For those interested in knowing everything about arguably the greatest financial innovation of the past century – passive investing, this piece delivers it – from the origins to mass market commercialisation to the risks it might pose in the future. A balanced piece with some gems from the man himself, John Bogle, the founder of Vanguard (who according to the article was preceded by over a dozen pioneers ranging from Eugene Fama to Paul Samuelson, who contributed to the birth of passive investing). The common thread among these people was the belief that investing was science than anything else.
“Index funds have revolutionised investing, saving millions of people untold billions of dollars in fees that would otherwise have gone to fund managers with a dismal long-term record of actually beating the market. It is no exaggeration to say that the rise of passive investing is probably one of the most consequential financial inventions of the past half-century. It is rewiring markets and reshaping the finance industry….
…The University of Chicago and MIT were at the centre of this nascent financial-academic revolution. In 1965 Eugene Fama, the famed Chicago economist, first articulated his “efficient markets” hypothesis, which stipulated that securities fully reflect all known information, and the market cannot be beaten. But even for those who believe that markets are inefficient, there is a simple, inescapable mathematical truth: the market is made up of investors, so the average investor cannot do better than the market. For every one that beats it, someone else must fall short.
…And when the cost of trading and the fees charged by a fund manager are factored in, the average investor will, in fact, underperform the wider market, points out Burton Malkiel, the Princeton economics professor and author of A Random Walk Down Wall Street. Some skilled managers might beat the market in any given year — or maybe even over a decade — but identifying consistent stars has proven to be tricky both in theory and practice. “The intellectual case for indexing is airtight,” Malkiel says.
“He suggested that Mellon start an index fund, but his boss was underwhelmed. “He accused me of trying to turn his job into a science,” Fouse recalls. “So I fled.””
….(John)Bogle admits that he was a zealot. “It was a crusade. If you really believe in something, you have to become a preacher,” he says. “I believed the numbers would ultimately tell. The superiority of the index is guaranteed. The math will never let you down.” By the end of 1976, the Vanguard fund still languished with $14m. But in 1982, it crossed $100m. By 1988 the fund boasted $1bn. By 1996 it crossed $10bn. Today the now-renamed Vanguard 500 Index Fund manages more than $400bn…
…In a 2016 tribute to “a real f**king people’s hero”, the writer Hamilton Nolan said: “John Bogle founded a multitrillion-dollar investment firm and did not use it to make himself into a multibillionaire but instead used it to produce a good product at a fair price that saves money for everyone who uses it.”Bogle says he appreciated Nolan’s sentiment — if not the strong language — and bristles with pride over Vanguard, even if it didn’t bring him the financial rewards that other investment behemoths have brought their founders. “What do I need a private jet for? I need my wife to drive me around. It doesn’t do my psyche any good to know that I have more than someone else,” he says. “I’m very comfortable with what I’ve done for the world.”
“The sheer force of flows into these funds has been an important driver of the relative outperformance of indexed assets. When these flows reverse, or even pause, the effects could be just as impactful on relative prices, but in reverse, and possibly more abrupt and intense.”
Every great invention comes with side effects that should be recognised and addressed. Within the foreseeable future, they could hold a commanding vote in most major US public companies — a development that worries even Bogle.“Is that good for capitalism?” he questions. “It’s hard to know how big we can get, and the consequences. But it does raise issues that we need to address. We cannot ignore them. But to solve this we should not destroy the greatest invention in the history of finance.”
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