The John C. Bogle Center for Financial Literacy is pleased to sponsor the twelfth episode of Bogleheads® Live. In this episode Robin Wigglesworth discusses the history of index funds and his book, Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever.
Robin Wigglesworth is The Financial Times’ global finance correspondent, and is a graduate of City, University of London and The London School of Economics and Political Science.
Robin Wigglesworth
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Bogleheads Live with Robin Wigglesworth
Jon Luskin: Bogleheads Live is the weekly Twitter Space where the Bogleheads community asks questions to financial experts live. You can ask your questions by joining us live on Twitter each week. Get the dates and times for the next Bogleheads Live by following the John C. Bogle Center for Financial Literacy on Twitter. That's @Bogleheads at Twitter. For those that can't make the live events, episodes are recorded and turned into a podcast. This is that podcast.
Thank you for joining us for the 12th Bogleheads Live. My name's Jon Luskin, and I'm your host. My guest today is Robin Wigglesworth. Today we'll be discussing Robin's book Trillions: How a Band of Wall Street Renegades Invented The Index Fund And Changed Finance Forever. I'll rotate between asking Robin questions that I got beforehand from the Bogleheads Forum bogleheads.org, and Bogleheads Reddit, and taking live audience questions from the folks here today.
Before that, let's talk about the Bogleheads, a community of investors who believe in keeping it simple, following a small number of tried and true investing principles. You can learn more at the John C.Bogle Center for Financial Literacy at boglecenter.net.
We will be holding the annual Bogleheads Conference on October 12 through 14th in the Chicago area. The speaker lineup is phenomenal and includes speakers such as Eric Bachunas, author of The Bogle Effect, economist Burton Malkiel, Jason Zweig of the Wall Street Journal, Rick FerrI, host of The Bogleheads On Investing Podcast, Christine Benz, Director of Personal Finance at Morningstar, and much more. You can find a link to register pinned to the top of the Investing Theory and News and general forum at bogleheads.org.
Mark your calendars for future episodes of Bogleheads Live. On June 7, we'll have Dan Egan, Vice President of Behavioral Finance of Investing at Betterment, discussing the conflicts of interest in the robo-advisor space. The following week, David Blanchett, managing director and head of retirement research at PGIM DC Solutions, will be answering your question about retirement planning. The week after that, we'll have Jorge Soriano answering your questions about annuities. Other future guests include Barry Ritholtz, J L Collins, and Jim Dahle of The White Coat Investor. You can see the full line of future guests at Bogleheads Live.
We're doing a call for volunteers. We're looking for both editors and transcribers. If you want to help spread the message of low cost investing, shoot me a direct message on Twitter @Jon Luskin.
Before we get started on today's show, a disclaimer. This is for informational and entertainment purposes only, and not to be relied upon as a basis for investment, tax, or other financial planning decisions.
Let's get started on today's show with Robin Wigglesworth. Robin Wigglesworth is the global financial correspondent at the Financial Times. He focuses on the biggest trends that are shaping markets, investing and finance more broadly across the world, and writing longer form features, analysis, profiles, and columns. Before joining the Financial Times in 2008, he worked at Bloomberg News. Robin, thank you for joining us today on Bogleheads Live. Tell us about your book Trillions: How A Band Of Wall Street Renegades Invented The Index Fund And Changed Finance Forever.
Robin Wigglesworth: Hi, Jon. Thanks so much for inviting me to this. It's a real honor to talk to Bogleheads. The book is about the history of the index fund, how it was invented and grew into a $20 trillion behemoth, how it's affecting markets, and the broader finance industry. A history of how investing has changed over the past century. The index fund is the humble hero at the center of the story, the unlikely protagonist.
But for me, researching the book and then writing it, I became very aware that it's quite a familiar story of technological disruption, because essentially that's what I think the index fund was, and still is. One of the most profound, disruptive innovations in finance. And as we know, technological disruption is often very, very unpopular with incumbents. It can have unforeseen and negative side effects. I try to both be a fanboy of the index fund, which I am, but also be open minded about the potential and actual downsides to their growth.
Jon Luskin: Absolutely. You certainly touch about some of the challenges that index funds do face and may face in the future as part of your book. My first question is from TX Frog from the Bogleheads forum. TX Frog writes, “Is the risk of the concentration of voting shares of global public equities among a handful of index fund providers fully understood? As investing grows, and as the major index fund providers receive a higher percentage of inflows, it's theoretically possible that more than half of voting shares could be held by just those large index fund providers. Are there any practical solutions to alleviate this concern and or give some degree of voting rights to the shareholders of index funds?
Robin Wigglesworth: I do actually think this is becoming better understood. Jack Bogle, before he passed away, talked about this. He wrote about it in his final book as well, that he felt that the concentration that naturally flowed from the economics of scale, the scale economics of indexing, meant that the big would only become bigger. And it was conceivable, if not actually likely, that BlackRock, Vanguard and State Street would at some point control a majority of the voting shares of every major listed company in the US. And possibly in the world. The issue is understood now. This is brokered through political circles as well. The FTC has talked a little bit about it. The real problem is that all the solutions are really difficult, impossible, or suboptimal.
I was under pressure from my publisher to say, what do I think should happen? One thing I've really discovered, being a financial journalist, is that people wildly smarter than me screw things up all the time. I just have to be humble about what I know, and it's always very tempting to come with, “here are my policy options and this is what we should do.” But I just don't know. I do think this is the most reasonable concern to have about index funds or really the trend in the asset management industry as a whole. That concentration is potentially more problematic in investment management than it is in somebody selling you burgers. If McDonald's controls half of all burger sales in the US, probably not great. It doesn't show that it's a free market, but I don't think that's societally harmful. But you can imagine a situation where just two or three big asset managers control half of all voting shares of every company in the US--or major listed company. That gives me the heebie jeebies.
Jon Luskin: TBS blue rafters writes, “John McQuown is a legend. Can you tell us about your interview with him? “ Robin, for those who haven't read the book, give us a little bit of context. Who is Mac? How did he contribute to the creation of the index fund?
