It is hard to overstate the impact of Jack Bogle on field of finance. However the average American has no idea who he was or how he affected their financial life. Eric Balchunas’ new book The Bogle Effect: How John Bogle and Vanguard Turned Wall Street Inside Out and Saved Investors Trillions looks to rectify that situation..
Balchunas is the Senior ETF Analyst at Bloomberg and the co-host of the Trillions podcast and ETF IQ on Bloomberg TV. Balchunas is already out there talking about the book including a visit to The Compound & Friends.
AR: You spoke with Jack Bogle on a number of occasions. Does one stick out? How did it change the way you think?
EB: The first time I met him I was stunned at how much he knew about ETFs, something he was not even a fan of. He knew specifics about assets, flows, turnover numbers as well as all the new launches- even obscure theme ETFs. His office was spilling over with papers and charts. He was basically working as a fund analyst despite being in his ‘80s and retired from running Vanguard for nearly 20 years. He always stayed interested in things and a little pissed off, which I’m now convinced is the secret to longevity.
AR: In a recent interview you said that at one point you wanted to name the book ‘Addition by Subtraction.’ How does this and the ‘cost matters hypothesis’ explain the Bogle philosophy?
EB: Yes, I think ‘addition by subtraction’ summarizes Bogle’s life work- much more so than “father of the index fund” Through Vanguard, Bogle basically removed all the stuff that tends to detract from investor returns – especially over the long term – be it management fees, turnover costs, broker commissions, market timing and emotion. It took a long time but he eventually removed all those things. He referred to this mission as the Costs Matter Hypothesis (CMH) which was sort of his take on the Efficient Market Hypothesis (EMH) which got attached to him and index funds but wasn’t his thing at all. I think it was smart too as the EMH doesn’t really pass peoples’ sniff test while the CMH does.
AR: People in finance, like Warren Buffett, know Jack Bogle’s impact, but the average person who has benefited do not. Your book is a reaction to this, but do this ever really happen?
EB: While the book is definitely a way to show how one guy and one idea saved a ton of money for average investors, Bogle and Vanguard also are a great vehicle to show all the ways the financial industry is changing- from funds and ETFs to wealth management and trading platforms to active management and behavior. This book is really about the future as much as the past. The ripple effects of Vanguard’s ownership structure are wide-reaching and will reshape portfolios and the entire industry in the coming decades.
AR: Jack Bogle stepped down as Chairman of Vanguard in 1999. The bulk of Vanguard’s growth has occurred since then, not unlike the situation with Apple. If Jack is Steve Jobs, who is Vanguard’s Tim Cook?
EB: I think all the CEOs that came after him are in their own ways Tim Cook, which can be a tough job given the extreme reverence for the founder. But it’s a good metaphor I think as 87% of Apple’s current market cap came after Steve Jobs left but is largely due to the foundation he laid and products he developed. In Vanguard’s case it is even more extreme as 97% of their assets came after Bogle stepped down as CEO. In both cases though the successors did a good job of building on the foundation and not mucking it up.
AR: On page 17 you have an astounding chart. It shows Vanguard with 29% of fund industry assets yet 5% of revenues. Why do you call this chart the most important in the book?
Because it foreshadows the serious challenges coming to the financial industry. Let’s say all the money in mutual funds was earning the same revenue as Vanguard or BlackRock ETFs —which is where the majority much of the flows are going – the revenue of the mu fund industry would drop from around $140 billion a year to $20 billion a year. It would also remove tens of billions in trading revenue generated from said funds. That’s an 85% decline. That said, I don’t think it will get that bad. I think a 40-50% decline is more realistic. But this is crucial revenue given how fruitful retail investors have been to the financial industry for so long. This is why another title I almost gave this book was The Man Who Shrunk Wall Street.
AR: The Vanguard Effect – why is this so unusual in the history of business? And why does it keep growing everyday?
EB: It’s not unusual for a business to have a big effect on its industry. Just look at Amazon or Tesla. What makes Vanguard so unusual relative to other businesses is it is customer owned essentially. The founder didn’t become a billionaire. In fact, the founder, Bogle, was so unusual he once said he would know Vanguard has created a better world for investors is when its market share began to erode. That speaks to the different trip Bogle was on as well as how potent the ‘effect’ of Vanguard is and will be.
AR: What is the relationship of the rise of Vanguard’s approach to indexing and the rise of the independent RIA?
