Jack Bogle knew how to make a nuisance of himself.
“What he meant to most people in the investment business was that he was a royal pain in the bottom,” says Jeremy Grantham, co-founder of Grantham Mayo Van Otterloo in Boston.
By the time of Bogle's death, last week at the age of 89, his victory was nearly total. Low-cost index funds, the idea he championed, are everywhere and Vanguard Group, the company Bogle founded, is now a $5 trillion giant.
This year, the investing industry will hit a symbolic tipping point: The amount of assets in US index funds is almost certain to surpass the amount in actively managed products for the first time. Meanwhile, Vanguard collected inflows of $218 billion in 2018, Bloomberg data shows. The rest of the US. fund industry lost $237bn.
Bogle, who suffered the first of six heart attacks at the age of 31 and ended up with a heart transplant, didn’t seem like such a threat to Wall Street when he started Vanguard back in 1975.
Many thought he was crazy. Practically his only allies were academics, economists like Nobel Prize winner Paul Samuelson and Princeton University’s Burton Malkiel, who thought the idea of index funds made a lot of sense. Money managers were charging big fees for the privilege of racking up mediocre returns. Bogle’s concept was simple. Since it was nearly impossible to consistently beat the market, why try? Just buy a large basket of stocks (or bonds), skip the cost of hiring an investment pro, and patiently collect the market return as the savings from those lower fees compounded.
Nice idea, but could anyone make money offering it? Other investment companys experimented with index funds, to underwhelming results. Clients didn’t seem to be clamouring for the product at a time when Wall Street’s marketing was all about investing prowess. Batterymarch Financial Management, a company Mr Grantham co-founded before GMO, tried it. One barrier, beyond client skepticism, Mr Grantham says, was that “it was destined to be a very, very low profit business".
And that - low fees, low profit margins, letting investors keep more of their money - was Bogle’s entire point.
The first-ever index mutual fund, accessible to all investors, not just institutional clients, was a flop. With Bogle expecting investment of as much as $150 million, Vanguard launched it with only $11.3m. Even his fans in academia weren’t pleased. Mr Samuelson complained about the fund’s 6 per cent sales load, which was standard at the time. Loads were used to pay for kickbacks to financial advisers so they’d recommend the funds to their mostly unaware clients. Vanguard eliminated its loads in 1977, a virtuous move that nonetheless made it harder, at least at first, to attract assets.
Perhaps more disappointing was the fund’s performance. In the late 1970s, three-quarters of active-fund managers were still delivering better returns than Bogle’s index fund. By the early 1980s, half were outperforming the index fund, despite the lower fees. Then, later in the 1980s, the tide turned, and Vanguard’s index fund began outpacing the vast majority of active funds.
Technology played an underappreciated role. Index funds have to buy and sell hundreds of securities every day, to deal with investment flows, re-invest dividends and generally keep up with the index they’re meant to track. Vanguard’s first fund could only handle about half of the Standard & Poor’s 500 index. By 1992, computers and trading systems had advanced to the point where Vanguard could launch its Total Stock Market Index Fund, which is now a $672bn behemoth that buys every single US stock, 3,500 in all, for fees as low as 0.04 per cent per year.
Another reason Vanguard was able to turn the tide was the fierce competition active-fund managers started facing from each other. Investors were eager to jump into the surging markets of the 1980s and 1990s. Celebrity fund managers multiplied, and they were also up against new, high-tech hedge funds, which built powerful computers and hired scientists and maths doctorates to run them. The arms race made it more and more difficult to outsmart the market.
The stock-picker's joke
By now, it’s become almost a joke on Wall Street. Every so often, some pundit predicts that this year, finally, will be a “stock-picker’s market,” when skilled individual stock selection can finally triumph over the quants and the indexes. But with each passing year, mutual funds, and even hedge funds, fall further behind the plain old index fund.
As Vanguard won more and more assets, along with the respect of many personal-finance experts, it was competing against a financial industry that loved to steer clients into higher-fee products. Vanguard, which Bogle had set up as a cooperative, would periodically cut fees, passing the savings from efficiencies and economies of scale to its customers. Other fund companies mostly held the line.
Then, investors started asking about fees, particularly after the steep market declines of 2000-2002 and 2008. Only the most unsophisticated investors would still put up with an adviser who recommended load funds.
Suddenly, Vanguard started facing serious competition of its own. A fee war broke out, with players like Fidelity Investments and Charles Schwab angling to cut costs closer and closer to zero.
The craze for indexes took on qualities that made Bogle unhappy. In his later years, when he was no longer in charge at Vanguard, he railed against exchange-traded funds, or ETFs, which are index products that can be bought and sold like stocks. He worried that ETFs encouraged the sort of wasteful trading that hurt investor returns. Few agreed with Bogle - even at Vanguard, which offered its own ETFs - and the funds now hold $3.5tn in assets in the US.
The Bogle philosophy
Still, Bogle’s philosophy - that trying to beat the market was futile, especially if you’re an investing amateur - was winning the day. His advice became conventional wisdom for big companies setting up retirement plans in the US. They encouraged workers to buy and hold index funds with low fees, and discouraged them from getting in their own way by trading too much. Today, a generation of workers is ploughing its retirement savings into index funds, whether they realise it or not.
The ultimate savings for the American investor from Bogle’s persistence may amount to more $1tn, according to an estimate by Bloomberg ETF analyst Eric Balchunas. And the windfall will continue to rise as the benefits of lower fees compound year after year after year.
Bogle was a folk hero to investing nerds and an outspoken enemy of stock-pickers and self-serving financial advisers. But he wasn’t a household name. The biggest beneficiaries of Bogle’s invention are regular investors who might have no idea who he was.