Freezing rain is falling on the sidewalks at Vanguard Group’s sprawling suburban campus outside Philadelphia, but it doesn’t slow down company founder John C. “Jack” Bogle as he hustles from his office to the cafeteria for lunch. “This is a walking stick, not a cane,” he jokes, and he waves it in the air for a moment. “Anyone who calls it a cane will get three good whacks.”
They’re not the only ones likely to get a good thrashing from Bogle, Bloomberg Markets magazine will report in its April issue. Even with the ailments that come from being 85 years old and having had a heart transplant 19 years ago, Bogle arrives at work every day itching for a fight with anyone who questions the wisdom of the low-cost index funds he has advocated for four decades. His message—he will repeat it as often as necessary—is that trying to beat the market is a fool’s game and that fees collected by fund managers who say they know how are a waste of money.
He compares himself to the mythical “man in the arena” evoked by former President Theodore Roosevelt in a famous speech in 1910: the doer of deeds who exhausts himself in a worthy cause and “whose face is marred by dust and sweat and blood.” Which raises a question. Is there no one to enter the arena and take Bogle’s place?
A slew of money managers and academics—Robert Arnott of Research Affiliates, for example, and Andrew Lo at AlphaSimplexGroup—say they’re building on what Bogle created. As they offer new categories of passive investment products, Bogle mostly grumbles. Likewise, as established money management giants such as BlackRock cut fees on some funds and expand their index offerings, he remains skeptical that they embrace his world view.
On this icy January day, holding court in a cluttered office more reminiscent of a state university than a Wall Street firm, Bogle says he’s still a one-man crusade. “I don’t want to sound too egotistical, but I think it’s crystal clear that nobody, nobody, plunges into this battle to build a better industry with any more enthusiasm than I do,” he says. “Certainly nobody within the industry. Everybody thinks: ‘Kind of, fat, dumb, and happy. Let’s enjoy what we’ve got.’ Because they’re making a lot of money.”
Making money for themselves, he means, not for the investing public. Performance by active managers is dismal, especially of late, and investors are fleeing to passively managed index funds, so Bogle is enjoying something of a told-you-so decade. Only 25 percent of actively managed equity mutual funds beat their benchmarks last year, the lowest rate since 1995, according to data from Morningstar. For U.S. stock funds, the beat rate was only 21 percent, the worst on record.
Investors have pulled money from actively managed U.S. equity funds for nine straight years. They withdrew $98 billion last year while putting $167 billion into passively managed U.S. stock mutual funds and ETFs. The trend toward passive management is unlikely to reverse, Bogle argues. Investment firms that make their money off actively managed funds will milk the cash cow, but their business will wither, he says. Their thinking might go something like this: “‘We’ll shrink, but we’ll take a lot of money out of it on the way down, year after year.’ That’s what a cash cow is,” Bogle says. “In 25 or 30 years, they’ll be gone. That seems like an extreme statement, but I think it’s not without possibility.”
As much as that idea pleases him, other recent trends don’t. The proliferation of ETFs—there were 6,618 worldwide as of mid-February, up from several hundred a decade earlier—alarms Bogle. With so many options, choosing the right ETF becomes almost as prone to error as picking individual stocks, he says. Bogle rejected the first ETF when it was just an idea being shopped around in the early 1990s by Nathan Most of the American Stock Exchange. Vanguard started offering ETFs only in 2001, after Bogle had given up the CEO and chairman posts. Bogle will concede that ETFs haven’t ruined the place. But simplicity is his watchword, so he’ll never make his peace with an industry that offers investors an ever-expanding collection of ETFs linked to solar power companies or Brazilian stocks or gold or some kind of algorithm. “We’ve had too much innovation in this business, far too much,” Bogle says. “How many innovations have helped investors?”
As the conversation turns to ETFs, Bogle gets up from the couch and starts searching for something, checking the stacks of books and papers piled on his desk, shelves, and floor. “Sorry, but this office always looks like this.” After a minute, he gives up the search, sits back down, and explains that he was looking for an old Wall Street Journal page with listings for hundreds of ETFs. He delivers his punchline without the prop: “Just throw a dart.”