Robin Wigglesworth: I think legend is the right word for Mac. It's a massively overused word, especially in finance. There are so many people that call themselves legends. Mac is genuinely one. I was lucky enough to have spoken a dozen times for the book, and for a magazine piece that eventually became the book, and he's joined me to do some press in the past. He's just a really interesting guy. One of my main things I took away from him and some of the other people I interviewed for the book, who are also up in their 80s, is how finance and economics changes all the time. The people that do well in it are perpetually curious. When something changes that much and they're curious, it keeps them young. Gene Fama, Mac, Harry Markowitz, Will Sharpe-- these people just radiate enthusiasm for what they're doing to this day.
They are twice as sharp as I am at twice my age. I thought that was awesome. Mac is one of those guys that radiates stubbornness and determination. It's probably what you needed as well to be that much of a disruptor, as he was. When he first started pushing the ball that became the index fund it was very much an uphill battle. You needed to be somebody like him to really do that. But he's an incredible guy. He still does a fair bit of press and interviews that are floating out there. that I definitely recommend people check them out, because he is legitimately described as a legend.
John McQuown was like a young investment banker in the ‘60s. He was the first in his family to go to the university. He started mechanical engineering at Northwestern, and came across a computer, a big hulking IBM mainframe at the time, and he was just fascinated by them. He became one, probably one of the first people on Wall Street that learned how to code. He started doing this on the side of his day job as an investment banker, working in corporate finance. Then the local IBM sales manager saw this young mop head guy playing around with the computer, trying to figure out whether stock market prices can be predicted.
Thought it was so cool that he sent him out to the West Coast to give a speech to other IBM prospective clients. IBM was just desperate to sell these computers to clients outside of the military industrial complex and the government. Mac gave a presentation that basically said, here's what I'm trying to do. I haven't succeeded. In that audience was the chairman of Wells Fargo. He offered Mac a job on the spot, and Mac set up something called Management Sciences. It was kind of a Skunk Works or a Bell Labs that was dedicated to using computers and data to find out a better way of banking or investment management. They did lots of really cool stuff. TECO schools grew out of Management Sciences. Mastercard. Some of the work that became Mastercard started there as well. But the index fund was the greatest. But to do that, he hired this absolutely insane all star cast of economists to consult for Management Sciences. And just as I mentioned, the Nobel prize winners, there's Gene Fama, Harry Markowitz, Bill Sharpe, Theo Schultz, Fisher Black, Jack Traynor, and Merton Miller. I call this the Manhattan Project of Finance in the book. And then the atom bomb that they invented was the index fund. The way they got there was not necessarily purely because they thought markets are efficient. Jack McQuown was a big fan of Gene Fama. He definitely thought so. But they researched the best way to manage money, and the index fund was what came out of all this research.
Other people were more zealots in that invention of the index fund, but for Mac and the Wells Fargo lot, it was mostly “this is a smart idea that we can sell through pension fund clients.” The first client was Samsonite.
Jon Luskin: Super interesting about that first index fund, the purpose of it and where it ended up going. Robin, let's talk about how you open the book. You discuss Buffett's Bet, where famed value investor Warren Buffett made a million dollar bet with a hedge fund manager as to which would outperform over the next ten years, a plain vanilla S&P 500 index fund or the top fund of fund hedge funds. You wrote, “A good investment track record means that an investment fund manager typically attracts a lot of new investors. But the more money one manages, the harder it is to find good investing opportunities. Since most advisers in the industry are paid according to how much money they have under management, those managers have little incentive to keep their size manageable.” Robin, tell us, how did Buffett's Bet end?
Robin Wigglesworth: Probably not giving away a huge secret of the book when I reveal that Buffett didn't just win his bet, he absolutely smashed his opponents. It was a massacre. The S&P 500 index fund they chose, the Vanguard 500, just completely obliterated every single one of the five fund of funds, individually and as a group.
And I used it as a way into the story because I said I wanted to tell a story of the history of investing over a century, really, before the cinematic elements of Buffett's Bet, and how it happened and how he finally won and how he presented it, because he is a great showman as well. And the vindication it was for Jack Bogle, who was invited at the Berkshire Hathaway meeting where the result of the bet was announced. I thought it was just too delicious. And it is an incredible bet. And all kudos to Ted Seides, who was the counterparty to the bet. I spoke to him again several times at length for the book, and he's a fascinating guy and really thoughtful about, frankly, what he got wrong, and what he actually thinks he kind of got right, and the implications for the investment industry. It's a fascinating bet. At some point, I hope it gets made into a film of some kind.
Jon Luskin: That would be a fascinating film. I certainly would watch that. But then again, I'm an investment nerd, so no surprise there.
Robin Wigglesworth: I think we all are here.
Jon Luskin: That's fair. Absolutely. One thing that's so damning for the results of that bet is that when it comes to investing, all Bogleheads know fees are critical to investing success. And when you invest in a hedge fund, you've got massive, massive fees. But the thing that's even mind blowing, and you point out in your book, is that the hedge fund manager on the opposite side of Buffett wanted to compare the index fund to not just a hedge fund, or a bunch of hedge funds, but funds of funds. Which, folks here may know, means that in addition to the hedge fund fees you've now got additional fees on top of that. So when you just add fees on top of already huge fees, the odds that you're going to do better versus a low cost model are pretty low. And that's exactly what ended up being the case. To your point, the low cost index fund smashed the results of the hedge funds.
Robin, in your book you write, indexing was a strategy that suited Vanguard's mutual ownership structure perfectly. None of Vanguard's competitors wanted a low cost product that could cannibalize sales of higher fee funds. Vanguard's “at cost” structure was the perfect match to grow index fund investing. I think about the serendipity, about the events that had to take place for all of this to be possible. Tell us more about any number of rare events, that if they didn't turn out the exact way, we wouldn't be enjoying ultra low cost index fund investing today.
Robin Wigglesworth: This story is rife with serendipity. I mentioned Mac as well. His life is several very fortunate terms. The fundamental logic and results of indexing and low cost investing, passive investing, are so overwhelming that even if Jack Bogle hadn't done it, somebody would have. We were fortunate that it happened when it did, because of the fairly incredible set of circumstances around Vanguard and Jack Bogle. In the early ‘70s there were three companies that started indexing. There was Wells Fargo, Batterymarch in Boston, and. American National Bank of Chicago. They all started for different reasons but they all targeted institutions because that's all they could do. Glass Steagall was still in place. There were very strong limits to cross border banking and mingling institutional and retail money.
