Wed, 29 Oct 2014
Vanguard founder John Bogle on strategic beta, alternatives, and narrowly focused index funds.
Benz: I'd like to get your take on some of the big trends that we've seen either in terms of fund rollouts or in terms of where investors are putting their dollars. One of the biggest buzz terms in the industry these days is strategic beta or a smart beta. What's your take on that particular phenomenon?
Bogle: First of all, what the devil are they talking about when they say smart beta? I think it was Bill Sharpe who said smart beta is stupid; and I think he is right, by the way. It's just another marketing gimmick with an easy tag. We all want smart, don't we? But it's what this industry has been selling for a long time: management that will give you better performance. And I just don't see that there's anything there except a big claim to be able to do better. Most of it is available through ETFs, because that's the easiest entrée into the mutual fund marketplace today by far. So, I'd say if anybody can explain it to you, find out that before you reject it.
Benz: Do you think investors could reasonably tilt their portfolios? There is certainly a lot of long-term data that points to small-cap value stocks outperforming, for example.
Bogle: Well, it's not going to hurt them in all likelihood. But if you look at the long sweep of data going back into the '20s--and, of course, data are suspect--but there are long periods, 20 years or so, when large do better than the small and when growth does better than value. In the long run, it is correct, if you believe the data, that value does better than growth and that small does better than large.
But I'm of the school that says, if that is proven--and it is, I think, a little bit in the marketplace--if it is proven to be the case, then people will bid up the prices of value stocks and bid down the prices of growth stocks until they reach an equilibrium and then future returns will be the same.
So, I wonder first about the data; second, about trying to rely on something that happened in the past as a forecast of the future. So, I don't think you need to do it. It's not going to be awful. The fundamental thing: It's all the same stocks; it's just the different weights. It's the S&P 500. The Jeremy Siegel dividend thing. There is nothing awful about them. But I would rather bet with the whole market and be guaranteed of my share of the return than bet with either of those two funds: RAFI 1000, I think it's called, and the WisdomTree Dividend (DTN). I'd rather bet that they will do better--because they may do better or worse--and I'd just as soon go down the middle path. It's cheaper. And I think you will be very well served in the long run.
Benz: How about alternative investments? This is a category of investment types where we have actually seen very strong flows over the past few years. I'd like your take on whether such investments are appropriate for most retail investors.
Bogle: Well, the problem is that, first of all, there are a whole lot of different investments. I'll take the easy one: commodities and gold--gold being just another commodity. When you buy it, it has no underlying intrinsic value. Stocks have dividend yields and earnings growth. Bonds have interest coupons. Gold and commodities have nothing. There is nothing to support them other than when you buy one, you are saying, "I think I can sell it to somebody else for more than I paid for it." There is no better definition of speculation than that.
So, no. Hedge funds, I think they have had quite a comeuppance. But whether they are good or bad ... And very few of them are hedged--people should understand that--that is to say, totally market-neutral, half long, half short. That was the original idea, and they are doing very speculative strategies, very short-term trading. They think they are helping price discovery, and they probably are.
But when more and more people get into that game, the markets become more and more efficient and, therefore, more and more difficult to beat. And there is also this big marketing thing. But most of all, in hedge funds and private equity, too, there is a huge selection premium. There are a couple of thousand hedge funds out there. Which one do you pick? And if you say, "Well, I am going to get a hedge fund of funds." Then, you are paying another couple of 100 basis points, and that's never going to work. Well, it may work for short periods; but in the long run, this none of this will work. It's just too expensive to give you the market return. And we know that they all can't win, any more than any group. There's no strategy out there that always wins, no group of managers that always wins. So, I think it's a risk not worth taking and, yet, the federal government seems to be making it easier and easier for people to get into these kinds of things, advertising and so on.
So, I'm straight down in the middle, capture the returns delivered by bonds, capture the returns delivered by the interest coupons delivered by bonds, capture the dividend yields and earnings growth captured by stocks. And then forget it until you retire.
Benz: Another area where we've seen a lot of investor interest as well as a lot of product launches is in the indexing space. Investors appear to be heavily favoring indexed products over actively managed products. What's your take on that trend? I think that, in a lot of ways, it's very much a vindication of the things that you've been saying for many years. But I'd like your take on some of the more narrowly focused investment types that we've seen crop up under the banner of indexing?
Bogle: Well, there is certainly an odd group of index funds out there. Most, but not all of them, are in the ETF, as they would say, space. And something like triple leverage on the S&P 500 and bet on whether you think it's going to go up or down. It's just absurd. Only a nut cake or a fruit cake would do that. Then, we get narrower and narrower segments--for instance, cloud computing, at the very beginning of the ETF craze. There was emerging cancer--
Benz: I remember that.
Bogle: --which struck me as kind of an unfortunate name. The turnover rates of ETFs in this marginal way are quite high. But there was a speech I gave some years ago in which I asked, "How is it possible that just as actively managed funds are becoming more and more like index funds, index funds are being used more and more like actively managed funds?" So, people still have advisers who the trade back and forth in ETFs (or they are doing it themselves), and I think that is a way to lose.
Now, this is a booming business, but it's kind of a fake business when you compare it with the mutual fund industry because about 50% to 70% of all these ETFs, particularly things like the SPDR, even higher, are owned by financial institutions. And they are trading. They are going long, and they are going short. They are speculating. The daily turnover, as I mentioned earlier, $160 billion in five days on a $160 billion fund is really intolerable. And if you look at the most active funds in the market: At least 85% of their volume is in the ETFs, the ETF NASDAQ Cube [QQQ]--I guess it's called--the small-cap ETF, the emerging-market ETF, and of course, the S&P 500. So, it's really irrelevant, in a way, in the industry. It's really not part of the mutual fund industry as an investment for families to build their wealth for retirement.
Benz: Jack, thank you so much for being here. It's always a tremendous privilege to hear your insights on so many topics related to investing.
Bogle: Thank you. It's fun to be with you.