In last years 40th anniversary issue of the
Journal of Portfolio Management,
John (Jack) Bogle recounts how he founded Vanguard Group
and the ubiquitous index strategy now synonymous with the $3
trillion firm. His inspiration: a 1974 paper by Nobel economic
sciences laureate Paul Samuelson in the first issue of
JPM, Institutional Investors sister
publication, outlining a fund that would track the S&P 500
index. Bogle launched Valley Forge, Pennsylvaniabased
Vanguard the following year; he retired as CEO in 1996 and is
now president of the Bogle Financial Markets Research Center,
where he does research on behalf of investors.
The index idea caught on: In 2014 active U.S. equity funds
had outflows for ten consecutive months through December,
reports Chicago-based Morningstar; passive U.S. equity funds
saw inflows for 11 straight months. Vanguard was the winner
among passive-fund firms.
Among the changes since the early days of index investing is
the proliferation of exchange-traded
funds. Active managers are fighting back with so-called
smart beta products, which use new indexes built around factors
such as value and growth. Senior Writer Julie Segal talked to
Bogle, 85, about the passive craze, ETFs and the future of
1 Investors are sending massive amounts of money to
index funds. Have they finally gotten your message, or is
something else going on?
Weve been through ups and downs, and weve seen
actively managed funds come and go in terms of performance.
Nothing lasts forever. While its hard to understand
reversion to the mean and that past is not prologue in this
business, investors do finally get the value of indexing from
their own personal experience in the markets. I get letters all
the time from people thanking me for how theyve done.
You should know Im now over $1 million or $3
million, they write. More than anything, its the
experience of investors and the power and logic of my ideas,
which arent world-shaking. Its gross return minus
costs equals net returns.
2 Exchange-traded funds make up a big part of the
flows into passive. Have you changed your views on
No. Ive often said the ETF is the greatest marketing
idea so far in the 21st century; I doubt its the greatest
investment idea. ETFs are fine if you dont trade them;
and if you dont trade, you might as well own the regular
fund. Were indifferent at Vanguard. We have the exact
same portfolio available in different packages; ETFs or regular
funds. Look, Ive had to invent my own word now: a
traditional index fund, to differentiate it from the ETF.
Dividend reinvestment and other things are cleaner with the
There are two issues here. One is that with ETFs there is a
huge amount of institutional ownership: large organizations
that trade like the dickens. Every day the SPDR is the most
actively traded stock in the world. A recent Vanguard study
showed that 90 percent of investors in traditional index funds
are long-term. Only 80 percent of investors in ETFs are
long-term. Thats a 100 percent increase in short-term
investing. Investors always do worse than the funds themselves.
Investors returns lag fund returns by 150 basis points in
TIFs, but they lag by 250 basis points with ETFs.
There are also two segments of noninstitutional users: those
who own the broad market funds like the S&P 500 and those
who own niche segments of the market or leveraged funds. Some
investors in the broad market funds are traders. But the
fruit-and-nutcake fringe of ETFs is just poison for investors.
Investors in these are subject to abuse, subject to
opportunism, subject to overzealous marketing. They are unsound
investment products. I dont like investment products
anyway. I banned the use of the word product all
those years ago at Vanguard, but its come back even
3 Investors are buying your message then, but a lot
are using ETFs and trading more. Is it two steps forward and
one step back?
I dont know what to say. The SPDR turns over 7,000
percent a year. I think 3 percent turnover is pushing it. On
balance they all lose. There is a lot of opportunism here:
Advisers or whoever saying you should get out of health care
and into technology or into financials. Thats a way to
manage money that doesnt work. Who knows what will do
best? I dont even know anybody who knows anybody who
4 If all money were indexed, some argue, there would
be no one setting fair market values for companies. Do you
believe this is true?
Whats important in the long run in investing is how
the corporations do. One hundred percent of stock returns come
from dividend yields and subsequent earnings growth. The change
in price-to-earnings ratios valuation goes up and
goes down. Its a vibration and contributes zero in the
long run. So 33 percent of the market is now indexed. Maybe in
ten years we could get to 50 percent, and we can reexamine it
then. But thats a long time away. There are those who say
when indexing gets big they dont put a number on
it then the markets will get less efficient and it will
be easier to win. Absolutely correct. But it will also be
easier to lose!
5 Active managers are losing market share. Is smart
beta their attempt to turn
Smart beta is stupid; theres no such thing. Its
an idiotic phrase. Quoting Shakespeare, I guess: Its a
tale told by an idiot, full of sound and fury, signifying
nothing. Its just another way of saying, I know
Im going to be above average. Active managers are
just trying to come back and say there is a better way to
index, when they know damn well there isnt a better