Where’s the greed?

Written by John Osbon on February 2, 2011

Tales of Wall Street greed and grifting are as old as the Buttonwood Tree itself. Outrage continues to flare over reckless borrowing, insider trading, and elaborate Ponzi schemes, not to mention stupendous pay packages for executives who created investment products that nearly destroyed our financial systems. But here’s one tale of greed that never was, the story of an investing powerhouse that doesn’t even seek a profit. Listen in…

I mentioned Vanguard recently as the gorilla that grew to 800 pounds through low fees and respected index investment products. But there’s more to that story. Vanguard was built from day one on a greed-free corporate structure, about as far from the traditional Wall Street profit model as you can get.

Vanguard is owned 100% by the Vanguard funds, which are 100% owned by fund investors – the clients. That’s right, the business is owned by clients, not by a huge holding company, nor a billionaire entrepreneur, nor external shareholders with expectations for growth and dividends. See how Vanguard’s CEO describes the business.

We expect that Vanguard’s 12,500 employees – the teams that manage its mutual funds and ETFs and provide customer service – are compensated fairly. We assume the company spends millions to stay at the forefront of technology. But by not spending as much as its competitors in other areas (the company has just three domestic offices and doesn’t pay commissions to salespeople like American Funds), and by not paying a dividend, expenses stay very very low, averaging just 23 basis points in 2009. With investors paying more attention to fees recently, Vanguard’s low expenses may induce others to cut fees as well.

Even with its low expense ratio and greed-free approach, the company generates a healthy revenue stream. At 23 basis points on $1.6 trillion, we estimate annual revenue at $3.7 billion. It’s the largest mutual fund company in the world, yet it has reached this lofty position quietly and, notably, without bailouts.

Because of its unique ownership model, it’s difficult to compare Vanguard with any other investment firm. Companies like Merrill Lynch must spend aggressively on salespeople and commissions to attract new clients, support growth and increase profitability, which in turn drives up the stock price and allows a higher dividend. Meanwhile, Goldman Sachs paid out 39% of its revenue in compensation, more than $430,000 per employee, a number that is remarkable or sickening, depending on your viewpoint.

The Vanguard ownership model exists nowhere else on Wall Street. In my opinion, Vanguard will continue to thrive because of its cost advantage and refreshing business model. Growth without greed. Amazing, but true!


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