Jack Bogle was interested in some of the ideas around indexing. But he was a young hotshot executive at Wellington at the time. Primarily known for his balanced funds in the ‘60s. Although he was a voracious reader, he went to Chicago and attended the seminars on efficient markets and all the theory that underpinned indexing. He never really talked about the advantages, and in fact, and this is little known, Jason Zwieg has written about this at the Journal, and I was able to get the details about it in 1996. He wrote this pseudonymous article rubbishing the idea of an index fund. Some academics on the West Coast had presented it not as such a pure investment form, but more of an “Investors have too many funds to choose from. How about somebody sets up a market fund, they invest in the time market, and they can at least be exposed to the markets whilst they find a fund manager they're comfortable with.”
And Jack Bogle, just under a pseudonym, John B Armstrong, cracked on the idea and says, “Terrible, laughable. Everybody knows that the major fund management groups outperform the benchmarks in the long run.” But what happened was Wellington fell on hard times. He’d taken over the reins from the founder, became the CEO, one of the youngest CEOs in American financial management history at the time. It was going to hit a bad patch. In the ‘60s was the GoGo era. It was the first dot.com bubble, but rather than Amazon, today Tesla, it was like Xerox and IBM and Kodak with hot tech stocks of the day. And Wellington was really cautious and conservative and just wasn't very cool. He merged Wellington with a group of hotshot fund managers up in Boston. That worked out well for a couple of years. But when the GoGo era ended and the ‘70s bear market started he fell out massively with his partners, and they'd given away too much equity in the merger, and the Boston partners ganged up and basically sacked Bogle. In a Hail Mary he managed to engineer his way into the funds themselves, setting up an independent administration company that he gave the grandiose name Vanguard.
He was able to be the CEO of this clerking company and get paid $100,000 a year, which was a lot of money at the time. Keep his old Wellington CEO salary and then he skewed. Jack Bogle – who’s a genuinely a great man, genuinely a titan in our lifetimes – but he did edit his life story a little bit after the fact, and he became a huge proponent of indexing. And he was always a proponent of low cost investing to his credit. But his belief in indexing frankly came late.
I talked to a lot of people that worked with Bogle at the time in the ‘60s and ‘70s and they say that this was a corporate gambit, this was a ploy. Indexing was not what he wanted to do. It just happened to be the only thing he could do because the divorce agreement with Wellington precluded Vanguard from doing any investment management. And he argued, almost like tongue in cheek to the board, well, an index fund is unmanaged, so let's do that. It's an unmanaged thing. It doesn't compete against Wellington. Let's just do that. Is this a way of gaining a little bit of independence and doing something a little bit more exciting than just paperwork? That's how it started.
If the Boston partners hadn't sacked him, Jack Bogle might have just retired as a very successful CEO of a big traditional mutual fund group called Wellington, that still is around today and is a trillion dollar asset manager. It was a real sliding doors moment. I spoke to a friend of Jack Bogle who argued those Boston partners should be listed as co-founders of Vanguard because if they hadn't sacked him and humiliated him de facto, if it hadn't fired up this insane drive that Jack Bogle already had to thermonuclear levels, then maybe he wouldn't have been able to be the same Jack that we know today.
Jon Luskin: Absolutely fascinating tale, the way everything worked out, the personalities of the people involved. Riveting if you are an investment nerd. Robin, you write that “There are those who think that the faults of great people should be ignored, that highlighting their weaknesses is mean spirited when stacked up against their achievements. But flaws don't detract from their greatness, they enhance it, making them real people.” What would you say are the character flaws of those who worked so hard to bring indexing to everyone?
Robin Wigglesworth: I can't remember who said it, but from the crooked timber of mankind, never a straight thing was made. I think that is true. Also, people that did great works and great humanitarians and people like Jack Bogle, who oozed integrity and credibility from every pore, and was a phenomenal human being, had massive flaws. All the people I talked to that used to work for him, his assistants over the years, his various lieutenants and executives, they all loved him, would die for him. But they all said, look, he was a very difficult man to work for. Maybe that is what made him so successful. The fact that he was so driven. And he was so hurt by the falling out with his former lieutenant Jack Brennan, that soured the legacy a little bit at Vanguard for some people. It reflects that drive he had. And if you hadn't had that drive, you wouldn't be Jack Bogle.
McQuown as well. I mentioned his drive. Some of these people, Jack Bogle never got divorced, but got McQuown divorced out on the West Coast. These things take a toll on your own psyche, and frankly, all the people around you sometimes. That just makes them human. And for me, that makes them more heroes. In my book, my metaphorical book, but also my literal book, humans are more interesting, but they're multifaceted, than when they are one dimensional heroes or villains.
The one character flaw, as it were, that dates pretty much all the characters in my book, is that they are unusually driven, and sometimes to the detriment of people around them. That drive was necessary for them to do what they did, but it might not have always been easy for everybody around them at the time.
Jon Luskin: Robin, in your book, you write, “BlackRock has done for investing what Henry Ford did for the car: constructing a financial assembly line that produces products for investors more efficiently than almost anyone else.” What's more important? The greater tax efficiency of BlackRock or the mandate to operate only at cost, such as with Vanguard's mutual ownership structure?
Robin Wigglesworth: It's a good question. My first instinct is to say, why not both? There are many ways to heaven, as it were, the final outcomes that match investors. If BlackRock can produce cheap investment funds as cheap as Vanguard, then all credit to them. Great. Fantastic. BlackRock is a very popular bogeyman these days, and God knows I've written lots of mean things about them myself at the FT [Financial Times]. The index funds they sell are high societal boot. They are very, very cheap. They are competitive with Vanguard.
“At cost.” That is a very nebulous term. What are Vanguard’s costs? Do you know how much Tim Buckley makes? I don't. Do we know how much the crew members make? And we don't know all this stuff. I love Vanguard. I love what they represent. But I still think that they have cloaked themselves in the garb of virtue for too long. If they say that investors are owners in their funds, the owners should know how much you're paid. Vanguard could and should be more transparent with their cost and where the money goes to.
