The Man Who Gave Away a Trillion Dollars

If you had to think of the most influential financier of the last 50 years who would it be? Warren Buffet owns companies whose products touch many aspects of our lives. George Soros famously “broke” the Bank of England. Ray Dalio heads the largest hedge fund in the world focusing on macro strategy with $125 billion in assets under management.

As history has shown us though, the most influential people aren’t always the ones that have made the most money. Johannes Gutenberg topped many lists around the turn of the millennium for the most influential person for having invented the printing press, which revolutionized the dissemination of knowledge and ideas. Similarly, my vote for the most influential financier of the past 50 years is someone maybe not everyone has heard of: Jack Bogle, who happened to pass away earlier this month.

Mr. Bogle is probably best known for founding The Vanguard Group, which offers ultra low cost mutual funds and ETFs . His passing has brought out praise for his life’s work from the likes of Warren Buffet to Ralph Nader.

Source: chineseposters.net

The Slow March Towards Revolution

His ideas started in his dissertation paper at Princeton University, The Economic Role of the Investment Company, where he laid out his thesis that mutual funds can claim no superiority over market averages in the long term once fees and taxes are accounted for. After his graduation in 1951, he was hired by the Wellington Fund and worked his way up the corporate ladder by challenging the way the company did business. He pushed management to change its strategy of focusing on one single fund, even creating a new fund of his own to prove his point. His innovations and strategy led him to become chairman at age 38 in 1970.

A few years later, in a merger he approved with an aggressive mutual fund company based in Boston, he was fired as chairman when the bottom fell out of the market in 1973 and put the company on the ropes.

Bogle managed to salvage a role in a new subsidiary that would only oversee fund administration only and not be involved in active investing decisions. He named the new subsidiary Vanguard after British captain Horatio Nelson’s flagship in The Battle of the Nile.

Soon after, Paul Samuelson, who had recently won the novel prize in economics, published an article arguing for a mutual fund that tracked the S&P 500 available to retail investors. By 1976, the first Index Investment Trust was launched and managed to raise a measly $11 million from the $150 million Bogle had hoped for.

However Bogle had structured the fund in a unique way that is almost still singular on Wall Street: he made the investors owners of the fund and focused on cutting their costs as much as possible. Slowly this strategy started to win adherents. In 1982 the fund had $100 million in assets and by 1988 it had $1 billion.

The Revolution Takes a Turn

It took time for Bogle’s fund to build assets because he was stressing the outperformance over the long term of a buy and hold strategy. Then, just as now, people were chasing the “sexy” money. The latest trend, the industry in the spotlight, the growth story, the “it manager”. Meanwhile over time, Bogle’s fund gained assets as he was proven right as his S&P 500 fund outperformed all the highly paid managers. The typical mutual fund charges on average 1.15% in fees while the current cost of Vanguard’s S&P 500 index fund is 0.04%. Meaning mutual funds would have to on average perform at least 1.11% above the market return over time to be worth their cost. As more and more investors started to realize this outperformance over time was nonexistent, investors gradually started to move their funds over to the index.

In 1990, Bogle was approached by Nate Most, a former WWII submariner who had an idea for creating an index based on the commodity trading he had witnessed in Asia. Most noticed that the traders of cooking oil would buy and sell warehouse receipts representing the physical oil rather than physically move the oil back and forth. This gave him the idea to trade receipts representing ownership in an index by brokerages which could facilitate trading in electronic shares of a passive basket of shares. In this way, the Exchange Traded Fund, or ETF was born.

Bogle rejected the idea, as it enabled fast paced buying and selling of entire indexes which was antithesis to his buy and hold mantra. However some unique technical features of ETFs, such as the absence of 12b-1 fees (marketing fees of mutual funds passed onto investors), no load fees, and market based trading which eliminated capital gains and administrative costs passed onto investors, ETFs became an even cheaper alternative to index mutual funds which really brought the revolution home to the small retail investor.

The first ETF was taken up by State Street and was dubbed the S&P Depository Receipt or SPDR as it is commonly know. This ETF is the most widely traded ETF currently with $260 billion in assets and allowing everyone from day traders in Ukraine to hedge fund moguls in New York to play an entire index for a millisecond or 10 years.

How the Little Guy Benefitted

From the launch of the SPDR fund in 1993 to the proliferation of indexes and ETFs we see today, the simple idea put into practice of low cost indexing has given the power back to the retail investor. In addition the advent of the internet and plummeting brokerage commission costs have presented the opportunity for the retail investor to spread his assets across the world into a multitude of strategies at a lower cost than a large institutional manager.

Although actively managed funds continue to dominate as can be seen below, in the coming decade it is estimated that in the US, passively managed funds will pass the 50% mark to overtake actively managed funds.

Source: BIS

Bloomberg estimates that through driving down the cost of other mutual funds, casting away the under performers and leading the surge into indexing, Bogle’s creation has saved investors over $1 trillion since his first index fund came about. This is an astounding gift back to the clients and away from fund managers. In essence this represents money back into the pockets of millions of people all over the US and the world that can use this money for their own retirement, legacy or simple enjoyment. The fact that Bogle decided to give this back to the people instead of using his smarts to just slice a bigger piece of himself is the reason why many are considering him one of the Giants of modern finance.

A Warning Before Parting

As late as last year, Bogle was starting to sound the alarm about the power of the 3 biggest index managers Vanguard, State Street and Blackrock. The oligopoly of 3 managers holding over 80% of index and ETF funds seemed to have little appetite make sure the companies they owned were practicing sound corporate governance and this was opening the door for a new wave of corporate shenanigans that has the potential to defraud unsuspecting investors.

If the historical patterns hold, index funds could become a problem, Bogle argued: “A handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation.”

How to solve this problem may be the next horizon in investing: how to have a passively owned company that adheres to sound corporate governance. The solution awaits.

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