Breaking With Bogle
Now before I commit blasphemy, a few words: I am as close to being a Boglehead as you will find, without actually being one. The bulk of my portfolio is in passive indexes. Most of the assets I manage are in a broad allocation model.
This is a tribute to the wisdom and teachings of investing legend John Bogle, who founded Vanguard Group 40 years ago on the premise that matching market-based returns yielded better results for most investors than picking individual stocks, market-timing or any other investment strategy. During the past four decades, the sleepy firm Bogle started has turned into an investment giant, now managing about $3 trillion.
But we have learned many things during the intervening years. I don't want to commit the sin of ignoring the accumulated quantitative evidence. There are certain mathematical truths in investing, and to pretend they don't exist would harm my portfolio (and my clients).
Please understand that my deviation from Bogle's philosophy isn't due to hubris, but rather, mathematics. Certain facts of long-term investing have such strong evidence behind them that they are almost incontrovertible. It would be irresponsible for any investor, or their fiduciary, to ignore this evidence. Hence, I find myself at odds with someone I respect in four areas of portfolio management:
1) Overseas Investing: Last year, Bogle restated his bias against emerging markets and non-U.S. assets, saying, “I wouldn’t invest outside the U.S.,” primarily because of currency costs.
This approach has numerous problems. It ignores diversification of assets. It ignores equities in other parts of the world that are both cheaper and faster-growing. It ignores that over time, currency issues are a wash. It reflects a home-country bias. As Cullen Roche pointed out, excluding a vast class of assets turns Bogle into “an active investor in passive clothing.”
2) Smart Beta: Bogle recently said this to Institutional Investor: “Smart beta is stupid; there’s no such thing. It’s an idiotic phrase. Quoting Shakespeare, I guess: It’s a tale told by an idiot, full of sound and fury, signifying nothing.”
By smart beta Bogle means moving from market-capitalization-index investing strategies to alternatives. Look, it's almost an accident of history that the Standard & Poor's 500 Index was built in a market-capitalization-weighted form. As numerous studies have pointed out -- perhaps most famously by Rob Arnott of Research Affiliates -- weighting indexes on just about any other fundamental basis not only outperforms market-cap-weighted indexes, they do so with less volatility. It's an improvement on the original concept.
3) Small-Cap Stock Premium: The small-capitalization stock premium has persisted long enough that we now know it isn't random. Weighting a portfolio toward smaller-capitalization stocks -- especially small-cap value stocks -- generates additional returns over time. AQR Capital Management’s Cliff Asness recently summed this up in a post declaring, “The Small-Firm Effect Is Real, and It’s Spectacular.” If you are going to deviate from a pure passive index, then this is the way to do it.
4) Exchange-Traded Funds: Bogle hates them. Investors like their low costs, and the ease with which they can buy or sell them without some of the hassles involved in buying or selling a mutual fund.
People can overtrade ETFs, they can turn the pursuit of smart beta into another dumb alpha-chasing exercise. There could always be a currency loss from overseas investing in any one quarter. But overall, they do more good than harm.
Ultimately, any of these four areas can lead to poor investor behavior. However, to adapt an aphorism, finance advances one white paper at a time.
Bogle is in the pantheon of the greats. His contributions to the investing world can't be overstated. But the world has learned much since John Bogle started Vanguard in 1975. If he stands for anything, it's having an intelligent investment philosophy based on hard-won wisdom. It would be an unfortunate error to ignore the newest data that logically leads to deviations, however minor, from his original plan.
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Barry L Ritholtz at firstname.lastname@example.org
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