However, indexing was only one half of the Bogles equation. Vanguard is unique among mutual funds in being owned as a mutual. Despite their name, mutual funds are not actually mutual enterprises, with the exception of Vanguard. Vanguard is a fund management company owned by the funds, which in turn are owned by the customers who invest in the funds. In the rest of the industry, the mutual funds pay fees to a management company, typically a publicly listed corporation. These management corporations seek to maximise their fees. Vanguard on the other hand distributes all surplus from fees back to the funds that own the management company.
Bogle believed that this mutualist structure was key to Vanguard’s success, stating:
“We have enjoyed an advantage some of our rivals have described as “unfair,” Because the fund shareholders own Vanguard, none of their investment returns have had to be diverted to the owners of a management company… our structure has been an essential element in the returns that our shareholders have enjoyed. That shouldn’t surprise anyone, for as the economist Peter Bernstein has observed, “what happens to the wealth of individual investors cannot be separated from the structure of the industry that manages those assets.” (States and Security, 2004)
Under the most intuitive assumptions of market competition, one would expect the most successful structure to also be most common. This makes Vanguard’s structural exceptionalism so astonishing: the most successful company in the industry uses a structure that far from being the most common, is one of a kind. This anomalous malfunction does not prevail in some fringe part of the economy - but in the mutual fund industry, which is perhaps the purest example of what capitalism should be most efficient in doing; allocating capital.
One could say that while it might be odd that it took so long to discover this structure and for it to be adopted by only one company, the success of Vanguard shows that once discovered, the market economy is rational enough for a more efficient mutual structure to outcompete its competitors. Nothing could be further from the truth: far from being a recent discovery in the mutual fund industry, when the very first mutual fund was formed in 1924, it had a mutual structure. It was also the biggest mutual fund with the lowest fees until 1965 when it was demutualised. After the demutualisation, its fees increased substantially, eating away returns and therefore leading to gradual diminishment (Bogle, 2004).
Instead of a more efficient structure replacing less efficient ones, in his 2004 essay “Remutualising the Mutual Funds Industry” Bogle points out that the mutual fund industry had become less efficient in delivering value to its customers, despite the tremendous success of Vanguard in providing a more effective alternative:
“…the accelerating trend toward higher fund expense ratios that today seems endemic in the fund industry…. Fund expenses have risen 238 fold(!) since 1965, nearly double the 128-fold increase in equity fund assets. In a field in which, as today’s lone mutually structured fund complex (Vanguard) demonstrates, the economies of scale in fund operations are truly staggering, it is a truly astonishing anomaly.” (Bogle, 2004)
How can cooperatives or mutual businesses possess competitive advantage but be simultaneously a rare type of business in market competition?
This might be because mutualist advantages are attained at the expense of those bearing the initial costs and risks to start the enterprise. If a person wants to start a grocery store, they might gain a pricing advantage if they give away their profits to the customers as in a consumer cooperative. However, it is irrational for a person to take out a loan to start the store and bear all the risks of failure alone, only to give away all the gains to others if it succeeds.
This can lead to a rather paradoxical situation, where cooperatives and mutuals that possess the greatest competitive advantages might be the type of cooperatives that are the most rarely started. This counterintuitive dynamic can occur if attaining the advantages requires founders to take risks that are disproportionate to the rewards they get compared to their competitors, because the rewards are shared to other stakeholders - customers, suppliers, employees, etc. In other words, founders of successful coops might take similar risks as their competitors for smaller rewards. Mutualist advantages might be gained at the expense of the founders - and the greater the advantage generated, the less incentives there are to take the risk to attain them and start such a cooperative or a mutual.
Far from being something specific to cooperatives and mutuals, this is just a very pure example of one of the core problems of the economic system. One could say that the best economic system maximises rewards for those who increase the well-being of others the most and minimises incentives to benefit at the expense of the well-being of others.
Too often this is not the case. In the UK, the highest paid CEO in 2019 was a founder of an online gambling site (McWeaver, 2019). It is hard to argue that inventing an online casino would have benefited others rather than benefited the casino owners at other peoples’ expense. Nevertheless, the economic system deemed the founder worthy to earn the highest portion of the economic resources as a reward. Reducing the obstacles of starting mutualist enterprises can tackle some of the root causes of our problems in the economy - how to reward people who take risks to increase well-being of others, while reducing risk-taking that happens at other peoples expense.