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Charley Ellis: Why Active Investing Is Still a Loser's Game

The prolific author and investment consultant weighs in on whether indexing has gotten too large, Vanguard's foray into private equity, and the spots where active management might still work.

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Our guest on the podcast is investment consultant and author Charley Ellis. In 1972, Ellis founded Greenwich Associates, an investment consultant to institutional investors, government organizations, and wealthy families. His seminal book about the benefits of passive investing, Winning the Loser's Game, is in its seventh edition. Ellis has also authored or coauthored books about investment policy and strategy, the retirement system in the United States, and large investment firms, including Goldman Sachs and Capital Group. He has taught investment management courses at the Yale School of Management and Harvard Business School and was the successor trustee of Yale University, where he chaired the university's investment committee with David Swensen. He also served on the board of directors at The Vanguard Group. Ellis was awarded the Graham & Dodd Award of Excellence from the Financial Analysts Journal and is one of only 12 people recognized by the CFA Institute for lifetime contributions to the investment profession. He received his undergraduate degree from Yale College, his Master of Business Administration from Harvard Business School, and his doctorate in financial economics at New York University.

Background Charley Ellis bio

"The Loser's Game," by Charles D. Ellis, Financial Analysts Journal, July/August 1975.

"Words From the Wise: Charley Ellis on Challenges Facing Investors," by Antti Ilmanen and Rodney N. Sullivan, AQR Insights, June 5, 2015.

Passive Versus Active Management "How to Decide Where to Hire Active Managers," by Alex Bryan,, April 8, 2020.

"Index Funds Aren't Too Big, but Asset Managers Might Be," by John Rekenthaler,, Jan. 17, 2020. "The Secret History of Index Mutual Funds," by Stephen Mihm, InvestmentNews, Sept. 6, 2016.

ESG Investing "David Blood and Al Gore Want to Reach the Next Generation," by Imogen Rose-Smith, Institutional Investor, Sept. 8, 2015.

"The ESG Fund Universe Is Rapidly Expanding," by Jon Hale,, March 19, 2020.

Private Equity "Vanguard Moves Into Private Equity With HarbourVest Partnership," by Chris Flood, Robin Wigglesworth, and Richard Henderson, Financial Times, Feb. 5, 2020.

"The Cons (and Pros) of Vanguard's Decision to Offer Private Equity," by John Rekenthaler,, Feb. 25, 2020.

"Fran Kinniry: Applying the Vanguard Approach to Private Equity," by Christine Benz and Jeffrey Ptak, Morningstar's The Long View podcast, April 1, 2020.

"SEC Looking to Open Private Markets to a Wider Audience," by Hazel Bradford, Pensions & Investments, Oct. 28, 2019.

David Swensen/Yale Endowment David Swensen bio


Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar, Inc.

Jeff Ptak: And I'm Jeff Ptak, global director of manager research for Morningstar Research Services.

Benz: Our guest on the podcast today is investment consultant and author Charley Ellis. In 1972, Charley founded Greenwich Associates, an investment consultant to institutional investors, government organizations, and wealthy families. Prolific author Charley's seminal book about the benefits of passive investing, Winning the Loser's Game, is in its seventh edition. Charley has also authored or coauthored books about investment policy and strategy, the retirement system in the U.S., and large investment firms including Goldman Sachs and Capital Group. He has taught investment management courses at the Yale School of Management and Harvard Business School and was the successor trustee of Yale University, where he chaired the university's Investment Committee with David Swensen. He also served on the board of directors at The Vanguard Group. Charley was awarded the Graham & Dodd Award of Excellence from the Financial Analysts Journal and is one of only 12 people recognized by the CFA Institute for lifetime contributions to the investment profession. He received his undergraduate degree from Yale College, his MBA from Harvard Business School, and earned his Ph.D. in financial economics at NYU.

Charley, welcome to The Long View.

Charley Ellis: Glad to be here.

Benz: Your famous paper "The Loser's Game" was published in the Financial Analysts Journal in 1975. In it, you wrote that gifted, determined, ambitious professionals have come into investment management in such large numbers during the past 30 years that it may no longer be feasible for any of them to profit from the errors of all the others sufficiently often and by sufficient magnitude to beat the market averages. Fast-forward 45 years since you wrote those words, would you say that challenge for active management has gotten even harder?

Ellis: Oh, yes, much harder.

Benz: What are the main factors that you think are working against active managers today?