When something displeases Jack Bogle, he’ll say so in the most forceful way. He describes himself as an independent thinker, very contrarian, very stubborn, who is looking out for the little guy. (He still answers every Vanguard fund investor who writes to him; handwritten notes get handwritten replies.) The investment management industry needs “more management and less marketing,” he says. It needs “more stewardship and less salesmanship.”
Such complaints would be easier to dismiss if Bogle were an outsider, but he’s not. He started Vanguard four decades ago, and today it oversees more than $3 trillion in 280 funds and is the second-largest money manager in the world, after BlackRock. “I don’t think we’ll see his like again,” says Cliff Asness, co-founder of AQR Capital Management. Asness tries to follow in Bogle’s footsteps by daring to champion contrarian views, even when they might offend some of his financial industry peers.
Asness is one of the seven people we look at in more detail below, assessing their ability to take on Bogle’s role. The rare combination of outsider critic and insider business legend is what makes Bogle such a tough act to follow. Many people in the investment industry call Bogle their friend—justifiably, as Bogle mostly directs his criticisms at ideas and has kind words for individuals. And many want to extend what he’s done, but they’re unlikely to get his endorsement for their innovations.
F. William McNabb
CEO, Vanguard Group
Any examination of Bogle’s heirs has to start with the person running the firm Jack built. That guy today is Bill McNabb, a 29-year Vanguard veteran. McNabb has overseen spectacular growth, building assets to $3.1 trillion at the end of 2014 from $1.25 trillion when he became CEO in 2008 (two weeks before Lehman Brothers collapsed) and $180 billion when Bogle gave up the CEO job in 1996. That means Vanguard runs about as much money as all of the world’s hedge fund managers—at a cost nowhere near 2 percent of assets, let alone 20 percent of profits.
Vanguard charges fund owners on average less than 0.15 percent of assets a year, $15 per $10,000. McNabb, 57, is as proud of that as Bogle is, but he expresses it with a buttoned-down calm rather than the bombast of the founder. The rest of the money management business operates with annual costs in the range of 0.65 percent or 0.70 percent of assets, McNabb says. “In every other industry that you can name, when it becomes pretty successful and margins are pretty rich, those margins get competed away,” he says. “That had not happened in investment management.” It’s beginning to occur, he says, in no small part because Vanguard is forcing others to respond. “Prices are coming down. We’re seeing people at least take steps to compete with us in certain segments of the marketplace.”
McNabb, chairman of the Investment Company Institute, the industry’s research and lobbying group in Washington, is comfortable with an insider role that Bogle long ago rejected. (Bogle grouses that ICI represents investment companies but should be working on behalf of fund investors.) When asked about Bogle’s more strident views, McNabb chuckles and says only this: “Reasonable people can disagree on things.” And this: “Our job here at Vanguard is to continue to consistently improve what we do for that end client and, in a sense, walk the walk.” It’s Bogle’s role to talk the talk.
Global Head, Blackrock iShares
If you actually threw a dart at a list of ETFs, there’s a decent chance it would hit something from iShares, run by Mark Wiedman. A fast-growing unit of money management giant BlackRock, iShares captured almost a third of the $331 billion that flowed into global ETFs in 2014. With more than $1 trillion invested in some 700 different iShares ETFs, the BlackRock unit has a hefty lead in this category over second-place Vanguard and third-place State Street Global Advisors.
So is Wiedman, 44, following the Bogle path? Yes and no. He doubled the number of low-fee iShares Core funds last year, and BlackRock pitches ETFs to pension funds and other large institutional clients as a simpler, cheaper way to invest in the asset categories they want. In June, iShares cut fees on six existing funds. Singing the praises of index investing and cutting fees may be a page out of the Bogle songbook, but Wiedman isn’t always in the same key.