Like just a total stock market fund, despite charging close to zero, it still throws off more revenue than some entire asset management groups. At that scale of over a trillion, it's just incredible. Vanguard, the ethos there suits me. I was very much brainwashed by Bogle in my conversations with him on some of this stuff. It's important to recognize that there are different ways here. And as long as the fundamental product is cheap, well diversified, long term savings products for everybody is produced, do I care that much who does it, whether it's a supposed nonprofit or a commercial entity.
Jon Luskin: I think about how Vanguard has some growing pains right now with respect to customer service, etc. And I wonder if they do need more than just that at cost mandate to do the best job possible.
Robin Wigglesworth: That’s a great point. I only mentioned it in passing in my book but there have been times throughout Vanguard's history, and some of the listeners say, well, no different than me, where Vanguard has technologically and service wise come close to tipping over, that they have perennially under invested in a lot of areas.
Occasionally they have had big pushes, but they've always been kind of after a near miss. After Black Monday in 1987, I talked to several people at Vanguard who said that was a bad time. We were not equipped to deal with that, both on the service and the technological level. There's been tons of reports that everybody knows about some of the technological problems that Vanguard has had. I still think these are some manageable problems. Vanguard is huge these days, but it's not beyond the genius of mankind to solve this.
There needs to be more transparency on salary costs and comp because from my reverse engineering of their revenues, they should be able to afford a state of the art system. But they're investing very heavily in wealth management. One of the less appreciated stories in the investment industry is that Vanguard is actually pivoting away from competing with something like Fidelity or BlackRock, but more becoming a broader wealth management group. They're going after the financial advice side as well, which now actually has quite high fees compared to the cost of the funds. Before, the cost of the funds was higher than the advice. Now it's switched, and I think they can do a lot there. They've invested heavily and they've done really well in the personal advice service.
They should remember not to neglect the core stuff, people's savings, you don't screw around with that, and making sure that you don't need to be a leader in absolutely everything. But having stuff kind of pieces fall off, as it were, fairly frequently or too frequently is not ideal. And that might be a result of the at cost structure. Or maybe the culture of always being cheap, potentially. That's what we like about Vanguard, but that does have a downside.
Jon Luskin: That'll be interesting to see how Vanguard does in the future, if they're able to solve the growing pains that they're having right now. Rick Ferri has requested to be a speaker. Rick is the host of the Bogleheads on Investing Podcast.. Rick, take it away.
Rick Ferri: Thank you, John, and good to meet you. Robin. We've never spoken before. Thank you for doing this. I reiterate your question, and I've asked it many times, and many Bogleheads have asked the question, if Vanguard is truly owned by the shareholders, then why aren't salaries disclosed? Why don't we know how much the CEO is making? This has been a question that has been recurring over and over again. And because we don't know that, then it isn't truly owned by the shareholders. Now, maybe each individual fund is owned by the shareholders of that fund, but we don't know what Tim Buckley makes. So we don't own the company. That's number one.
Second thing is, I'd like to reiterate another thing that you were alluding to. Vanguard is moving down the path of niche investments. They're going down the path of hedge funds. They're going down the path of wealth management, as you said, Robin. But individual investors need big investment areas to be looked at, that Vanguard has neglected. And one of them, Jon, boarded up in the introduction, is annuities. Vanguard used to have low cost annuities, and they've pawned that off to Transamerica. This is a huge area which could help millions of investors. And yet Vanguard has decided to neglect that and pawn it off onto another company while they concentrate on things like hedge funds. Is this really the right direction for Vanguard? Is this the direction that Jack Bogle would go in with Vanguard? And my answer is, I don't think so. Robin, if you want to jump in and make more comments on that, I'd appreciate it.
Robin Wigglesworth: I think they're great points. I care less about what Buckley makes, personally. That's the kind of stuff that journalists love. But I don't think it means that much for Vanguard clients. Actually having a more granular sense of compensation and the cost of funds and all the fund complex itself, I think is essential. I agree that it's frankly long overdue. And I know the Bogleheads have talked about this. Even Jack Bogle has talked a little bit about this before he passed away. I think the reason why the move into private equity primarily, and some other niche areas is as a corollary to them becoming more of a wealth manager.
Then especially not necessary people that have ten, $20,000, but a couple of million dollars more, you want to be able to provide them with the full range of investment options that rivals are able to, and that includes private equity and hedge funds and real estate and other things like that. I think it's unfortunate. I always hoped that they would go into these areas with the spirit and ethos that has always been core to Vanguard. You can do some of these things in a credible, cost effective, cost conscious way, and that you can use the scale to beat down the fees that you pay the private equity managers and so on, hedge fund managers.
On the mission on cheap, low cost annuities, I agree, in an ideal world, Vanguard would be a boon to the entire world that it would open up in many other markets where its products would be needed. I'm coming to you from Oslo, Norway. Scandinavia has ridiculously expensive fund management costs because all the distribution happens through banks. And obviously banks generally put people in their own expensive, active funds. Vanguard is a business, and they've decided that certain markets that have too difficult barriers because of the distribution being through banks, they won't go into or they pull out of it they've tried.
This is the core issue, that Vanguard runs itself as a business. The real shareholders are the only insiders. That's fine if you're a Capital Group or a Wellington or Fidelity with family owners, But if you are going to go around and say you're owned by your shareholders and benefit from the halo effect, you do need to get cleaner on that. The balance of being a business and being a mission driven organization is tricky. At some point, I think they'll have to open up a little bit. I hope so at least.
Rick Ferri: Thank you, Robin. That was well said. Robin, we briefly touched on this in the beginning. In your book, you talk about the first ever index fund. Folks may not know that it was Wells Fargo, not Vanguard, that launched that fund. Why didn't Wells Fargo end up being the world's index fund leader? What went wrong with that first index fund?
