Investor John Bogle’s Legacy

Bogle steered many people away from the exploitation that is all too prevalent in the financial system by encouraging usage of index funds, and his legacy deserves praise for that.

Bogle’s great innovation was to minimize the cost of managing individual accounts. The key Vanguard asset is an index fund. It does minimal trading, it just tracks the market. Bogle argued, supported by much evidence, that the vast majority of investors are not going to beat the market. This means trading costs are simply a transfer to the folks running the account. Since most of us have people we would rather give money to than our stockbroker, we are better off just having an index fund.

And it does make a huge difference. Many of Vanguard’s index funds have costs of less than 0.1 percent annually. By contrast, many actively traded accounts will have fees and service charges in the range of 1–2 percent annually. This adds up over time. If you invested $1,000 that got a 6 percent nominal return, it would grow to $5,580 at Vanguard after 30 years. At a brokerage charging 1.0 percent in annua,l fees it would grow to $4,320. At a brokerage charging 2.0 percent annual fees, it would only grow to $3,240. And the gap is all money in the pockets of the financial industry.

While his low-cost index fund was a great innovation in finance, he did not personally get rich from it. He organized Vanguard as a cooperative. The people who invest with the company effectively own it.

The Failed Investments of Ivy League Schools and the Future of Hedge Funds

If the elite universities had simply invested in index funds that matched the stock market average instead of hedge funds, there would be much more money to grant to disadvantaged youth and to valuable research initiatives. Those universities have all that prestige and influence, and they even have a tax exempt status — and pound for pound they still did worse than a good average investor would have.

The New York Times highlighted the findings of a remarkable study last week. The study, by Markov Processes International, examined the 10-year returns of the endowments of the 8 Ivy League schools. The study found that all 8 endowments had lower returns than a simple mix of 60 percent stock index funds and 40 percent bonds. In some cases, the gap was substantial. Harvard set the mark with its annual returns lagging a simple 60-40 portfolio by more than 3.0 percentage points.

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And, just to be clear, the Markov comparison was overly generous to the universities. Their benchmark comparison of a portfolio of 60 percent stock and 40 percent bonds is in fact far safer than the alternative investments they hold. If they actually equalized risk, the comparison portfolio might be 80 percent or even 90 stock, making the Ivy league endowment returns look even worse.

The Ivy League schools are not the only big institutional investors who are turning to alternative investments. State and local pension funds also play this game in a big way. The beneficiaries are more often private equity partners, but the basic story is the same: people who make themselves very rich by playing financial games. And, as with the hedge fund folks and the Ivies, they do not provide the promised returns.

And, there is considerably more money at stake with public pension funds. The cumulative size of the Ivy League endowments is just under $140 billion. While this is hardly chump change, state and local government pension funds have more than $8 trillion in assets. Most of this money is not in alternative investments, but if just 10 percent were placed with private equity funds and other alternatives, it would come to $800 billion.

There is much to dislike about the behavior of these financial actors. They routinely play games with the tax code and bankruptcy law to increase returns. It is standard practice for private equity funds to leverage their companies as much as possible to take advantage of the deduction for interest on corporate income taxes.[1]

They also strip valuable assets, such as the real estate on which stores and restaurants sit, so that they can book a quick profit while leaving the companies they control more vulnerable to a business downturn. Bankruptcy is a common tool, which they use to get out of not only interest payments on debt (presumably lenders knew the risks they were taking), but also pension and health care obligations to workers, and payments to suppliers.

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In terms of inertia, people can point back to a period where the hedge funds did produce outsized returns, as did the private equity funds. People can think that the last decade or so is just an aberration, and that the good times will return.

While I can’t predict the future, there is a simple story that would imply the opposite. Both hedge funds and private equity funds prospered by finding seriously under-valued assets and then leveraging heavily to maximize their return. When there were few actors in the field, it was possible for some number of funds to make large returns this way. But now that there are many actors, with trillions of dollars to invest, seriously under-valued assets are few and far between.

This means that most hedge funds and private equity funds won’t be able to make outsized returns going forward. The high fees to the fund managers are a direct drain on returns that would otherwise more or less match the market average.

And just to be clear, we are talking about a 10-year period in which hedge funds have failed to match the market average. (It’s a similar story with private equity.) This is a long period, it’s not just a case of these funds having a bad year or two.

The Misconduct of the “World’s Most Admired Companies”

In terms of misconduct, usually what is found among the biggest multinational corporations is exploitation and benefits from immense public subsidy without providing adequate returns to the public. There are numerous examples showing that to be true, but they often manifest as the use of super-exploited workers and the highly profitable use of technology that was originally developed through public investment.

For example, Walmart long hasn’t paid workers living wages, resulting in those workers (among other things) having to use publicly-funded programs such as SNAP. Then there’s computers, which were developed in large part through taxpayer-funded research at the Department of Defense in the latter half of the 20th century. And speaking of the military, Lockheed Martin’s weapons manufacturing has been complicit in U.S. war crimes that violate international law for decades, and Lockheed likely wouldn’t even exist today if it hadn’t been bailed out by the public under the Nixon administration in 1971.

