for Wellington, but there was leadership on every level, from long-term policy to day-to-day operations, involving many others. Brennan and Doran were convinced that they could make it work and were determined to be patient and persistent. They first put their emphasis on understanding the goals and interests of both firms, and the personal objectives of the other firm’s leaders.
McFarland, one of Bogle’s assistants several years before and now a leader at Wellington, took on the vital role of representing Wellington in managing its still-complex relationship with Vanguard. This involved two- and three-day meetings at Vanguard every few weeks plus preparation and follow-up. The purpose of all these meetings? Making sure each of the Wellington fund managers made a successful presentation to Vanguard’s senior staff, who were responsible for evaluating managers for Vanguard funds, and to the Vanguard directors, who took a serious role in selecting and terminating external investment managers. McFarland looked for potential obstacles so he could surmount them quickly and made sure that all communications between Vanguard and Wellington were complete, open, and objective; he knew that it would take time to build a reservoir of trust and understanding.
Jack Brennan performed the most important role: peacemaker. As CEO, he knew far more than anyone else that Vanguard faced an array of daunting challenges. Of these, the one most visible to the world would be investment performance, particularly if ever it fell seriously short. While many other firms were in the investment management business, only a few could meet three vital criteria for a Vanguard partner: a strong professional culture that would continuously attract and keep top investment talent; the ability to achieve superior long-term returns for investors in many investment categories; and willingness to accept low fees in exchange for the opportunity to work with Vanguard to serve millions of investors. Brennan saw that unusual “strategic troika” in Doran’s Wellington.
The supply of high-capability long-term managers was limited. As Vanguard grew, that limit could constrain Vanguard’s own growth. Wellington had many types of investment capabilities and the culture to keep its professional leaders for their whole careers. With his pragmatism, Brennan made building a win-win relationship between the two organizations his top priority.
Bob Doran specialized in developing and preserving the professional culture that attracted the most accomplished investment professionals to Wellington. He believed that in every professional organization, the dominating factor is always the same: culture. The best people in every field each have special talent. Those people look for comparably special qualities in the organization in which they will spend their careers. Doran may have learned the lessons of teamwork playing fullback on the Andover football team and the importance of combining talent, discipline, and a sense of humor as a member of Yale’s fun-loving a capella group, the Whiffenpoofs.
Each superior professional firm has developed its own distinctive, almost “tribal” culture, or set of values and ways of working together, with well-understood standards of behavior and achievement. In the very best firms, the pursuit of excellence is central to the values and expectations that each professional holds for himself or herself and expects of every other member of the organization. Symbols of culture include such things as dress code, how early or late people work, where lunch is eaten, attendance at one another’s weddings and funerals — and always, at the best firms, exceptionally high standards of partnership collegiality and persistent commitment to excellent work for clients.
Some of the symbols are generic. Some are unique, like Wellington’s fabled Morning Meeting, inherited more than half a century ago from TDP&L. The Meeting, before the stock markets open, is precise on its start and end time and open to all — a daily forum for the swift exchange of views, information, and ideas among the firm’s analysts and portfolio managers. The open sharing of each professional’s most valuable resource, winning investment ideas, was central to the partnership character that Thorndike, Doran, Paine & Lewis had developed before the merger with Wellington. It had been shunted aside during Bogle’s headstrong tenure as CEO and then brought back to preeminence by Doran and other “culture carriers.”
TDP&L was committed to a basic “structural” principle: no branch offices. But when partner Phil Gwynn expressed determination to locate in Atlanta, the firm agreed and set up a telecommunication so the “one firm” Morning Meeting could be continued, with one innovation: a meeting manager to ensure participation and pacing. Later, John Neff would participate from his office in Valley Forge. In the 1990s, to accommodate Wellington’s international growth, offices were opened in London, Singapore, Sydney, Tokyo, Hong Kong, and Beijing.
Neff, with his hard-earned expertise on companies and industries, thought the Morning Meeting was a waste of his precious time, so he decided not to go. Doran went to Neff and gently shared his hopes: “John, we all know you are an expert and creative investor and hope you know it would mean a lot to all of us if you would be an active participant in our Morning Meetings. Could you do that for us, John?” Neff knew he could only say, “Yes, Bob, I’ll come.”
