“The ETF is definitely one of the most important financial innovations of the past 30 years.” – Barry Ritholtz
This past weekend I saw the new movie Yesterday. The premise of the movie is killer: after a freak event everyone in the world, except an underperforming singer-songwriter, has forgotten the music of the Beatles. The movie doesn’t live up its inventive setup but it a perfectly pleasant viewing experience, especially if you have a fondness for the Beatles.
The point of this isn’t to review the movie, but it is fun, and sometimes illuminating, to ask – what if? What if something happened or didn’t happen that changed the course of history? There is a whole subgenre of fiction called alternative history that explores these very ideas. Think, what if Hitler survived and escaped to Argentina in 1945?
What got me thinking about this was the news that the Vanguard Group passed $1 trillion, that’s trillion with a T, in assets under management in its exchange traded funds or ETFs.* This is second behind market leader Blackrock.** What’s makes this story notable is that in an alternative scenario Vanguard would have been even more delayed entering the ETF market, if not out of the market altogether.
Google the words ‘Jack Bogle’ and ETF’ and will get no shortage of articles on the topic. While Bogle saw some utility in broad based-ETFs for long term investors in general he was not a fan. Bogle wrote:
“I freely concede that the ETF is the greatest marketing innovation of the 21st century. But is the ETF a great innovation that serves investors? I strongly doubt it. In my experience — almost 64 years in the fund industry — I have learnt to beware of investment “products”, especially when they are “new” and even more when they are “hot”.”
Bogle recounts how he turned down the opportunity to sponsor the first ETF. Bogle wrote at the FT:
“Mr Most offered Vanguard the opportunity to join forces with him, using our Vanguard 500 Index Fund as the trading vehicle. But the idea of using Vanguard’s original index fund for frequent trading was anathema to my investment philosophy.”
It wasn’t until Bogle was no longer an active part of management, did Vanguard enter the ETF market. In fact, when Vanguard entered the ETF market they did it in the most Vanguard possible way. They used a unique (and patented) construct that made their new ETFs as a separate share class of already existing index mutual funds. More importantly Vanguard has pushed the industry to lower its expenses on its ETFs.
The irony is that the ETF was crucial in helping expand the adoption of index funds which Bogle was such a fan of. Rick Ferri writing at Forbes notes:
I sympathize with Mr. Bogle’s view that ETFs may entice some people to trade more, but I’ve also witnessed firsthand the huge increase in long-term money that has flowed into low-cost index funds as a direct result of ETF acceptance. The industry hasn’t been given enough credit for this. In my view, the benefits from popularizing Mr. Bogle’s investment philosophy overwhelm any blemishes that the ETF industry may have acquired along the way.
The point of all this isn’t to criticize Bogle who passed away earlier this year. If nothing else he was consistent in his views and their application to the investment world. There is no doubt that Bogle was a singular champion of the individual American investor. The point is that history is a funny thing.
Seemingly small decisions can have big effects on a company, an industry and the world. A different decision in 1993 might have accelerated the development of ETFs. Or if Bogle had continued to have significant sway at Vanguard the ETF industry may not have seen the growth in assets and the reduction in expenses we see today. Either way the world would be different.
The ETF industy is now standing at the edge of another inflection point. Non-transparent structures will soon make active ETFs a more attractive option for firms that have, to date, shunned the ETF structure. Other industry holdouts are seeing their options limited as other more nimble competitors take their strategies and run with them.
True innovations in the financial world are few and far between. ETFs are one of them. Let’s recognize the progress they have made possible and note how the world could have looked very different than it does today.
*Coincidentally, around the same time bond ETFs also crossed the $1 trillion market in AUM.
**Ten years ago Blackrock purchased the ETF business, i.e. Barclays Global Investors, from Barclays Bank amidst the Great Financial Crisis. A cool what-if would examine what would have happened if BGI had been purchased by private equity firm CVC Capital instead of Blackrock.