Literally trillions of dollars worth of taxpayer research and subsidies over the past several decades has been fundamental to the advancement of industries such as the aerospace industry, the computer industry, the pharmaceutical industry, the biotechnology industry, and the telecommunications industry. Much of this taxpayer funding into developments that otherwise probably wouldn’t exist today has often translated into the phenomenon known as public costs and private profits, which is hardly a fair return on investment.

Fortune magazine recently released its 2018 list of the World’s Most Admired Companies. From a pool of roughly 1,500 candidates, Fortune picked the 50 “best-regarded companies in 52 industries.” Apple topped the list for the eleventh year straight. General Electric plummeted in the last year from number 7 to number 30. Lockheed Martin and Adidas both cracked the top 50 for the first time.

Of course, Fortune’s ranking is somewhat skewed and self-serving. It is based on a survey of corporate executives and financial analysts. “Admiration” is measured according to criteria that emphasize companies’ financial shape over their track record of integrity and business ethics.

So, we took it upon ourselves to document the dark side of the world’s 50 most admired companies. Ten of the companies are in our Federal Contractor Misconduct Database (FCMD), which includes civil, criminal, and administrative misconduct instances dating back to 1995 for 220 of the federal government’s largest contractors. All but 3 of the top 50 are in Good Jobs First’s Violation Tracker corporate misconduct database, which includes enforcement data from the federal regulatory agencies and the Justice Department dating back to 2000 for over 2,800 companies. Both databases show that most of the companies have multiple instances of misconduct for which they paid millions of dollars in fines, penalties, judgments, and settlements.

Tax Cuts and Growth

The data is revealing enough about the lie too common among politicians.

In decades past, there was bipartisan support for policies that laid the basis for a long period of broadly shared prosperity. Unfortunately, this consensus seems to have been replaced by the narrow-minded greed of the very rich and, insofar as they can continue to get their way, the story is not likely to end well.

Take, for instance, the Republican tax plan, which passed in December and contained a potpourri of tax breaks for special interest groups and high-income households. Its centerpiece was a large cut in the corporate income tax; the plan lowered the rate from 35 percent to 21 percent.

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First, we tried cutting corporate taxes to stimulate the economy before: Although it received little attention during this most recent debate, the corporate rate was lowered from 46 percent to 35 percent in 1986, roughly comparable to the current cut. If we consider the share of profits that firms get to keep, the 1986 cut meant that the share kept increased from 54 percent to 65 percent, a 20 percent increase. The latest tax cut increased the share of profits that companies get to keep by 22 percent, going from 65 percent to 79 percent.

The 1986 tax cut did not, however, lead to an investment boom. In fact, investment actually fell relative to the size of the economy in the next two years. So, it’s hard to believe that the slightly larger tax cut in the new bill will have a more positive impact on investment.

Besides which, as a practical matter, tax rates have been shown to be a relatively minor factor in determining where companies invest – but they do affect where companies have their profits appear. For example, Apple reports that a huge share of its profits were earned in Ireland, where the corporate tax rate is just 12.5 percent, and Google claims to earn billions in the Cayman Islands, where the tax rate is even lower.

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But what is perhaps most disturbing about the Republican tax plan is that it seems to steer the United States in the opposite direction of proven paths to growth. Looking back in the past, whether across states or across countries, low tax rates have never been the spur to growth. The spur to growth has been a well-trained and well-educated workforce, coupled with the infrastructure needed to support growth.

In 2016, 73% of Fortune 500 Companies Used Offshore Tax Havens

All of those hundreds of billions of dollars being deprived of productive use for the public, and that because of a few greedy corporate executives no less.

new study reveals the extent to which companies are using tax havens to avoid U.S. taxes and undermines the case for any tax proposal that would allow companies to repatriate their U.S. profits at a special low tax rate.

In 2016, nearly three in four Fortune 500 companies maintained subsidiaries in offshore tax havens, according to “Offshore Shell Games,” an annual study of offshore tax avoidancereleased today by the U.S. PIRG Education Fund and the Institute on Taxation and Economic Policy.  Fortune 500 companies’ offshore cash hoard now totals $2.6 trillion, a sum on which these companies are avoiding up to $752 billion in U.S. taxes.

Corporate tax avoidance is a central part of the current tax reform debate. Republican lawmakers have proposed not only to lower the statutory corporate tax rate, but also to allow corporations to repatriate offshore profits and pay just a fraction of the current statutory 35 percent corporate tax rate.

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“Real tax reform would fix the deferral loophole, not reward companies for using the loophole to avoid taxes year after year,” said Richard Phillips, a senior policy analyst at the Institute on Taxation and Economic Policy. “Lawmakers shouldn’t be discussing how to sweeten the pot and give corporations a huge tax break that amounts to a huge financial reward for engaging in bad corporate behavior.”

The amount that these corporations will help the American public at a low repatriated rate is comparatively insignificant. This experiment was already run in the 2000s, and the corporations used most of the money for stock buybacks and other corporate malfeasance back then. As the same would happen today, it would be a far superior outcome for those profits to be taxed at a rate that’s actually fair and then used for productive investment in the public interest. An infrastructure project would be one of many sensible ideas.

Lower corporate tax rates aren’t going to lead to more productive investment either. The data from the last 7 decades proves that there’s no correlation between higher aggregate corporate profits and investment.

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The effective corporate tax rate in the U.S. is also already about half of the statutory rate too.

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