As much as BlackRock embraces low-cost index products, the firm also actively manages billions of dollars for its clients. Wiedman, formerly head of corporate strategy for the entire company, says the active versus passive debate kind of misses the point. Every investment portfolio has to start with an active decision about where to invest, he says. “Low cost begs the question: low-cost what? If you think about the most important decision in any portfolio, it’s asset allocation.” He goes further: “When we talk about active versus indexing, we are obscuring the basic point that God did not hand out benchmarks on the tablets of Sinai. God didn’t give us indexes. Those are creatures of man’s mind.” If the best type of index isn’t set in stone, it follows that there are always more index products to be dreamed up (and drive Bogle crazy).
Founder and CEO, Research Affiliates
Rob Arnott has spent more than a decade trying to free ETFs from what he sees as the tyranny of indexes weighted by market value. “We’ve stepped away from saying the market is the center of our universe to saying the economy is the center of our universe,” explains Arnott, 60, who founded Research Affiliates in 2002 as he was honing his ideas. His firm offers fundamental indexing, which also goes by the newer, flashier name smart beta. The idea is to weight companies based on measures such as sales, dividends, buybacks, and cash flows.
Research Affiliates pitches this as the future of what Bogle and Vanguard started. A white paper on the firm’s website explains: “Smart beta strategies can be the prime alternative to active management for our times, just as cap-weighted index funds served so admirably in that role for the past four decades.” The discussion that follows is respectful of Bogle’s legacy but also stakes a claim on where it leads.
Bogle, however, says such ideas lead nowhere and dismisses smart beta as “baloney.” He objects that Arnott and others who tout ETFs indexed to fundamentals instead of market cap are offering something different but not better—adding complexity for no good reason. “Sometimes it’ll do a little better, and sometimes it’ll do a little worse. And in the long run, it should do about the same,” Bogle says.
Arnott is familiar with the reaction, and unperturbed. He says market-cap weighting implies that investors have faith that the market is pricing company shares correctly—efficiently, in the language of academics. In reality, he goes on, investors are vulnerable to bubbles and what he calls “anti-bubbles,” such as the depressed valuations of bank stocks in the wake of the financial crisis. “Those who anchor on cap weighting and who hew to the notion that prices are fair and that the market is efficient simply won’t acknowledge that severing the link with price has any value,” Arnott says. “That’s the Achilles’ heel of the classic indexing community.”
John Bogle Jr.
Founder, Bogle Investment Management
Jack Bogle may have only himself to blame for raising a son who turned out to be a stock picker. He got John Bogle Jr. interested in the market as a teenager, helping him select a handful of shares. “I probably should’ve gotten him to buy an index fund, but that wouldn’t be very interesting for a young man,” the elder Bogle told Bloomberg Radio last year.
The father believes enough in his active manager son to invest some of his own money in the Bogle Investment Management Small Cap Growth Fund, a mutual fund that posted a 20 percent average annual return after fees during the past three years, beating 96 percent of its peers. The $205 million fund uses quantitative models to pick small-cap stocks based on such things as earnings trends and earnings surprises, relative valuation, and financial strength. The firm uses similar methods for a hedge fund that includes both long and short bets, chosen by sifting through about 6,000 stocks worldwide.
Bogle Jr., 54, has a sense of humor about the tension that comes from being an active fund manager and the son of the most famous advocate of passive investing. At an event honoring his father in 2012, he joked about some of the rules his dad taught him. “Always wear a wool tie in preference to silk, lest you be thought of as being flamboyant or be mistaken for an active fund manager or, worse, a hedge fund manager,” he said.
The most important lessons the younger Bogle says he learned from his father have nothing to do with the market. He remembers visiting Vanguard headquarters on weekends, when the only person they’d encounter was the night security guard. “And my dad would know him by name, and he’d ask him about his kids and wife by name,” he recalls.
Co-Founder, AQR Capital Management
Cliff Asness will sometimes boast that AQR Capital Management runs the type of hedge funds Bogle hates least, because their strategies are transparent and their fees are lower than most. Bogle doesn’t contradict him on this, and he quite likes Asness as a person. They have in common a willingness to stick their necks out.