EB: This is a great question and point. I point out in the book that the trend towards brokers becoming RIAs is at least in part – if not almost entirely – due to Bogle and Vanguard. Because if you wanted to put your clients in cheap index funds – which you could argue is the most fiduciary choice – you couldn’t do it as a broker back in the day because Vanguard wouldn’t pay or your company so the boss said no. This was pretty ballsy of Bogle at the time because he was basically saying if you wanted to use Vanguard funds you had to leave the whole system. And many brokers did.
AR: The rest of the world is behind the U.S. when it comes to empowering individual investors. How has Vanguard made a dent in the rest of the world?
EB: If the Vanguard Effect of Bogle Effect is in 4th inning in US, it’s still in the 1st inning overseas. The problem is the same problem Bogle had to overcome in the 70s, 80s and 90s in the US which is advisors and brokers are still paid to push product. The move to a fiduciary or fee-based model is still so young there. It’s like changing the plumbing and infrastructure for an entire city- it takes a while. Further there’s less DIY retail investors as they tend to use the bank for everything. And unlike the US where DC plans forced average investors to learn about investing, they don’t have that there so they are less tuned into returns and fees. But eventually much of the world will likely resemble the US although it will take a long time.
AR: Vanguard is really the only mutually owned asset manager. Why hasn’t any one else tried to copy them?
EB: I asked everyone I interviewed this question and most had the same answer: “because there’s no economic incentive to turn the ownership over to the investors. No one goes to Wall Street to drive a Volvo.” Then I’d ask them why think Bogle did it and they all had the same answer: “that’s a good question.” In reality it took a totally freakishly rare situation in the Wellington breakup as well as a freakishly rare character like Bogle to create such a freakishly rare structure. I dive deep into both of those things in the book as I feel like those two things are the real source of everything we are seeing today. Indexing is merely a byproduct of that. It gets way too much credit for the index fund revolution, ironically.
AR: In Chapter 2 you go through the circuitous path Bogle followed to found Vanguard. Do you ever think of the alternative where Vanguard is never founded? What do you think the investment world looks like?
EB: Yes, I think had things not blown up the way they did at Wellington, Bogle would have remained a happy CEO of an active mutual fund company. Circumstance played a huge role multiple times in his career. In fact, I was so blown away at how much serendipity there was when researching story it almost seemed like the Universe just simply wanted it to happen. But yeah, without Vanguard’s ownership structure, index funds and even ETFs may have happened but we’d be paying 70-100bps for the funds – just like active – and they’d have distribution fees and loads. They’d be niche products. They only went mainstream because they are so cheap.
AR: The concept of ‘enough’ is rarely talked about. In fact, the opposite still seems to be the case. While Bogle exemplified this, does Vanguard still?
EB: That’s a complicated question and one I explored in the book in a chapter called Bogle vs Vanguard. On one hand, they clearly have more ambition for expansion and growth than Bogle ever did. But on the other, you could argue it’s good Vanguard is moving into other areas, such as ETFs, wealth management, direct indexing, trading platform, private equity, as it will likely drive down costs helping the end investor. I am torn to be honest and so I just present both sides in the book and let the reader be the judge.
AR: For a big chunk of the investing world, the idea of indexing, or settling for average returns has taken hold. Where does that leave active management?
EB: This is a huge underrated part of the Bogle Effect, which is that the more index funds take over the core of portfolios the more it is forcing active to get either very cheap, or much more active. Investors now feel like they have the vast majority of stocks and bonds covered in their index funds but its pretty boring – like watching a tree grow – so they are looking for things very different to complement it with and even distract themselves with. This is why flows and assets in ARK, themes and crypto are so strong in my opinion. This is why, right or wrong, active share is now more important than excess return. Put another way, Cathie Wood’s staying power is a somewhat a byproduct of Jack Bogle’s life’s work, however weird that may sound.
AR: How much of Vanguard’s success can be traced to the popping of Internet bubble and the GFC? It seems many investors simply gave up on trying to beat the market.
EB: Vanguard’s success was definitely aided by these crashes and scandals as they tended to look Boy Scout-ish in comparison. I think 2008 in particular was a huge turning point for index funds and ETFs which took in cash as active funds bled. Many people saw active funds for the most part didn’t do any better than the market. Many did worse. The internet was also in full bloom around then as well which also expedited the move to passive, which has seen parabolic growth since.
*Full disclosure: Eric was kind enough to send me a copy of his book.