Many other examples of accommodation to individuals’ special situations were part of the Wellington culture of caring. Hazel Sanger, after delivering her first child a year before, had joined TDP&L in 1977 as a manager. Finding herself short of money, she requested permission to borrow a modest amount from her account in the profit-sharing plan. When Nick Thorndike told her, “It has been decided that you cannot borrow from your account,” Sanger was naturally disappointed. But quickly she was relieved to hear, “But the firm will gladly lend whatever amount you want in anticipation of your year-end bonus.”
When a leading analyst, Bill Hicks, wanted to learn German, a group of learners were organized, and an instructor was brought in.
When partner John Gooch was having a “down” period he could not shake off, he went to Doran to ask, “Bob, do you think I should leave the firm?” Doran shook his head and suggested they share his office for at least a few weeks.
Julian Robertson, who was developing an exciting hedge fund organization in New York City, was courting one of Wellington’s young portfolio managers with higher and higher pay packages. Finally, Doran asked the manager what exactly about the offer was so compelling. “It’s not the money, Bob. It’s the core idea. I really want to run a hedge fund!”
“OK, fine. Why not do it here?” “Can I?”
“We’ve never done it before, but I’m sure we can work it out with the firm. Let’s work together to build the case for Wellington managing hedge funds.”
As a result of that willingness to try something new, hedge funds became a significant part of Wellington, and their need for both long and short investment ideas provided a stimulating new challenge for the firm’s analysts.
Exceptional investors are individualistic because “eagles do not flock.” To develop a major investment organization, there are two ways to go. By far the most common way is to find a few talented professionals who agree on one particular category of investing such as growth, value, small cap, or large cap; develop around them a team of like-minded practitioners; and seek out prospective clients who want the specialty this group has defined as their one best way of investing. The strength of this approach is its clear focus; the weakness is that high incremental profitability tempts the managers to accept more and more accounts, and more assets. Success over time can attract more clients with more assets than the firm has the capacity to manage well.
The other way to develop a major organization is profoundly different: create an accommodating “umbrella” culture that attracts, and can accommodate, investors with different styles, each based on a set of strong investment beliefs, and facilitate their working unusually well in a “big tent” with strong central research resources, while differences in disciplined application are expected and appreciated.
Wellington chose the second, and that has made all the difference in its success. It developed a diversified portfolio of different investment capabilities, an important protection against the whole firm’s being dangerously out of step with the market for two or three years and losing a lot of business by being “true to its convictions.” Moreover, Wellington’s several different business units’ large aggregate capacity avoids the common problem of performance success leading to growth in asset size, which often makes it harder and hard to continue achieving superior performance.
Wellington could accommodate substantial asset growth and achieve superior performance because, even if particular portfolio managers decided to stop accepting additional assets, the organization could keep growing. Distributed responsibility empowered those with strong ideas to develop different modes of investment management, to a high standard. They created a diverse portfolio of investment units that could be custom-blended to suit each major client and, most particularly, Wellington’s largest client: Vanguard.
Wellington’s open organization and its investment-product complexity might have confused some clients and prospective clients, but Wellington managed that by developing an unusually skillful group of professional relationship managers. Most investment firms have great difficulty understanding the value of superb relationship managers, perhaps because they see them as much like the stock-brokerage salespeople they see every day, and not as professional equals. Wellington’s relationship managers work closely with each client, ensuring the client and Wellington understand each other, and then jointly select the most suitable group of investment managers. That’s what McFarland did with Vanguard for its many different Wellington mandates.
A key strength of Wellington is the large, experienced, skillful research organization built initially by Bill Hicks, who had joined the old Wellington in Philadelphia and then moved to Boston. Then Gene Tremblay made it clear that an industry or company analyst could make a great career as an analyst without managing investments; he introduced industry-specific “sector teams” that contributed importantly to the firm’s success managing hedge funds. Another success factor was the openness to internal entrepreneurial experimentation and the personal nurturing provided by Doran and others. Later, they established a group of two or three managing partners who concentrated on operating the Wellington partnership as an organization, giving systematic attention to career development and compensation, which many investment management firms treat as only a sideline.
By the late 1970s, Wellington was gaining, not losing, assets under management, and profits were going up, not down. The spiritual impact of shifting from fear of losing to surging confidence in winning was as important as the turnaround in the firm’s economics. The client base was diversified, and revenues were growing. The stock market soon entered the longest, strongest bull market in history. Wellington gathered enormous assets through Vanguard and its other clients.
