Asset Management

Book Review: A Fund Management Legend Says Let's Get Back To Basics

Tom Burroughes, Group Editor, London, 10 September 2012

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A new book by industry legend John Bogle, founder of Vanguard, unsurprisingly makes the case for index investing and chides an industry for excessive complexity and short-termist behaviour.

The Clash of the Cultures: Investment vs Speculation. By John C Bogle, with an introduction by Arthur Levitt Jnr. Published by John Wiley & Sons, Inc.

RTM. Remember that acronym: it stands for reversion to the
mean. This notion, which says that if a variable like a company’s stock price is
extreme on its first measurement, it will tend to be closer to the average on a
second measurement, is one that lies behind the idea of passive investing. In
other words, abnormal behaviour doesn’t endure.

Allied to this is the idea of the “efficient market
hypothesis” – the idea that market prices tend to discount all known (key
word!) facts driving them, and that as a result, there are few opportunities to
find index-beating returns in an efficient, liquid market. Where markets are
illiquid and opaque, the EMH might not apply so much, which is where those
canny investors known as active fund managers say they can make a lucrative
difference, such as in private equity, for example.

This passive/active debate - which has been aired at
conferences put on by the publisher of this website and many others – is no
nearer to being resolved emphatically. It does seem, however, that high trading
turnover costs – or portfolio “churn” - when coupled with inability to time markets, mean that for many, the
smartest approach is the “passive” one. (By passive, one does not necessarily
mean the investor does not take a close interest in how money is earned. Far
from it. Smart asset allocation, which is said by academics to drive about 90 per cent of variation in returns, is essential.)

As a no-nonsense advocate of passive investing and scourge of
short-term speculation and finagling, few people in the asset management
industry come close to John C Bogle. A legend in the asset management industry,
he founded Vanguard, the US
firm, in 1974 and is the grand-daddy of index investing. (He also is president
of the eponymous Bogle
Financial Markets
Research Center.)
In his tenth book – he’s no slouch as an author – Bogle attacks a number of
practices. And what gets him really fired up is how unnecessarily complex this
industry has become and how end-investors suffer from this.

He is particularly concerned about the amount of churn that goes on in markets. Consider this paragraph (page 2-3): “When I entered this
business in 1951, right out of college, annual turnover of US stocks was about
15 per cent. Over the next 15 years, turnover averaged about 35 per cent. By
the late 1990s, it had gradually increased to the 100 per cent range, and hit
150 per cent in 2005. In 2008, stock turnover soared to the remarkable level of
280 per cent, declining modestly to 250 per cent in 2011….When I came into this
field 60 years ago, stock-trading volumes averaged about two million shares per day. In recent years,
we have traded about 8.5 billion shares of stock daily – 4,250 times as many.
Annualised, the total comes to more than 2 trillion shares – in dollar terms, I
estimate the trading to be worth some $33 trillion. That figure, in turn, is
230 per cent of the $15 trillion market capitalisation of US stocks.”

The 353-page book takes a tour around the history of index
funds and their development; Bogle examines what he argues are regrettable
practices in the asset management industry that enrich the professional
intermediaries but are of dubious worth to the actual investor. But this is no
mere set of sharp criticisms: Bogle spells out what he calls “Ten Simple Rules
For Investment Success”. 

Rules for investors

Here are Bogle's rules:

1. Remember reversion to the mean; 2. Time is your friend,
impulse is your enemy; 3. Buy right and hold tight; 4. Have realistic
expectations: the Bagel and the Doughnut; 5. Forget the needle, buy the haystack; 6. Minimise the croupier’s take; 7. There’s no escaping risk; 8. Beware fighting
the last war; 9. The hedgehog bests the fox; and 10. Stay the course.

This all seems pretty smart advice (readers will have to buy
the book to understand what is mean by lesson 4). Of course, Bogle’s advice to
investors is not going to end the passive/active debate - he’s
been staking his case for over half a century and is realistic enough to know
that the marketing departments of fund management houses will be unfriendly to
some of his views. But investors can get the message.

Indeed, that message may fall on more fertile soil in the wake of the
2008 crisis. Wealth managers have to be more transparent than before about
their fees, due to developments such as due to the UK’s
Retail Distribution Review programme and a push in the US for a
uniform fiduciary standard (still very much a contentious issue at the time of writing).

Bogle is a believer in the free market system, but
feels that capitalism needs to be saved from some of its less considerate
practitioners. It is a wise stance to take.

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