Ellis: Well, to start with, most of us really have thought all along that the best way to describe fees would be "low" and" only," as in, "only 1%." Actually, that's not true. Because if you look at it the way we have traditionally looked at it, it's accurate, but it's not really true. The reason it's accurate is that fees are not the only cost. You also have the expenses of operations, the expenses of taxes, and so on. And if you make a comparison to index funds with the same target, what you find is that 85% of the actively managed funds are not able to keep up with their target, which is a terrible shortfall. And if you look behind that to say, Why in the world would it be with so many talented people working so hard--long hours, long weekends, long nights, reading, studying--they're doing everything they possibly can, they get the most wonderful technology. It's just amazing how good the technology is in the investment management and securities industries. And they've got unbelievable flows of factual information. And they get that access right away. And if they want to go back and look at history, all they have to do is pick up their Bloomberg terminal and go to work on connecting any set of data they want with any other set of data to see if there's some significance there. It's just wonderful.

So, if the question you have on mind is, Could I find a really good active manager? The answer to that is, "You bet, it's easy." However, and "however" is the part that is just stunning, it's so darned easy to find really gifted, hardworking, talented, and well-armed, and well-informed investment managers that it's almost impossible for them to outperform the market--that they chose for organizing the way they wanted to be organized. And since I know so many of those people are truly wonderful--and of course, they're hardworking, and of course, they've been successful in virtually everything they've always done--it's really hard for them, particularly when they're so well-compensated. It's really hard for them to give up on the notion that they're going to win that game. And we all enjoyed watching Rocky run up the steps to the Museum of Fine Arts in Philadelphia. But that was a movie. And we're talking here about real money, which most people will put aside for their retirement security, help their kids get off to a really good college education, help their kids buy a home, buy a home for themselves, all kinds of important reasons. So, it's not a flight of fancy. "Let's run up the stairs and cheer at the top and let's get into really good training and then we'll go out and beat the other guys." It’s "be realistic, pay attention to what's going on, and then go down through the cataclysm or category of different specific things that have changed." And if you'd like, I can give you a quick review of some of those because it's really interesting when you add them all together.

Well, I'd like to make a comparison because I'm in my early 80s now. I tend to think in terms of, well, let's go back to the early 1960s when I came out of business school, wildly interested in the investment world, and had wonderful opportunity. What's changed? Well, because I was working for the Rockefeller family and they were very good at venture capital and particularly interested in technology, they had the first set of Scantlin Electronics devices. It looked like a large adding machine, and you could on the keypad type in a stock exchange symbol, and it would print out on heat-sensitive tape what was the high price for the day, low price for the day, last price, and the total trading volume. It was magical. Because then you don't have to pick up your phone and call a broker and say, “Do you remember the last time you saw the price of General Motors or IBM or AT&T?” You could find it out for yourself. And you could do 10 stocks in a row, 30 stocks, whatever you might want in the way of accurate information.

We've come a long way from those days. When I was first getting started--again back in the early ‘60s--we all had slide rules, and they were important to have, and we needed them, and it was part of the play. And trading volume on the exchange was, in a good day, 3 million shares. Business volume had picked up enough. So, Saturday morning trading had been dropped, so that people could have a nice weekend and just work the five days. There were all kinds of advantages in terms of information. If you wanted to go to a luncheon, or a breakfast, or a dinner with a group of five, six, or seven other people, you could be talking to the executive vice president, the president, chairman of the board, vice president, or whatever of any major corporation as they're trying to give you information because everybody wanted to be sure their stock was at least fairly priced. And most companies felt that their stock was a little bit underpriced at the time. And that was just the beginning of half a dozen firms that have gone out and started doing fundamental research in-depth. Until then, it was S&P tear sheets, two sides, give you the history, and were revised every six months. But now for the first time, you could get research from firms that had very bright people who have gone to business schools and learned a lot who were able to provide you with 10-, 20-, 40-, 60-, 80-, 100-page reports on companies that they were following, and then companies were wonderfully forthcoming with information. So, just the beginning of being able to have access to really good research.

