Leveraged Debt: A Letter to Vanguard

Mr. F. William McNabb III
The Vanguard Group
P.O. Box 1110
Valley Forge, PA 19482-1110

Dear Mr. McNabb:

I am a long-time investor with and admirer of Vanguard. I am proud of my association with a fund management company that places its investors first. I also appreciate the reputation that Vanguard has established so that when Vanguard speaks, others listen. I am writing to suggest a general investment philosophy that I think will address some of the debt-related ills on Wall Street and will piggyback on what is happening in the way of reform brought on by the over-leveraging of financial firms. I think Vanguard could play a significant role in a practice that I believe takes money out of investors’ pockets and lines the pockets of “investors” in hedge funds. Let me explain.

I realize that prudent hedging has a role in investments, but the extremes we have seen among investment banks and others in recent years has jeopardized the security of our country, our businesses, and investors like Vanguard’s customers. While those concerns are being addressed, another aspect of them has not been—the leveraged buyouts of well-capitalized companies which are resold to investors after the LBO has stripped the company of its assets and loaded it down with debt. Investment management firms that sell stocks when the LBO is buying up the company and then repurchase the reissued stocks after they are loaded down with debt are allowing their investors to be ripped off. The hedge funds are reaping great returns, but investors are getting weakened companies that are hampered in their growth by overhanging debt. I think that high levels of debt weaken companies, make them more vulnerable to failure if the economy shifts, and hinder their ability to grow and expand in a competitive economy.

I am suggesting that Vanguard consider the following ideas in developing guidelines for investments made by Vanguard based on Vanguard’s desire to preserve, protect, and grow its customers’ assets. I also suggest that Vanguard utilize these policies to distinguish its commitment to protecting investor interests and to influence investment policies in general.

1. Vanguard recognizes that high levels of corporate debt weaken a company’s opportunities for long-term growth and make these companies less attractive opportunities for investment.

2. While an appropriate level of debt will vary from industry to industry based on the need for capital and how that capital is employed, Vanguard will use an appropriate level of corporate debt as a criterion in its investment decisions. I suggest that Vanguard begin with a guideline that no investment will be made in any company whose debt/equity ratio is greater than .8. I suggest that a long-term strategy be implemented to gradually reduce that guideline to .4. I further suggest that Vanguard consider offering a fund whose portfolio is built around companies with little or no debt (.05 or less).

3. Vanguard should adopt a policy that its funds will not purchase debt instruments, invest in any debt securities, or assist in any way in financing the leveraged buyout of any company.

4. In representing the interests of its clients, Vanguard will encourage company management and boards of directors to evaluate their debt levels carefully and to ensure that investors are rewarded for their investments and not management, directors, or LBO specialists. Mergers, acquisitions, and buy-outs should reward current stockholders only.

I really would like to see American tax policy focused on reducing personal and corporate debt and especially removing the deductibility of debt service for repaying LBOs. I think a better approach would be to get someone to address the debt issues in our economy both at the personal and at the corporate level. I believe Vanguard, in its concern for its customers and their debt loads and in its development of sound investment policies, could address these issues and give them prominence. I believe your customers and our nation would be in a better and more competitive position if the problems related to debt were addressed.

Thank you for giving attention to these concerns.