Acquired
00:21:24 · Ben Gilbert, David Rosenthal
[00:21:24] S0: Legal compliance, bookkeeping, making sure to communicate the prices of the assets with the newspapers so they can print it, all the administrative stuff. [00:21:34] S1: Yep. And the way that the Massachusetts Fund worked is the management company just got paid a fixed percentage of the assets under management that year for the fund. So you can see the immediate conflicts of interest all over the place here. If management of the fund gets paid solely based on the size of the assets in the fund with no penalties or rewards for actual investment performance, well, you're basically just incentivized to grow the fund as large as possible and market it as best as you can and skim a lot of fees off the top. [00:22:14] S0: There there's a tiny bit of performance benefit built in because if the assets under management grows organically by the investments performing well, the fees grow, but it's very different than the way that a lot of funds would go on to be structured later with carried interest or a promote or some sort of performance incentive. [00:22:31] S1: Hurdle rate. You know, it it gets to benchmark, etcetera, etcetera. None of that. Yes. Investment returns are but one sort of arrow in the quiver of management companies at this point in time to grow their profits, and these profits could be very, very, very large. So let's say, for example, you have a $100,000,000 fund, which was reasonable even in that day. Yep. And it would have a management fee of, like, one and a half percent of assets annually. [00:23:03] S0: For a public equities fund.
00:23:03 · Ben Gilbert, David Rosenthal
[00:23:03] S0: For a public equities fund. [00:23:05] S1: Right. Right. So as a management company group in this hypothetical $100,000,000 fund, you'd be taking 1 and a half million dollars a year home, rain or shine, in 1950. That's like $20,000,000 adjusted for inflation today. [00:23:21] S0: And sometimes up to 2,000,000 because I'd I'd seen the number 2% too for mutual funds in this era. And this is, again, listeners, for mutual funds, baskets of publicly traded stocks that are just listed publicly to buy on exchanges. And these funds, in exchange for picking them, putting them in a basket, and administrating it, are charging 2% to do that. [00:23:43] S1: Yeah. And oftentimes, they're not even doing the administration. They're not doing the distribution. They're outsourcing that to, you know, stock workers. They're outsourcing the administration too. So all they're doing is picking stocks and getting a lot of money for it. [00:23:55] S0: So the things we've talked about so far are the one and a half, 2% management fee. There's the eight and a half percent sales load, so that bumps you down from whatever your current principal is to even the on day one when you enter the fund, you know, being down eight and a half percent. So you have that sort of to overcome. And then there's a third thing too, which is transaction fees at this point in time are very, very high. If the fund needs to go and trade stocks to add things to the fund or take things out of the fund, there were very, very large transaction fees relative to today to make those trades.
00:23:55 · Ben Gilbert, David Rosenthal
[00:23:55] S0: So the things we've talked about so far are the one and a half, 2% management fee. There's the eight and a half percent sales load, so that bumps you down from whatever your current principal is to even the on day one when you enter the fund, you know, being down eight and a half percent. So you have that sort of to overcome. And then there's a third thing too, which is transaction fees at this point in time are very, very high. If the fund needs to go and trade stocks to add things to the fund or take things out of the fund, there were very, very large transaction fees relative to today to make those trades. [00:24:29] S1: So, yeah, back to Jack in Firestone Library here reading Fortune magazine. Big money in Boston indeed. And you can imagine how this might be attractive to young Jack who comes from this destitute family. He needs to earn money to support his family. This sounds like a great new industry to get involved in. So in the 1951, Jack turns in his senior thesis to the economics department entitled the economic role of the investment company. He gets an a on the thesis and graduates magna cum laude from the economics department. [00:25:05] S0: And, David, what was the thrust of the piece? I mean, he wrote it, like, on this concept of big money in Boston, but what was his takeaway? Well, it's interesting.
00:25:05 · Ben Gilbert, David Rosenthal
[00:25:05] S0: And, David, what was the thrust of the piece? I mean, he wrote it, like, on this concept of big money in Boston, but what was his takeaway? Well, it's interesting. [00:25:15] S1: The thrust of the piece is that this is gonna be a big important industry within finance. Yep. But Jack does also have some idealism in here, as a young whippersnapper. And, you know, he recognizes everything that we were just talking about, which is that the fees charged to fund clients are gonna be a big drag on performance for these funds. And he doesn't go all the way to say, hey. Maybe we should eliminate them, but he does say that probably the best way to maximize returns to fund holders is to try and minimize the fees. And he does even in the thesis go one step further and say, well, it's sort of a tautological conclusion that the aggregate average of all these funds are going to perform in lockstep with the market. So if you really wanna try and beat the market, then reducing fees is the way to do it. [00:26:13] S0: Because all of these investors who are trading against each other collectively are the market. If you take all the winners and all the losers and sum them up and don't take out any fees, you come up with zero. Every positive winner on the the side of a trade has a loser on the other side of the trade. And so in aggregate, all investors together are the market.
00:26:13 · Ben Gilbert, David Rosenthal
[00:26:13] S0: Because all of these investors who are trading against each other collectively are the market. If you take all the winners and all the losers and sum them up and don't take out any fees, you come up with zero. Every positive winner on the the side of a trade has a loser on the other side of the trade. And so in aggregate, all investors together are the market. [00:26:33] S1: Now that is true in theory. And in practice today, that is absolutely true. Back in 1951, Jack was a little ahead of his time because professional fund managers were a small, small minority of the market back then. There were a lot of other players, mostly unsophisticated players, mostly retail traders. And so it really is not inconceivable that the pitch as a professional fund manager that's gonna dedicate their life and all their working days to researching and picking stocks and betting against the market probably does have a good chance of beating the market back in these days. [00:27:11] S0: Yep. The pitch of I can outperform all this dumb money in the market, probably right, and probably justifies significant fees.
00:27:11 · Ben Gilbert, David Rosenthal
[00:27:11] S0: Yep. The pitch of I can outperform all this dumb money in the market, probably right, and probably justifies significant fees. [00:27:19] S1: Yep. Yep. Now as graduation approaches, Jack has a goal. He wants to go to work in this new fund management industry. And he manages to get his A grade senior thesis in front of another prestigious Princeton alum in Philadelphia named Walter Morgan, who had founded and was running another early open ended public investment company in Philadelphia called Wellington Management. Walter Morgan hires Jack as his assistant right out of school, really takes a shine to him. Jack becomes sort of like a surrogate son to him. You know, Jack didn't really have a dad, and Walter didn't have kids. They become really, really close. Now, Wellington and its Wellington Fund was a super conservative and very highly regarded early mutual fund that pioneered the style that came to be known as balanced investing, I e, a balance between stocks and bonds all within a single fund. So the sort of marketing slogan that Walter Morgan had used for the firm and the fund was, quote, a complete investment program in one security. You can see how this would be attractive. Sounds great. And the Wellington Fund, this point here when Jack joins out of school, has attracted a $150,000,000 in assets. So they are smaller than the Massachusetts Fund, which was the largest fund in the world at that point in time with just under 500,000,000 in assets. But Wellington is still, like, among the top 10 funds in the industry and super well respected.