By Michael Edesess
Almost since its founding in 1975 by the late, great John Bogle, I have held Vanguard Group, the mutual-fund giant, in only the highest regard.
Vanguard’s mission has been to deliver the lowest possible cost for services to investors and to conduct itself in a highly ethical manner. By structuring itself — unlike other mutual fund companies — as a non-profit (all profits are returned to investors, none to outside shareholders) it has consistently offered extremely low cost and high-quality investment services, pushing competitors to lower their costs too.
Perhaps because it has no outside shareholders whose share value is to be maximized, Vanguard has also been the most reliable source of unbiased financial information and research. While other companies, sometimes egregiously, slant their research and the information they provide (often it is only a sales pitch), Vanguard stands out as being credible.
But even the best companies make mistakes. Unfortunately, Vanguard is making a big one.
Bogle supported a financial transaction tax (FTT) — as do I — as a way to throw sand in the wheels of excessive and potentially harmful speculative trading activity. Currently, more than half of U.S. securities trades are attributable to high-frequency trading.
By contrast, in Hong Kong, the world’s third-largest stock market , there is little or no high-frequency trading, because Hong Kong imposes a 0.1% two-way (purchases and sales) “stamp duty” on trades. This has had no discernible negative effect on Hong Kong’s market or its economy, which is rated by the conservative Heritage Foundation the freest in the world .
Yet unlike Bogle, Vanguard’s current management opposes a FTT. Vanguard’s argument might be of interest if it were made on reasonable grounds, but the research Vanguard has provided in support of that position is not reasonable at all.
That research reads like a polemic. Its headline is “Main Street investors at risk — A financial transaction tax would harm everyday savers.”
This is the same specious argument that other would-be protectors of the U.S. financial industry, aligned against any restraints on it, have made. In fact, it is manifestly untrue. High-frequency speculative traders would be heavily impacted by the tax, but Main Street investors would be hardly affected at all .
Yet Vanguard’s one-page research document highlights “the hardships imposed on American families.” That “hardship,” Vanguard’s document states, would reduce the value after 20 years of a $10,000 initial investment by 19%.
But Vanguard’s conclusion assumed an enormous 1.09% reduction in an investor’s annual return due to the FTT. (Although Vanguard doesn’t say so, I assume this refers to the FTT proposed in the “ Wall Street Tax Act ” legislation currently before Congress.) To make that assumption, a close look at Vanguard’s graph reveals, the firm had to base its case on a stock portfolio 100% invested in a small-cap actively managed stock fund.
Vanguard would never recommend that investors commit more than 10%-20% of their money to such a fund. An investor who put all of her stock portfolio in, for example, Vanguard Strategic Small-Cap Equity Fund /zigman2/quotes/207614988/realtime VSTCX -0.22% would have an undiversified, relatively high-cost, high-turnover portfolio — the opposite of what Vanguard generally recommends.
Furthermore, it is hard to understand how Vanguard could have come up with the figure of a 1.09% annual reduction in return because of the tax. Vanguard Strategic Small-Cap Equity as of the end of September 2019 had a 67% annual turnover rate . The direct effect of the 0.1% financial transaction tax on securities purchases can therefore only be 0.067% per year.
Where did Vanguard get the other 1.02%, to conclude that the FTT’s impact on the active small-cap fund would be 1.09%?