Robin Wigglesworth: Lots of things went wrong with that first index fund. The twist of the stories, of course, that Wells Fargo is the world's leader in index funds, one of them at least. It's basically BlackRock. The index funds and the ETFs at the heart of BlackRock that account for two thirds of their $10 trillion of assets under management, slightly below the sevenish of passive funds at Vanguard. That's basically the old Wells Fargo unit that went through various iterations. Wells Fargo never made money from index funds and they spent too much money on research and not being very commercial, and it almost imploded. And then Fred Grauer took over and turned the unit around. First by merging it with Nikko Asset Management in Japan so it became WFNIA - Wells Fargo investment Advisors or Nikko Investment Advisors.
Then he sold it to Barclays. There was always tension between the bankers and investment management at Wells Fargo. Essentially that became BGI. And that's what BlackRock bought and transformed itself into the behemoth that we know today. It is really interesting going back to the early days of that first iteration of an index fund because also, strictly speaking, it wasn't actually a fund, it was a separately managed account that managed $6 million on behalf of Samsonite’s pension plan.
Initially, and this goes to the whole point, this still ongoing thing, like some people are efficient market zealots, they believe markets are efficient, and Mac and the west, or the Wells Fargo people did. But they also thought that maybe they could beat it. And what their research discovered, it went through various iterations. Myron Scholes and Fisher Black did a lot of the kind of foundational work, but they discovered what we now know is the small caps factor. They essentially discovered that the best outcome was investing an equal dollar amount in every single stock on the New York Stock Exchange. When they tested the results of that, that did better than the S&P 500.
Which goes to show that even smart people can do dumb stuff. When I talk to people--why did you do that? They said it just seemed like a good idea at the time. We figured we could figure it out and find out how to do this more efficiently. Out of that work that went into doing this, they did invent something called portfolio trading, programmatic trading. Buying big bundles of stocks in one go. That was something that Wells Fargo hadn't really done that much beforehand. They went to a guy, at a shop called Saloman Brothers who went to his boss, who most people now know, Mike Bloomberg. That's why Mike Bloomberg was involved in some of the first portfolio trades on behalf of the first index funds back in the early seventies. It was a greater way of showing how the birth of the index funds and how they’ve grown so much have actually helped reshape the entire financial ecosystem around it as well.
It's such a big phenomenon now that it's like a black hole. It exerts force and everything around it, even if you can't always see it, it's there. And portfolio trading is one of those phenomena that we can thank the index fund for.
Jon Luskin: Squeeze taxes, ask your question about the history of index fund investing to Robin.
Audience member Squeeze taxes: From my understanding of the index, it is a powerful tool of bringing clumps and lumps of markets together into a basket. And you had made mention of how at least with Vanguard, it's more being controlled by the insiders instead of the actual shareholders. What would need to happen for it to shift, for it to go truly back to the shareholders?
Robin Wigglesworth: To stress the Vanguard side, it's a product of how Vanguard was set up. When Jack Bogle was fired from his old job, he set up an administrative company that didn't actually have a name, that became Vanguard, that was owned by Wellington's Funds. So that's why Vanguard is owned by its own funds essentially. And those funds, obviously the investors in them, are everybody else. Like millions of people, like 30, 40 million customers I think Vanguard has. So they are the shareholders kind of indirectly through several layers of Vanguard, the company.
The problem is being that they've never let – so you know if you invest in the Vanguard Total stock market fund, you can go onto the list and see everything there and like everything that it owns is perfectly transparent. And you own that through this vehicle. But the look through to Vanguard, the company itself, the Vanguard Group of companies or funds or whatever it's called now, that is at best, imperfect. I bet people like Rick and Jon have poured through some of the fund disclosure to see what you can reverse engineer. I know people have tried to do that over the years, at one point figuring out what Jack Bogle was paid as well, and he wasn't very happy about it. But I still think that given how much they lean on this, where we operate at cost, and how much that is part of their image, it would behoove them to be more transparent.
Their arguments about competition, and we're a privately owned company, and it's bollocks, as the British say. BlackRock survives perfectly well with everybody knowing what he and the senior executives get paid and how much BlackRock spends in comp every year. The idea that Vanguard can't shed a little bit more light on that is not very credible, frankly.
Jon Luskin: Certainly it is a curious decision.
Robin Wigglesworth: Yeah, they could set a bit more. like nobody's expecting them to itemize what every single person there is getting paid, or even give ranges. But the idea of how much their compensation eats on their costs would be handy. If they're at cost, we should have some better transparency on the costs, I feel.
Jon Luskin: Absolutely, I agree. Let's talk about the number of ETFs in your book. You share some data. In the year 2000, there were 88 ETFs, and 20 years later, in 2022, there are 7000. Bill McNabb, the former Vanguard CEO you mentioned in the book, was at an ETF conference and he pleaded with ETF producers, stop making so many ETFs. Why? What are the risks of having too many ETFs?
Robin Wigglesworth: It's not really about the how many number. I see quite a lot of criticism around this, and I think it's misguided. I've also fallen into the trap of making fun of how many ETFs there are and how many industries there are. There's probably close to 9,000 ETFs and ETPs around the world now. Probably close to 10,000, actually, and there are only 40,000 stocks in the entire world. But really, when you think about it, there's only so many letters of the alphabet, and we managed to produce an infinite amount of words. I don't really have an issue per se with the number, except what it signifies.
The actual real value of index funds and ETFs is packaging up in an effective wrapper, broad diversified market exposure in a cheap way and getting and selling that to people. But the number of ETFs and how it keeps going up is symptomatic of an industry that is just chucking product out and hoping it kind of captures the zeitgeist in some form or fashion.
In some cases. I think this is potentially harmful for the individual investor that thinks they're buying an index fund, and has been told whether that is cheap and a good smart use of money. But actually they're buying some god awful sectoral or thematic ETF. And this is my real financial stability concern, or an investor protection concern, is that the ETF especially has transcended its roots as just a passive fund. We think of ETFs, we think of index funds, because that's where they started. The first ETF was Spider. It's the world's biggest ETF. It still manages up to $300 billion. And it's passively tracking the S&P 500. It's an ETF version of the Vanguard 500. That's where most of the assets still are.