“I do have a natural tendency to take the other side of whichever way the world is leaning, perhaps too much for my own good at times,” Asness, 48, writes in an email. He figures that his most Bogle-esque work is the research he has done taking hedge fund managers to task for charging too much and hedging too little.
Bogle, who has authored some 10 books and always has a paper or article in the works, appreciates the extensive writing Asness does. He says he admires his way with words, and that’s especially true when the words are about Bogle himself. “Jack’s math, as he said, has never been wrong and never will be wrong,” Asness said during a panel discussion at the Bloomberg Markets Most Influential Summit in September.
Responded Bogle: “Would you repeat that, Cliff?”
Professor, University of Pennsylvania Wharton
Senior Investment Strategy Advisor,
Bogle blurbed the Wharton professor’s book years ago, and Jeremy Siegel’s research figured prominently in Bogle’s writing. Then Siegel joined up with WisdomTree Investments in 2006 to create a new type of ETF as an alternative to traditional index investments that are weighted on the market capitalization of stocks. Siegel’s funds were built on so-called fundamental indexes, which used such things as dividends and earnings to establish stock weightings. Siegel’s new approach didn’t sit well with Bogle.
They ended up debating in the oped pages of the Wall Street Journal. Bogle recalls the specifics of their exchange as if it were yesterday. Those who favored capitalization-weighted indexes were like astronomers who kept the Earth at the center of the solar system long after it had been shown that the planets revolved around the sun, Siegel wrote. He cast himself as Copernicus with a new paradigm for understanding markets. “They got it absolutely backward,” says Bogle, still irritated by any implication that his model of the investing universe is wrongheaded.
Siegel, 69, says the stock bubble of the late 1990s is what changed his thinking. “Did I really want 35 percent of my wealth in overpriced Internet and tech stocks?” Siegel asks. “No!” But that’s what a broad U.S. stock index fund did for investors during that mania. It followed the crowd as the crowd went mad.
Siegel still calls Bogle a hero and a good friend, while admitting that Bogle views him as having strayed from the true path. He believes Bogle will be proven wrong in due course as fundamental index ETFs develop a long-term record of superior risk-adjusted returns. “The proof will be in the pudding,” he says. WisdomTree had $45 billion in assets under management as of mid-February.
On one point, Siegel says, he’s a devoted disciple of Bogle: the virtue of low costs. Several fund managers, whom he declines to name, have told Siegel that WisdomTree could charge more—that WisdomTree’s fees are undercutting the market. “But I would have it no other way.”
Professor, MIT Sloan
Chairman, AlphaSimplex Group
Andrew Lo, a professor at the Massachusetts Institute of Technology, is known for his “adaptive market hypothesis.” This starts with the Bogle-like idea that efficient markets can’t be consistently outperformed and incorporates concepts from behavioral economics about how human psychology affects investing. (Bogle says with a laugh that he always saves Lo’s academic papers but doesn’t always understand them.)
Lo is also chairman of fund manager AlphaSimplex Group, where he’s trying to put his ideas into practice with passive investment products that incorporate active trading strategies and essentially run on autopilot. One of his strategies attempts to identify trades that reflect the collective wisdom of the entire hedge fund industry, a process known as “beta replication.” Another tries to take advantage of cycles of market volatility. “I think the idea of passive investing has really been transformed by technology,” Lo says. “Now, you can be passive even though you’re not market-cap weighting and engaging in this simple buy-and-hold strategy.”
Lo, 54, readily admits that Bogle won’t approve, even though he views his financial product innovation as building on the legacy of passive, index-based investment. “It really marries behavioral finance with the basic observation that passive investing can add value,” Lo says. “When you couple those two together, you can actually do better than the simple index funds. But it’s very much along the same lines with what Bogle was trying to do. That’s why I actually agree with him, although he may not agree with me.”
This story appears in the April 2015 issue of Bloomberg Markets.