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: Like many accomplished people Bogle was a bit of a duality, both ‘inspiring and moralizing.’ Do you think his ego was a necessary part of his success?
EB: Absolutely. By all accounts he had a big ego, which is one of about ten ‘ingredients’ that I explore in the book that help explain this unique person that many people I interviewed said was an anomaly. A big ego can be both an asset and a liability. And while he was seemingly immune to the magnet for more money that governs Wall Street, he could never get enough adulation and praise from Vanguard investors and the media. It was for this reason I thought that he was arguably miscast in this industry, or perhaps perfectly cast, depending on how you look at it.
AR: To the surprise of many, Vanguard is one of the largest active fund managers. But Bogle never saw this as an issue. Can you explain?
EB: One of the biggest misunderstandings with Bogle was that he was anti-active. He wasn’t. In fact, he spends more time in his books on the active Wellington Fund than he does on any index fund. That fund was like his first born child. Bogle distilled it all down to the word ‘stewardship’ and I think he felt like many active managers abused their duty as stewards with the public’s money by never passing on economies of scale after they got massive. Had they done more of that – which they could have easily done given how utterly large the dollar fees and their margins became over the years – they would have banked good will with their investors and had better ‘beat rates’ versus benchmarks and Vanguard and indexing wouldn’t have been nearly as disruptive. It was a missed opportunity. And I’m not judging them as I would have done the same thing as them. But as an analyst I’m just trying to explain and deconstruct the situation the best I can.
AR: The bull market has been covering up the outflows from actively managed funds. Are fund companies doing enough to protect themselves, i.e. launching their own ETFs?
EB: They are trying but for many it’s too late and won’t be enough to turn around the existing and coming exodus out of their mutual funds. In the next prolonged downturn – which looks like it is beginning now – they are likely to get hit with what I call the ‘triple whammy’ which is assets going down because the market is going down combined with a bump up in outflows from their largely older investors who have no time horizon left and very little loyalty to the funds given they were likely put in there by a broker who got a commission. On top of this there is a bunch of money that has been trapped in mutual funds due to unrealized capital gains. A downturn will give them the key to free themselves. It will get ugly. There will be a ton of consolidation. Bogle goes even further and predicts many will ‘mutualize’ like Vanguard although it is hard to see that and no one I spoke with agreed with it but it’s possible.
AR: You note that there will always be ‘shiny new objects’ when it comes to investing. How worked up should we get about these knowing that most money is flowing into ‘dirt cheap core’?
EB: The shiny object lane as I call is good for about 10-15% of ETF flows. Chasing shiny objects isn’t anything new, but the stickiness of the assets is. That is a direct result of the Bogle Effect. If you have a cheap beta core and then add on some high flying equity ETFs or crypto you will have much more tolerance for their volatility – and their higher fees – given your core is so expansive and so cheap. This is why the more money that goes into passive the more new ETF launches are going to get crazier and whackier. We wrote a note recently titled “Here We Are No Entertain Us: Passive Investors Crave Distractions While They Watch Paint Dry” as a way to frame this phenomenon.
AR: Bogle was ahead of the curve on so many things, but you point out that ETFs were not one of them. Despite this Vanguard ETFs played a big role in the spread of low cost, indexing. Did he eventually come around?
EB: Sort of. While he did soften as the years went on he saved his most savage language for ETFs. He had two big problems with them: trading and marketing. And he’s right to an extent, ETFs trade over $30 trillion worth of shares each year and the marketing is a huge part of the industry. That said, I think he took some comfort and even pride in the fact that Vanguard’s ETFs are less traded and less marketed. He would generally say something like “ETFs are fine as long as you don’t trade them. At least the broad market ones, all that other stuff I don’t have an intelligent comment for” I also think ETFs were tied up in his personal angst towards Vanguard and how he was pushed out of the board. Like I said, it’s complicated.
AR: The ‘world’s cheapest ETF portfolio’ is now essentially free. Is there realistically any more room for fees to fall? Or is the future the conversion of more assets to ‘dirt cheap core’?
EB: I think fees in broad equity and bond ETFs are pretty much settled at 0-4bps. I think international will come down to that level eventually. Commodities still have room to fall too. Then the fee war will spread to themes and crypto- although there is less pressure out there given how small an allocation those funds typically get in a portfolio. I think the next big area for fee compression though is the advisor business. Vanguard’s current CEO Tim Buckley literally said just that- he wants to do to advisor fees what they just got done doing to fund fees. And advisors manages $26 trillion in assets.
AR: In the book you talk about the potential for further consolidation in asset management? Yet we are already hearing complaints that Vanguard and Blackrock are already too big and wield too much (voting) power. How do you square these two observations?
EB: What’s interesting is the limit on ownership of a stock is 10% by any one fund. But this was a rule made back in the ’40s when most fund companies had one fund. Now they have complexes and so while Vanguard may be getting close to owning say 10% of Apple, its biggest fund – the Vanguard Total Market Fund – only owns 3%. So it could grow 3x before hitting that mark and Vanguard could simply launch a Total Market II Fund to begin again. Thus, Vanguard and BlackRock could get much bigger, and judging on the flows, they will. My guess is if they keep growing concerns over their voting power will induce some kind of regulation around this. We asked SEC commissioner Hester Peirce about this on our podcast and she thought active funds would have a big comeback and this would take care of itself, but I’m not so sure.
AR: Fees have been stickier in the advisory space than asset management. What will it take for a Vanguard-like pricing model to make more headway?
EB: It’s interesting, the advisory business which totally abandoned mutual funds because of their high fees is sort of where those funds were in the ‘90s. There’s a large chunk of advisors who probably don’t add a lot of value for their one percent fee and they are likely disreputable by low-cost providers such as Vanguard, Schwab or Betterment. That said, there’s high net worth advisors who require a lot of attention, advisors with strong local or industry connections and/or specialties who are probably safe. Also, advisors have relationships with their clients and so it is not as fee sensitive, but there’s a generational shift coming that I think will induce a sea change in the advisory business just like we are seeing in funds. I think asset-weighted fees will decline steadily and other models will grow such as hourly.
AR: You poke a lot of holes in the many arguments indexing has simply gotten too big. Which argument do you take most seriously?
EB: I think voting power and customer service are two of the more legit issues. It’s very possible Vanguard owns 15-20% or most stocks by the end of this decade. That’s a lot of power. I personally think they should pass on that power by letting the investors vote or poll them to find out where they stand as a group. I also think customer service is a legit issue. When you charge so little you don’t have a ton of money for tech and people to service clients who need help. Vanguard is beloved by its investors but this issue infuriates many of them. Not enough to leave but it’s something they need to fix.
AR: When Vanguard first started it had a lot of things in place to reduce trading and turnover. Many of those limits are gone, but Vanguard investors are still remarkably well-behaved. Do you largely credit Bogle with this?
EB: Yes, not only did he filter out bad money in the early days that was only going to stay in the fund for a short time and incur costs for the long-term investors but Bogle gave people something worth holding onto. This is a highly underrated point. There’s so much talk about behavior and psychology etc but all of that is so much easier to deal with when you have access to a broad index fund that charges nothing. Even when the market is in the doghouse index fund investors still feel they have best option so no need to change things so they hold onto it and keep investing. This is a far cry from back in day when people would jump from one hot active fund to another and sell low and buy high. As I argue in the book, a cheap index fund gets way too little credit for improving investor behavior dramatically. And we see this in the flows each and every downturn.
AR: Thanks Eric for your time. Good luck with the book!
*Full disclosure: Eric was kind enough to send me a copy of his book.