But if you look at where the innovation, and I'm using that word cautiously, with the innovation of ETFs, that each powerful tool, we can package more and more complex strategies into them. And I’m a financial journalist who wants to be a physicist. So I instinctively like complexity. I'm fascinated by it. I think it's fun, it's interesting, but I don't think it's wise or safe. And I worry that some of these ETFs aren't just potentially dangerous to the financial health of individual investors, they are potentially dangerous for the health of the financial system.
Jon Luskin: You hit on some great points there. Firstly, as we get all these various ETFs, we're not necessarily talking about, hey, low cost, broad market, super-boring, buy and hold, investing as we are just talking about speculation. With more ETFs means more ways for investors to speculate, that's not necessarily going to be great for them on average. Robin for most normal folks, investing is a pretty dull topic. Folks listening to this podcast, that can be an exception. What do you see as your favorite bit in researching this book?
Robin Wigglesworth: I like the individual stories. There were many people like Eric Balchunas you mentioned, he does God's work in the writing and explaining ETFs to people. I felt that I couldn't do a good job of really explaining like a dummies guide to ETFs. They already exist in index funds and here's how to invest. I really wanted to bring these people to life because I think one of the things that index funds and passive investing has maybe not had is our hero stories. We're humans, we love narratives. And the advantage active fund managers always had is that they always have some sort of narrative for why they're a genius. Or why, when they screwed up, it was somebody else's fault. Typically, index funds, or central banks.
And index funds are the boring thing that I wanted to bring to life. The entire story behind how they were born, because they were ordinary human beings or extraordinary human beings in some cases that did this, and we're all reaping the benefits from that. That's the main thing. I thought it was really exciting, discovering all the scorn that was heaped upon them.
And how many of the criticisms you hear about index funds today are verbatim what was said 50 years ago. The critics haven't really updated their playbook that much. The broad criticism I still hear is remarkably unoriginal. If you look at some of the academic research, there's a lot of interesting stuff happening there. There are people like Corey Hofstein and Mike Green who are on Twitter as well. They're always worth following because they actually do interesting stuff around this stuff. They're the classic, oh, if you're passive, you're the dumb money, you'll get picked off. That kind of stuff you still hear a lot. It just doesn't work as well.
On the delightful tidbits, one of the guys I always say is my favorite character, despite never actually having been able to interview him, was Louis Bachelier. The French mathematician first showed that stocks moved at random. He died and nobody--completely ignored – nobody cared about him. He had a really peripatetic career and now is considered the father of financial economics. There's a Louis Bachelier Society--seen as a giant in the field by other giants. I have a soft spot for people that essentially die in obscurity and are only recognized for their genius or their value after they pass away. It's kind of grim, but reading Bachelier’s life story, but knowing what he would go on to inspire, I thought was pretty awesome.
Jon Luskin: That's actually a good segue. I have another question. Who do you think made the biggest impact on index fund investing, and why? And who do you think was one of the most overshadowed characters in the history of index funds?
Robin Wigglesworth: Jack Bogle didn't invent index funds, but clearly his job in proselytizing for them had a huge impact on the public consciousness. I make the argument that Dimensional Fund Advisors, although not nearly as titanic as some of the other firms that we've mentioned, has done God's work in proslytizing for cash investing as well, for its very sort of madrasas or efficient markets boot camps. And I'm not really an efficient markets guy. I don't think markets are really efficient, at least in the way that most people understand that term. But I think it’s “all models are wrong, but some are useful,” and I think the efficient markets model is a very useful one. That explains pretty well how markets work and function, why passive does well.
The two people, I feel, often get overshadowed because Mack McQuown just got there first. But Rex Sinquefield, at American National Bank of Chicago, and Dean Le Baron are just frankly awesome interesting characters in their own right. Rex Sinquefield went on to also found Dimensional Fund Advisors later. And Dean Le Baron is an incredible character that wasn't an efficient market guy, he was an active manager. He loved the idea of engineering a product that would annoy all his colleagues in the industry and that became an index fund program essentially.
On the overshadowed characters, this is slightly controversial but maybe a bit of a shout out to Larry Fink, because as much as nobody likes Big Wall Street and Big Kings of Wall Street and all that, he has played a very instrumental role in spreading index adoption around the world. He took a massive plunge in buying Barclays Global Investors in 2009. A lot of people, including at BlackRock thought that was really dumb and dangerous, and index funds was a low margin business, that was never going to grow.
And he decided that it was going to grow and he was going to make it grow. And BlackRock has commercialized that relentlessly. It's hard to love a machine, but they've done a pretty good job of doing that. And he saw the way that the investment world was heading quicker than frankly most other people in the industry, probably even some people at Vanguard didn't quite appreciate how big this would become. He's helped spread that gospel inadvertently. Although he typically doesn't seem as a hero in this tale.
Nate Most, the inventor of the ETF, is just a fascinating character. He passed away long before I wrote my book, so I never got to interview him. His life story is really interesting. He invented the ETF when he was 70. Just imagine inventing something so impactful in your seventh decade, that's incredible. Around the ETF there are lots of people that did God's work as well and that was a real herculean task in getting the regulatory approval. That's boring stuff, but it's hard work. We all know not everybody is really prepared to do the hard work sometimes.
Some of the people around Vanguard as well are overshadowed. So a classic case is Jim Riepe, who was Jack Bogle's first assistant both in Wellington and Vanguard. He was essential to making Vanguard a success in those early years when the divorce with Wellington was still fresh, and went on to have a very successful career at T. Rowe Price ironically later on as well. His other assistant Jan Twardowski, who is Bogle's quant, he did the coding for the first Vanguard 500 fund--or FI as it was called, First Index Investment Trust.
Then later on Jack Brennan. Probably one of the great unsung CEOs. When I talked to people who worked at Vanguard about him, because annoyingly, Jack Brennan refused to talk to me--has never talked to any journalist or researcher as far as I can tell--apart from, he does his own little investment book. People without exception sing Jack Brennan's praises, and say that the reason why Vanguard is as big as it is today is, to a large extent, actually, thanks to Brennan almost as much as Bogle. Bogle will not have been able to do it, but Brennan was kind of running that ship for quite a while before he formally did it, and then afterwards also got Vanguard into ETFs, which Jack Bogle had kiboshed when he met with Nate Most. Another classic sliding doors moment.