Trading volume in those days, 3 million, 90% of it was done by individuals who did a trade every year or two or three. Usually about half their trading was done in AT&T common stock because that was the most popular. They usually traded in odd lots. And candidly, they were not very hard competition. Well, reverse that and look at what you've got going now. Trading volumes of 6 billion, 8 billion, 10 billion, not million, billion, a thousand times or 3,000 times as much volume of trading, and that leaves out the whole derivatives business, which is actually larger than the cash market. And you look at what's the mix of trading now. Well, it's not 9% or 10% institutional. And even then, when the 9% or 10% institutional, most of that was regional bank trust departments because we didn't have statewide banking those days. And a city like my hometown of New Haven had four trust companies, none of them very profitable, but they were providing an accommodation service to their regular customers, and so it was considered good form to have a trust department, and who was making the decisions? Guys in their 60s who, after a long and distinguished career, prudent judgment, and so on, were serving on the Investment Committee, and they met once a month, and they approved changes in the approved list. And it might be 30 different stocks, all of which were blue chip by name and reputation, had good dividend yield, and easiest to own for the long term. Those are really interesting phenomena back then compared to what do you have today.

And now, you've got 99% of trading is done by institutional investors. You think about it. 99% of trading. That means virtually every time you buy, you must be buying from a professional. And every time you sell, you're selling to a professional. And as I suggested earlier, what's happened to the professionals? They've got better and better and better and better. It's been a Darwinian process. So, now you've got tremendously talented people, almost always, terrific technologies for doing any kinds of mathematics you might want to do, wonderful information flows, and they're in there all day every day doing comparison shopping, trying to make the right sorts of decisions. And they've had considerable experience, and they've earned a CFA degree. There were no CFAs in the early 60s--the concept (hadn't been) been accepted. And look at the changes. And every single one of them has been … Take one. Regulation FD for fair disclosure means that SEC has that any publicly owned company must make a diligent effort if they give anything in the way of information that might be useful from an investment point of view to any one person, they must make a diligent effort to make that same information available to every investor. Use Twitter if you want to or other vehicles of communication, but make a diligent effort to spread it around. Well, it was nothing like that back in the early 60s, it was private meetings in series, sometimes two or three meetings, sometimes 15 or 20 meetings, meet with all the division managers. It was amazing how much information you would get that was not available to anybody else.

So, are you armed in a different way? Sure. What happens when you put in Internet, Bloomberg terminals, and you say, "I'm going to make it so that every really large securities firm will have between 500 and 600 analysts working in offices all over the world covering industries, economies, companies, and they go after companies in their own region, and then you add demographers and accountants and government regulatory experts. And all of a sudden you realize there's a huge crowd of people doing everything they can imagine collectively to serve the interests of anyone who's an active investor in the professional group. So, good work. What a bunch of changes that has made. And you have to have expected that that would have a big consequence. And then, you look at the end result data and then, as I said before, over a 10-year period 85% of actively managed funds fall short of what they chose as their benchmark. And when they fall short, they fall short by a great deal more than those who happen to win by. And if you say, "Well, I'm going to take the 15% that do well--that they ought to be some pretty good guys there." They're talented people. But what you'll find is about 85% of that 15% will fall short in the next decade. So, as I say, it's tough out there.

Benz: You referenced Regulation FD, and investment firms would tell us that that wasn't a big deal to them--that it didn't really change their world. Is that true, do you think?

Ellis: I think it changed the world as I knew it in the early '60s. By the time it passed as a regulation, I think so many adjustments had been made towards its being passed that it wouldn't have made a big difference. Well, it depends on how you ask the question.

Ptak: So, one of the things that I wanted to ask you about, Charley, is competition. I think that one of the points that defenders of active management have made is that, as investors rushed into index funds, it would make it easier for active managers to add value.

Ellis: Sure, I love that thought.

Ptak: Yeah, and what we've seen is probably the opposite. And so, I wondered if you could, having reflected on your long and distinguished career and having seen these trends played out, explain why you think that's so and what that might augur for the future?

Ellis: Well, there are two different parts to explain. I've just been doing an explanation of why I think the changes have been so unbelievably powerful. That's my idea of what would be the explanation. Another explanation is, Could I explain why people hold on to the beliefs that they hold? And for that, I think you have to go to the behavioral economists who will all tell you. If someone's income and it's substantial, and their way of life and it's lovely, are dependent on believing something, chances are pretty high they will believe it. And there's never been a line of work as well compensated or as much fun or as interesting or as perpetual learning as investment management. Candidly, most of my best friends are involved in active investment management, and they're wonderful people. So, who wouldn't want to be part of that group? That's the part for me much, much harder to explain other than just: Here's what behavioral economists say.

