It was in the early 1990s, after three or four years as a correspondent at CNBC, that it became obvious to me: the vast majority of active managers rarely beat their benchmarks.
Sure, there was Bill Miller (Legg Mason Value) and Peter Lynch (Fidelity Magellan Fund), but they were distinguished by their rarity: they were famous precisely because it was so rare for anyone to outperform for more than a few years.
That was when I became a Jack Bogle disciple.
It was not just that active managers didn’t outperform. A large part of the problem was the high expenses. Even into the early 1990s, it was not unusual for mutual funds to charge 1.5 percent per year, or even more, for “active management.”
Bogle’s central insight was that money managers were almost never worth their high fees. In 1975, he created the first index fund built around the S&P 500 which initially operated under the name First Index Investment Trust.
It attracted $11 million in that first year.
Bogle, who died Wednesday at the age of 89, outlined the reasons for the creation of the Trust in a 1997 paper: “The facts are: (a) most professional managers fail to outpace appropriate market indexes, and (b) those who do so rarely repeat in the future their success in the past.”
Indexing was not his only insight: he sought to outperform by keeping costs as low as possible. He said, “You want to be average and then win by virtue of your costs.”
In that same 1997 paper, Bogle outlined the essential theory of why the high fees charged by active managers were the enemy of long-term investing: “Investors as a group must underperform the market, because the costs of participation —largely operating expenses, advisory fees, and portfolio transaction costs — constitute a direct deduction from the market’s return. Unlike actively managed funds, an index fund pays no advisory fees and limits portfolio turnover, thus holding these costs to minimal levels. And therein lies its advantage. That, essentially, is all you need to know to understand why index funds must provide superior long-term returns.”
Despite his love for indexing, Bogle was never against active management. From the outset, Vanguard had many actively managed funds, including Vanguard Health Care, run for 30 years by legendary investor Ed Owens.
But even his actively managed funds were cheaper than the actively managed funds of his competitors. It was a double whammy: Vanguard attracted passive investors who simply wanted to invest with the markets, but at a lower cost, and it attracted active investors who were seeking alpha but also wanted in at a lower cost.
Bogle retired as Vanguard’s chairman and CEO in 1996 and its senior chairman in 2000. He spent much of his time after that as president of the Bogle Financial Markets Research Center, writing books and spreading the gospel of low-cost investing.
His insights, however, were not always perfect. He clashed with John Brennan, who served as Bogle’s successor as CEO from 1996 to 2008, over the rapid growth of exchange-traded funds, or ETFs, which Bogle never warmed to because he felt it encouraged too much trading and discouraged long-term investing.
Fortunately, Brennan and his successors went full-steam into ETFs, and as a result Vanguard pulled past its rival Fidelity and attracted an ocean of new investments as passive investing surged after the financial crisis of 2007 to 2008.
From those humble beginnings in 1975, Vanguard now has 20 million investors in about 170 countries and manages over $5 trillion in assets.
All this stemmed from a simple insight, again expressed in that 1997 paper: “Investors as a group cannot outperform the market, because they are the market.”
Thank you, Jack Bogle.