I like all these secondary characters, maybe sometimes more than the main characters. Imagine Napoleon. We all know the story of Napoleon, but Napoleon didn't fight most of those battles. He did quite a lot, but he had generals like Lena. Unless you're a real history nerd, you've never really heard of these people. But the marshals did a lot of the actual fighting and the logistics, and probably a good thing to remember in all walks of life there's always somebody doing the hard work so somebody else can get most of the glory--hoping people read my book, not just for the big characters, but also the people that helped do these great events as well, but maybe didn't always get the credit they should have.
Jon Luskin: Certainly Brennan is one person that I think of taking Vanguard past that founder level, bringing that professional level of management.
I think about the Wells Fargo executive that maybe is kicking themselves for selling that initial index fund project that they had. Where would Wells Fargo be today if they had the assets under management, index funds, that BlackRock has?
Robin Wigglesworth: Wells Fargo never made money. I don't think they could. I don't really blame them for that. But Barclays sold BGI so it wouldn't have to take a bailout. So they could keep their bonuses for another year. To avoid taking state money they sold BGI, and BGI is now the crown jewel of BlackRock. BlackRock is worth more than all of Barclays. That in the annals of historically awful M and A decisions or business decisions, I think Barclays selling BGI is up there, and especially since it does seem to have boiled down to mostly that they didn't want to take a state bailout that would restrict bonuses. You can turn around and say, actually, they did the right thing. They sold stuff so they wouldn't have to take state money. By lease in the long run for Barclays shareholders, that's something they probably regret.
Imagine if Vanguard had actually, under Jack Bogle, when Nate Most first came calling to him in the late eighties, early nineties, and said, I want to create tradable index funds. Can I do it with Vanguard? Imagine Vanguard, had not just dominated utterly the index, the first iteration of plain vanilla index funds. They'd actually done what States Street did. It would have been vastly bigger than BlackRock is today. It's one of the great strategic errors that Bogle made. I understand his motivations. He was worried about the tradability of ETFs, but I still think in retrospect, he would also agree that that was not the smartest decision.
Jon Luskin: That is a fascinating point. What if Vanguard had launched ETFs when Most came to Bogle? Sure is a certainly fascinating alternate version of history. Michael can ask his question on the history of index investing to Robin.
Michael: Thank you, Jon and Robin, for hosting the space. I recently read Trillions about a month ago, so I'm honored to be able to ask a question. My question is geared towards kind of what you view the future of indexing and passive investing to be the biggest consequence? You briefly alluded to the work of Mike Green and Corey Hofstein with liquidity cascades. And then there's the work of Valentine Hadald on the inelasticity of the market, as well as Chris Cole from Artemis. I'm curious to hear your viewpoint on what the future is, and what the potential consequences could be as it grows bigger and bigger?
Robin Wigglesworth: Mike Green and I discussed this. I haven’t spoke to Corey--but I read a lot of his work-- and Chris Cole has been doing all this. I think it's important for people like me who are fans, we need to keep an open mind. I remain unconvinced. There's a lot of stuff that is theoretically possible, but I'm unconvinced by what I've seen as the evidence of the elasticity and the disproportionate impact on liquidity. And basically, the most liquid, that an Apple isn't necessarily more liquid as a small cap stock is. So there can be a market impact. I think that's entirely possible.
But for me, my broad ford is twofold. It's essentially that markets are an ecosystem and it's a dynamic one that constantly is adapting with new animals that come and go die out there. The index fund is a new animal and it is having an impact on its ecosystem. I just struggled to see what the critics say as this being any particularly bad. I think all basically – it’s very really one cause or two or three, it's just tons of things going on at the time. And I think it's beyond the ken of our human imagination even to wrap our heads around something as complex as the global financial markets. A lot of the stuff that people attribute to index funds is better attributed to interest rates falling for 30 years. If I have to pick one culprit, as it were.
The second part is that actually markets and active management are doing better than ever. There have never been more mutual fund managers in the world. There have never been more quant funds. There’s never been more hedge funds, there’s never been more active traders. The factoid that I often throw out in situations like this just because it's a fun one and it's true, there are more hedge fund managers in the US than there are target fund managers.
Now, obviously the caveat is that all those invest in stocks and all that, but fundamentally between trading, high frequency trading, quant funds, active managers, I just don't see any signs of the efficiency of the markets eroding in any worrisome way. In fact, I see an asset management industry that has margins that are just outrageously large given the outcomes that they produce on average. The average asset manager in the US, listed asset manager in the US, is the margins around 30%, I think it is the last time I checked. That’s Google and Facebook levels. It's way above the average for the S&P 500.
They get that by basically selling what is de facto empirically a substandard product. Markets will get more efficient as dumb money or lazy money or mediocre money gets forced out over time. Active managers love the day trading boom because they are the source of alpha that has always sustained professional managers. So I'm convinced there is a theoretical tipping point where there is so much passive money that it is having such a huge impact on both a micro and a macro level that the opportunities become greater for active. But that will be a balancing act.
But I think we are very, very far away from that. I certainly can see that this is possible, but I doubt we'll see any sort of real evidence, or evidence I would accept in my lifetime. People always find something that essentially supports what they think and maybe I'm guilty of exactly the same, but I see very little concrete evidence that the market's efficiency or that the markets are doing more dumb stuff that they have throughout all of human history.
Essentially that's why I think passive is going to keep growing and the next phase is actually going to be worrying. And there I do think there are more things to worry about--is the impact of indexation in fixed income markets-- because I think that is growing very, very quickly now. And I think for all sorts of obvious reasons and some boring technical reasons, passive products in fixed income indexing doesn't work quite as well, or it needs to be approached in a different way because it is a fundamentally different asset class.
But that's going to be really fascinating to watch. And then the ongoing feature of the industry stuff, the ongoing evolution of the ETF breaking free of its roots as a passive index tracker and becoming a broader vehicle for all sorts of investment products and possibly supplanting the mutual fund is going to be really fascinating to see if that plays out.
Jon Luskin: Robin, you shared some great points there. It's going to be interesting to see what danger exactly passive investing will have to the market.