Benz: Charley, Morningstar's data on the success rates of active managers does show some variation by category. In categories like large blend, fund managers have a tremendously difficult time in beating their benchmarks and surviving, which is how we define success, whereas in categories like emerging markets, they seem to have a better shot. Are there any asset classes or categories where you might say, "OK, you can reasonably opt for an active manager," and then others where you would say, "Absolutely index all the time" based on the data that you've seen?

Ellis: Sure. The easy answer to the first part is China, because the Chinese market is still dominated by individual investors. And it's amazing how individual investors in China are very attracted to seeing a stock price going up and saying, "I know what's going to happen, it's going to go up again the next day." And so long as you've got a substantial number of amateur or retail investors, who are governed not by rigorous logic and quantitative analysis and objectivity, but are working on a more spiritual, emotional, and sometimes visual basis, then you've got an opportunity. Because if somebody is doing their activity and trading for reasons that are not appropriate to what a skillful stock market practitioner would do, skillful practitioner is going to have a really good opportunity to do better than that particular individual or to that market that's dominated by individuals. And best recollection is that the Chinese market is between 30% and 40% institutional, which means it's still dominantly individual. So, that'd be the first and best answer because it's a large and growing market. There are a lot of really interesting companies because the Chinese population has tremendous entrepreneurs and some very exciting companies inside it. And there's a lot of dynamics. So, if you were really well informed and rigorous in your work, that would be a terrific place to be an active manager.

I think when you say, the emerging markets is terrific, if you went back 15 years ago or 20 years ago, absolutely, emerging markets would be very much so. But so many people have gotten involved in the emerging-markets stocks that most people would be comfortable buying from overseas--Americans buying them, for example--they're pretty close to efficiently priced. It's not that it's as tight as it would be with large-capitalization stocks in the United States or the United Kingdom. But it's close enough so that I wouldn't want to make an effort in that direction at all.

And if you get to one answer to my proposition, or one response is to say: You're really talking primarily about the thousand largest companies in the world, maybe the 1,500 largest companies in the world. What if you went down to much smaller companies, and you're really an expert in the industry, and you had spent 10 or 15 years analyzing the companies, getting to know them, and you were diligent in your work, and you were trusted by the companies to be able to give good feedback as to what they might think about doing--because these get to be fairly small companies--if that's what you're working on, do I believe active management could be successful? I sure do. Hugely successful? No, I really don't, but reasonably successful. And to give you a more specific answer, if you said, “How would you design that sort of an organization?” Get six, eight, maybe a little more, but probably six or eight would be enough, really gifted analysts who've happened to have done very well financially, so they're going to put their own money on the line with everybody else in the firm. And one partner who has got deep pockets and is going to put his private capital on the line. That's going to be an investment management unit that has talent, experience, skills, and is operating in a level of the market where the competition candidly is not very good and not very frequent. There I think you've got another opportunity. But finding such firms is, candidly, really difficult. Finding those firms as an outsider to the industry would be, I think, almost impossible. But I do believe they exist. And I do think they're likely to be fairly successful. It would be also very helpful, if you didn't mind if they had quite unusual patterns of success, a great year, and then two or three not so great years, and then a great year, that sort of thing.

And then, the last answer to your question on the same would be: Jim Simons Renaissance Capital has obviously done exceedingly well with a whole bunch of mathematicians, roughly 100 mathematicians. And Jim, of course, is a brilliant person himself. And they have periods when it looks like they're just a complete failure. And then, they have other periods when it's just unbelievable how well they do. But they're doing something completely different from what anybody else does. And if you looked at their performance over time, most people that I know would say, "You know, it has worked really well for them. But I don't think I would be comfortable with that kind of a feedback pattern, and I don't think I would be willing to work with them. And so, I can't consider them as a candidate for me as an individual." And I can understand that. But I could also understand somebody, particularly somebody who's really good with mathematics, saying, “These guys have got a really gifted game. They're playing a game that nobody else is playing--almost nobody else is playing. They play it exceedingly well. Looks like they're going to be successful.” It sure has been successful. So, that's another possibility. But you're talking about only way to be successful is to be clearly an outlier, where the rest of us don't have very much in the way of experience or methodology for evaluating how well you're doing and whether we want to stay with you or not.

Ptak: I think you touched on a couple of the paradoxes of succeeding with active investing, which is that, you know, success can be lumpy, right? It doesn't happen consistently like clockwork over time. And then, you have to look really, really different. Can you talk a little bit more about that, and maybe in terms of how an investor who's really committed to active investing and trying to succeed with it, the kind of expectations you would want to set with them to know what they're getting themselves into if they truly want to commit themselves to succeed with it?

