Is the U.S. Financial System Failing Its Investors?

Indexing pioneer John Bogle joined a panel of governance experts this week calling for solutions to what they call a broken system.


Stephen Davis, associate director of the Harvard Law School Programs on Corporate Governance and Institutional Investors, tells a story: Once upon a time there were three sisters. One lived in the U.S., one lived in the U.K., and one lived in the Netherlands. They worked in the same field for the same salary and were close in age. They each put the same amount of money aside in a retirement plan for the same number of years. When they reached the end of their working lives, each one had accumulated a nest egg — but the Dutch sister’s savings were 50 percent greater than her family members’ in the U.S. and the U.K.

Davis shared this story at a gathering held this week at the University of Delaware’s John L. Weinberg Center for Corporate Governance, where a five-person panel of retirement experts convened to discuss a recently published book co-authored by Davis, What They Do With Your Money: How the Financial System Fails Us and How to Fix It. The panel included Davis’s co-authors, Jon Lukomnik, executive director of the Investor Responsibility Research Center Institute (IRRCi), and David Pitt-Watson, executive fellow of finance at the London Business School, along with Vanguard Group founder and indexing pioneer John Bogle and Jennifer Taub, a law professor at Vermont Law School and author of the 2014 book Other People’s Houses.

The problem with the U.S. and U.K. sisters’ savings, Davis told the MBA students, reporters, and others assembled, is the number of intermediaries in those countries’ retirement systems: Up to 16 different sets of hands come between plan participants and their savings. So complex is the U.K. financial system, Davis continued, that investment professionals at Railpen Investments, which manages the investments for Railways Pension Trustee Co., in 2014 had to hire a consultant to help plan officials figure out how much they were paying in annual investment management fees. Believing it to be about £70 million ($115 million), they were shocked to discover that their all-in plan fees included hidden charges that brought the total to £290 million.

The other panelists traded similar stories, painting a portrait of an industry where excessive costs, hidden fees, irrationally large volumes of trading, and questionable business practices have run amok. “We have lost track of purpose in the asset management industry,” declared Lukomnik, who served as investment chief for the New York City pension system from 1994 to 1998. “All of these agents should have fiduciary obligation from beginning to end of the chain.”

Mounting regulation deals only with the symptoms, not root causes, he argued. Rampant product proliferation — 76,669 mutual funds to date — “makes no sense to society,” he added. But it does make sense to the financial services industry eager to capture every investment fad. The industry needs to deemphasize trading and incentivize long-term investing, Lukomnik explained, pointing to the big Canadian pension funds that, seeking greater control, have increasingly brought more of their investment management needs in-house.

Bogle is a longtime advocate of corporate governance reform — not surprising given that Vanguard has grown to be the largest fund manager in the world in part because of the transparent, and low, fees it charges for its index products. Expressing fullhearted support for the three authors’ pleas for better governance of the financial services industry, he contended that financial value is unfairly divided between Wall Street and Main Street, with Wall Street coming out far ahead. “The mutual fund industry is fundamentally flawed,” Bogle went on. “It is an industry ripe for disruption.”

For her part, Taub sought solutions. The legal governance expert pointed to Chapter Seven in What They Do With Your Money, citing the authors’ key elements of a solid retirement plan: shared longevity risk, investment for the long term by professional managers, asset diversification, low cost, inflation protection, and portability.

Bogle said one sign of hope is the July 21 publication of “Commonsense Corporate Governance Principles.” The leaders of 13 corporations, asset managers, pension funds, and mutual funds — including CEOs Warren Buffett of Berkshire Hathaway, Mary Barra at General Motors, Jamie Dimon at JPMorgan Chase, and Bill McNabb at Vanguard — published these principles as a starting point to foster economic growth that would benefit shareholders, employees, and the economy as a whole. “I see a big improvement on the way,” Bogle concluded, sounding an optimistic note in the otherwise sobering discussion.