Robin Wigglesworth: I think the criticism is getting smarter. I still hear the knee jerk stuff I get from finance types is quite often the stuff that I literally read in the Wall Street Journal in the 70s. But there is interesting academic research being done now, and the dynamics of academic research that is publish or die, I'm always a little bit skeptical. But some of this stuff is really interesting. It's an element of people always saying hedge funds are ruining markets, or high frequency trading is ruining markets. And it's all not really, it's just adapting and evolving, and that's what markets do. That's their magic. They are really good at adjusting to new realities. And I think people saying hedge funds having an impact on the market, well, yeah, of course they are.
What I do think is, for example, is there is a very specific issue with treasury basis trading in times of great stress, like March 2020. Yes, probably, yes, you can blame hedge funds for some things. In the same way that there are index funds that do dumb things, or have grown too big for their underlying market, or use quintuple leverage S&P 500 futures, or inverse triple QQQ’s, stuff like that. People do dumb stuff. But fundamentally, it's not really, it's like saying cars are bad because people die in car accidents. I still struggle with that. Yes, you can find evidence that people are dying on the roads more than they did with the horses around, but I don't think we should go back to the horse and cart for that reason, and I don't think we should, and ever could, recork the index genie either.
Jon Luskin: Robin Wells said, “one thing that I think about with respect to the critiques of index on investing is that sometimes, not all the time, but sometimes, the solution to the problem of index on investing is pay more.” Right? Hey, invest in this other product instead. Oh, and yeah, by the way, you're going to pay more with index and fund investing. Oh, yeah, and by the way, I'm going to make more money if you do that. So that's why I always take a grain of salt when it comes to a lot of these critiques. That's not always the case, but it certainly can be often the case.
Robin, what's one thing that you found in your research that you relearned, something that you thought you understood, but having done the research for this book, you found out it wasn't quite what you had initially understood in the first place.
Robin Wigglesworth: One thing that you really hammered home I didn't quite appreciate the very familiar arc of the technological disruption. Like a new technology comes around, everybody said it can't be done or it's dumb or it's dangerous, and some stubborn people push it through and eventually it changes the world. The one thing, and this is probably too long to take this late, but I did actually become, despite my concerns around indexing and fixed income, I actually became more positive around ETFs, fixed income and credit ETFs. As not necessarily as a result of my book per se, but the stress test we had in March 2020. For all sorts of reasons that are wildly popular whenever I write about them in the FT, I think credit ETFs are not nearly as dangerous as I thought. And they might conceivably be a superior investment vehicle for illiquid assets than the classic mutual fund because of the pressure release valve that the secondary trading of the shares constitutes, even when essentially the creation redemption process gums up as it did in March 2020. Lots of people saw that as the near death experience of ETFs, and showed why they're terrible and awful. I actually, both in researching my book but also seeing in real life this huge stress test, actually became certainly less skeptical and possibly even borderline positive or credit ETPs.
Jon Luskin: We actually had a question about that recently when we had Dr. Bill Bernstein on the show, who is not a fan of bond ETFs for that exact reason. Little bit of nerdy investing for the folks there. Michael, go ahead.
Michael: Somewhat unrelated to the general theme of passive. And more tied to your take on John Bogle's criticism of concentration within passive. The risks of effectively BlackRock and Vanguard having accumulated economies of scale that allow them to compete at a level that is certainly beneficial to the lowest price that can be realized in the market. But potentially concerning in terms of the risk of what happens when net trading happens in either side just because of the size which they would end up hitting the market. If you think about the mechanics with which Vanguard accesses the market or with which BlackRock accesses the market, part of the way that they minimize their footprint is by crossing trades before they actually make it through. Right?
Robin Wigglesworth: Yeah. And in their internal pools.
Michael: In their internal pools. And so the challenge is an internal pool is wonderful and in many ways it's a fantastic innovation. But the size of that internal pool is effectively, if you think about it, like a bowl of water versus a swimming pool of water or an ocean of water, right. When overflow occurs, it can hit the market that is unprepared for that degree.
I'd be interested, if you spent any time thinking about the concentration risks that we're seeing where firms like Vanguard, for example, are now capturing something like fifty five cents of every retirement dollar.
Robin Wigglesworth: The concentration issue, that is one of my more ephemeral concerns, but it's one of the most real ones when it comes to the internal crossing on these internal dark pools as it were, I remember I came across an article where Barclays Global Investors was bragging that they had something like the fourth biggest equity exchange in the world, but it was all internal.
When they were really, like the index funds were really ticking off and they were behind the American Stock Exchange, I think the head of Philadelphia at the time. I've talked to some of the people internally about this, but I haven't spent enough time in looking at beyond how they function, and whether the spillover effects can be that great, can be at times in huge flows. But so far we've seen, that March 2020 being a good example, there were massive flows in and out of various asset classes. Mostly out, of course. I'm sure it had a market impact. Did it have a bigger market impact than people taking money out of Fidelity active funds? No, I'm not sure.
And actually, one thing that is a little bit interesting, and one of the reasons why Jack Bogle became more cautiously positive on the ETF towards the end, was that money, even in ETFs, is stickier than most people think. Most people like the convenience of them, but they don't actually massively trade them. And their institutions and hedge funds will use them as a source of liquidity and being able to put on a quick trade. Most ordinary investors don't dump and buy and sell very quickly.
So if you look at the EPFR fund late flow data from March 2020, the outflows from active funds were far greater than they were from passive funds. I don't see why the impact should be greater just because of the spillovers from internal funds. If they can't cross stuff internally, how do they do it? It spills over into the market, whether that one that would have a greater impact than active funds also moving very quickly into cash. Some of the research around market elasticity is one of the more intriguing areas around us.
Jon Luskin: That is all the time we have for today. Thank you to Robin for joining us for today. And thank you for everyone who joined us for today's Bogleheads Live. Our next Bogleheads Live, we'll have Dan Egan, Vice President of Behavioral Finance and Investing at Betterment, discussing conflicts of interest in the robo-advisor space. The week after that, we'll have David Blanchett, managing Director and head of retirement research for PGIM DC Solutions, answering your questions on retirement planning.
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