Ellis: I'll try, but honestly, I think it's very, very hard to give anybody a package of "If you will do the following, you might very well be successful in the selection of active managers." First, you would have to have developed an exceptionally independent way of thinking. It probably would be helpful if you had one or two very close-in colleagues because if you're a very independent thinker, you may be doing "too independent" and go off the deep end. But very independent thinker. You'd have to be exceedingly good in quantitative analysis. And you'd have to enjoy the game that includes long periods of nothing going on. So, deer hunter skills would be appropriate. Or maybe deep-sea fishing would be appropriate. But long periods when there's nothing going on and not needing to do something. You'd have to be very, very self-disciplined, so that when you did make a mistake, you would catch it fairly soon, and when you had made a mistake, you would stay with your process long enough. These are really tough criteria, and I'm having a tough time coming up with other criteria that might lead to a real success.

Ptak: That's understandable. I'm curious, though, just given the way the industry has professionalized itself, so to speak, knowing that success comes in bunches, and it doesn't happen like clockwork exactly as you described. Why do you think conventions like looking at a fund's 12-month or 36-month returns and make a judgment--and we're talking about very sophisticated Investment Committees and others that control capital--why do you think they continue to cling to methods like those which are almost destined to fail, wouldn't you say?

Ellis: I think the word sophisticated, if you ask me to reflect on Investment Committees I've had acquaintance with, there often very large numbers of highly sophisticated people serving on the committees, who are not very sophisticated about investing. And there's a huge difference from that sort of an Investment Committee to an Investment Committee made up of people who are deeply rooted in, and experienced in, and sophisticated about investing. When you say, "Let's get the real leaders of this organization--maybe the president, the chief financial officer. Let's get some of the major donors to this institution. Let's be sure we've got at least one lawyer. Let's get some people that we know." All of a sudden you get pretty quickly into wonderfully talented people who just don't happen to be experienced in contemporary investment management. People, I think, would give you the hardest time about being successful would be people who had experience in the '60s and '70s with investing and thought they understood it. And they did understand it back in the '60s and '70s. But the world has been made so different by this transformation from amateurs dominating to professionals overwhelmingly dominating, and the professionals being so unbelievably talented and so wonderfully high-skilled, that's really hard.

Benz: You've said that one of the key things to look for in an investment manager is character. What did you mean by that, and how can one identify or gauge character?

Ellis: Oh, I feel very strongly about that. I'm glad you asked. When I talk to my friends who are on Investment Committees, they agree, yeah, that's the most important single thing going. It's, if you don't mind my being a little autobiographical, when my father-in-law wanted to check me out, I didn't know exactly what this experience was going to be like. I'd never met him before. But I was driving up to his daughter's home, and I was thinking to myself, "He's a very senior-ranking naval officer. He was two-star admiral. He was commanding officer of the John F. Kennedy when it was the most powerful warship in the world. He set a record for at-sea at-night carrier landings because he was a flyer and a very talented flyer. He was called the Bald Eagle because in the Navy, whoever is the oldest active duty flyer is the Bald Eagle. This is a very formidable guy, a kind of guy that had not told his daughter until she was going off to college and it came up with a conversation somehow that he'd been All-America at Annapolis." I was an E4, which is an enlisted man, I was in the Army. And you know, the Navy's always looked down on the Army. Any officer would know that an E4 is a very low level of enlisted man. I don't think I'll play my military card.

And about that time, I arrived at the destination. We had a lovely conversation for about 10 minutes with my now-wife and her parents. It just couldn't have been more charming. And her father looked at me said, "You know, I think you've got something rather more important to talk about. Why don't you and I go in the next room and just sit down, and we'll talk man to man." So, obviously, off we went. And when we sat down, he said, "Well, tell me about yourself." And there's this dreadful silence. And so, I filled in the silence, as you have to do. Then, when it was all over, he had been pulling my chain the whole time. He just wanted to test me out, man to man, and it was, in retrospect, great fun. He said, "You know, I know what you want is my approval to marry my only daughter." He shook his head and said, "I can't give it to you. I'll tell you what I will do. I'll give you a temporary, partial, conditional, non-negative, and we'll see how it goes from here." Then he burst into a big smile. And I realized this has just been a marvelous pull-your-chain experience from his point of view. And I'm very fond of him. And after he died, his wife kindly gave me his wallet, and I carry it as a reminder that my responsibility to Fred Koch is to be darn sure that I take care of his only daughter.

