In an article for the Wall Street Journal that was excerpted from his new book, “Stay the Course: The Story of Vanguard and the Index Revolution,” John Bogle, the founder of The Vanguard Group and creator of the first index mutual fund asked an interesting question: “What happens if it (indexing) becomes too successful for its own good?”
That seem like an interesting question coming from the person that is uniformly recognized and respected as the father of index investing, and a champion of investing for the masses. But then, Bogle has never really been one to shy away from holding controversial opinions, or in voicing them. Indeed, the original notion of indexing – which was to simply track a broad market index, rather than trying to beat it – was so counterintuitive when Bogle launched The First Index Investment Trust (now known as the Vanguard Index 500 Fund) in December of 1975 that its initial public offering attracted only about $11 million of its original $250 million target.
Over the next decade, the picture didn’t get much better; by 1984, the fund on averaged about $16 million per year in new cash inflows. When I got my start in the mutual fund industry at Fidelity Investments in the early 1990’s, I was convinced that indexing was a silly way to invest. The attitude that Fidelity’s own founder expressed in 1976 when observing the lackluster response Bogle’s IPO inspired still resonated: “…the great mass of investors are (not) going to be satisfied with just receiving average returns. The name of the game is to be the best.”
Since that time, however, index fund assets now total more than $6 trillion. The Vanguard 500 Index fund as of this writing now holds more than $450 billon in assets under management, and Vanguard has grown to become the largest mutual fund company in the world. That would seem to vindicate Bogle, and certainly has cemented his place among the pantheon of the most significant and influential money managers in history; so why is he now criticizing the vehicle that built his fame and his fortune?
The issue is the sheer size, not only of index funds, but mutual funds in general. Bogle estimates that the total holdings of index fund represents about 17% of the total value of the U.S. stock market, while he estimates the combined assets of index and actively managed mutual funds at more than 35%. Most observers and analysts predict that the percentage of corporate ownership by index funds will only grow over the next decade, and Bogle seems to think that it is only a “matter of time until index mutual funds cross the 50% mark.” That could put the three biggest index fund companies, including Bogle’s own Vanguard, in control of 30% or more of the total U.S. stock market, which he asserts would give them effective control of the entire market. It’s hard to see under any circumstance how such a concentration of wealth and power would serve national or average investor interest.
What is the solution? Bogle suggested some tentative steps, some of which seem more practical than others. The most likely, and perhaps most constructive step could be to put federal regulations in place that establish and specify the fiduciary duty of index funds and other institutional investors to vote solely in the interest of their fund’s shareholders. To date, this has always been implied, but Bogle asserts that it should be made explicit, with appropriate penalties for violations.
If you’re among the millions who have benefited from the low-cost, passive model of index investing, you might wonder what the big deal is, or why anything should change. The problem really lies in allowing the voting power of the market to be controlled by only a few individuals, who then have the power to control the majority of U.S. public companies. This runs directly counter to the entire principle of a free, truly democratic market system. It’s something that should matter to every investor.
Personally, my investing career has been driven by the desire to take control of my financial future for myself, rather than trusting it to the inevitable ebb and flow of market extremes. That differs dramatically from Mr. Bogle’s contention, that the average investor’s best chances of success lie in passive investing, and emphasizing low-cost money management. There certainly are investors who prefer to leave the market to itself, and who only want to have to check in on it by looking at an account statement from time to time; for those investors, I would agree that the smartest approach would be to take advantage of what passive index investing offers.
I think another solution to the dilemma presented by Bogle, however lies in active investing. It is true that taking the time to educate yourself about the markets, and the different strategies that you can use to analyze the market and individual assets is a task unto itself. But if you think about it, don’t you already take the time to learn and educate yourself about any hobby or extracurricular activity you decide to take on? Learning about the market and how to invest does take some time, but it isn’t rocket science; and developing a functional, successful investing system is something that doesn’t have to take up major portions of your daily routine.
The truth is that one of the reasons the stock market has been successful at creating more wealth than any other financial vehicle is because of the democratic, self-correcting and self-regulating elements of it. I’ve long thought of the stock market as a great equalizer, because it gives everybody a level playing field to work with. Your opportunity to invest and be successful in your investments is the same as mine. That logic suggests that perhaps another solution to the problem is to encourage more average investors to consider moving away from passive investing systems like index funds and shift to more active investing strategies.
I’m not talking about moving from index funds into actively managed mutual funds; I do agree with Bogle’s contention that those funds are largely built to benefit the mutual fund company more than they are the average investor. Instead, I’m suggesting that if more investors decided to learn about the markets and develop their own investing systems, no matter how simple or complex, it would help the market move naturally away from the threat of putting control in the hands of just a few select individuals.
If regulation is needed, perhaps measures that incentivize active investing strategies and a greater level of financial education and literacy would be more constructive and beneficial in the long term than simply setting up another set of rules or another regulatory agency to try to force financial institutions to do what they should naturally. Perhaps the best way to make sure money managers do right by their clients is to make it easier for those clients to explore their options, increase their financial literacy, and make their own investing decisions. Instead of regulating management activity, incentivizing active, individual investing could force those same money managers and institutional investors to focus on doing the right thing in order to survive.