The company’s stock price, however, still wallowed in the mid-single digits, down almost 90 percent from its years-ago high. Wellington tried to lift the price with a share repurchase program, and then considered but decided against an Employee Stock Ownership Plan (ESOP), a popular concept at the time. Then one day in 1978, Nick Thorndike — noting that the “Bogle Wars” seemed over, and that revenues from diverse clients were growing — posed an intriguing notion: “I wonder if we could go private.” A few smaller companies had done just that, but one, Hartz Mountain, had recently been challenged by the SEC and several lawsuits. The leaders of Wellington decided to consult with their adviser on financial matters, Noah Hurndon at Brown Brothers Harriman. After a feasibility study, his conclusion was that the window had closed on any such transactions.
Fortunately, Jim Walters, Wellington’s general counsel, did his own additional research and found the perfect solution. Under ERISA, “fiduciary responsibility” had been defined in 1977 by the Department of Labor with two distinct requirements: the duty of loyalty, and the standard of care. Under the duty of loyalty, a fiduciary’s sole responsibility is to act always in the best interests of the client. But in corporate law, a company always has a fiduciary duty to act in the best interests of its shareholders. As Walters pointed out, these two rules meant that a publicly owned corporate fiduciary like Wellington was in the contradictory position of having to serve two different masters at once.
As Walters explained, the elimination of public shareholders would provide Wellington with the “legitimate business purpose” required to go private under the laws of Delaware where it was incorporated — the need to focus 100 percent on always putting client interests first. This logic would hold up in court during two subsequent lawsuits.
With Walters’s solution, going private went from impossible to achievable — almost imperative. Still, a major issue was the form of organization that would be the surviving entity. Should Wellington Management be a corporation or a partnership? Other firms were moving away from general partnerships, because partners had unlimited liability. Was there a way that a prospective Wellington partnership could offer limited liability?
There was. Wellington’s advisers determined that the firm’s rigorous process in research and security selection, and its unusual openness with clients, met the tests of prudence under ERISA. This concept had been established as a solid defense against liability almost two centuries earlier by Judge Samuel Putnam, in the case of Harvard College v. Amory, and became famous as “the prudent man rule.” This meant that Wellington could form a partnership to buy up the publicly owned shares, and then carry on the Wellington business as a private partnership. Wellington had not yet proven it could fully rebuild its business, and it might have to struggle with another bear market, but Bob Doran said, “I think we can make this work.” He recommended buying in the publicly owned shares and becoming a private partnership.
Doran was making the most important financial decision of his life and urged his colleagues to take the plunge with him. Part of the purchase money would come from liquid assets inside Wellington and the rest from a loan from Brown Brothers Harriman, where Doran’s brother-in-law worked. Doran and his partners all knew the private partnership would be open to lawsuits. In fact, Wellington’s long internal deliberations were vital to its defense against a subsequent shareholder suit.
Dillon Read was retained to make an independent valuation of the shares, working jointly with three independent directors of Wellington, Professor Samuel Hayes of Harvard Business School, accountant Richard A. Eisner, and William P. Crozier, CEO of Bay Banks. They settled at first on $11 a share, but after declaring a large special dividend, changed that to $11.50, for a total valuation of about $11 million.
It was not clear that most mutual fund investors and the newly established major institutional accounts would stay with Wellington — but they did. And no one could be sure that the stock market would head north soon enough — but it most certainly did.
An important decision yet to be made would be the terms on which a partner could retire and withdraw capital. Some partnerships had a book value balance-sheet policy based on each partner’s exact date of departure. Some based withdrawals on a multiple of current earnings. Wellington decided on a 10-year formula based on declining percentages of future earnings. This dependency on the future would encourage retiring partners to focus on the continuing strength of the firm and its culture. The internal mantra, “Client/ Firm/Self,” made explicit the commitment to put the interests of the firm ahead of the partners’ — and the clients’ interests always first above all.
The process of going private, begun in May 1978, took 17 months, and was finally completed on October 31, 1979.
For Vanguard, having Wellington prosper, grow, and continue increasing its professional skills in various specialties was clearly important. For Wellington, having Vanguard grow so dramatically was at least as important. The deliberately revived partnership and the organization-to-organization synergies, which had once come so close to hostile termination, have now been exemplary for over 40 years.
Excerpt from Inside Vanguard: Leadership Secrets From the Company That Continues to Rewrite the Rules of the Investing Business by Charles Ellis pp. 143-155 (McGraw Hill, October 2022).