Now, what was he doing in that conversation? First of all, he's having some fun. And I like that. And the second thing is: He was finding on who I was and what I'd been doing because I had to fill in the blank. But the real answer is: He was looking for the one thing that would really, really, really make a difference. Character. Would I be a good friend for his daughter 10 years later, 20 years later, 30 years later? Would I be a good co-parent? Would I be a good provider or at least do my best I could in that direction? Would I be someone she could trust? And when she was having a difficult time, would I be the first to say, "Let me help"?

And there is no right answer to how do you figure out somebody's character. But if you get them to open up and you pay close attention to what you're looking for is character, and you do your reference checks, which he didn't do, but that would have been impolite, I suppose. But you can these days do quite a lot of serious examination of what's going on. You can learn a lot about character and values and trustworthiness. And candidly, the non-negative of really good character is so important that it overwhelms the possibility of doing "better than the market." Because as you know from your own experience, most investors do worse than the market, and when they do worse, they often do worse not because of their own mistakes--which are plenty, and there are lots of those, we could get into that if you want to--but because of the mistakes that managers make of letting themselves pay too much attention to the business side instead of the professional side of their work, letting the assets under management get too large for them to be able to handle it the way they're doing. When they get to be very large organizations, they typically choose as their leaders, organization leaders, people who are skilled in business management more than investment management, and those kinds of things, not doing it, not being tempted, being able to say, "No, I'm not going to do that," as the owner of a firm or the leader of a firm, that makes a tremendous difference to how the long-term success or failure of your clients works out.

And if you look back over the last 20, 30, 40 years, which of the firms that have done really well, year after year after year after year, I promise you that the single governing characteristic is character. And some people call it culture. That's fine by me. Some people call it integrity. That's fine by me. But it's one of those key words that describes what we all look for in President of United States; what we all look for in leader of our companies; what we all look for in the people that our kids marry. So, it's really worth all the time and effort and attention that it takes to learn it.

Personally, as you know, I had a long wonderful 17 years on the Yale Investment Committee working with and for David Swensen, and I think it's one of the most beautiful experiences anybody in the investment world could possibly have to get up close and see exactly how they've done it. And one part of it was when due diligence was on for an investment manager, the quality of their digging, backgrounding, backgrounding, backgrounding, digging was at least as high, I would say, higher than we usually have in this country when the President of United States is considering somebody for Secretary of Defense or Secretary of Treasury. They go into any possibility that there might be any difficulty anywhere. Same sort of thing for Yale's investments and the same sort of thing, I believe, is the single best investment the client can make in getting a great relationship with an outstanding investment manager.

Candidly, if you said, "I have to get somebody who's smart"--that's so easy. There is a lot of really smart people. Even worse than that, there are a lot of really smart people, and some of them don't have anything like character. They're really terrible. Bernie Madoff was a charming guy and very bright, and he had terrific connections. And he was the SEC's go-to-person for complex questions about the securities industry, a marvelous person in so many ways, and probably the biggest skunk or a cheat or a crook, any of us know about.

Ptak: This is the same as character. But one of the things that we're seeing the Street peddle these days is values, ESG. And I'm not using those terms pejoratively--that has become a very popular category of the investment management world. I was curious what your take is on that niche and the way you see it being embraced by asset managers and investors alike?

Ellis: Well, we all know that demand creates supply. And there is a lot of demand, particularly in universities or public funds, where there is a social dimension that's rather large and important. So, that's probably the driving force, is that kind of demand. And if it's out there you might be able to sell something into it, it would make sense to think seriously about, Is that a skill set that you could develop? And it's not terribly complicated to develop that skill set. So, I think that makes it relatively easy to offer to provide supply.

I think if you did it the other way around and said, Are there investment managers who came to believe that was the right way to invest for the long term, and then developed a capability and brought it to the marketplace--then you get much smaller number. And candidly, I would turn to generation, cheerfully known by its nickname, Blood and Gore, because it was set up by Al Gore and David Blood, who had been longtime partner of Goldman Sachs and very, very able, truly wonderful human being. And that two of them jointly figured out that if you did invest in companies that were systematically and unrelentingly doing "the right thing," they did have a comparative advantage. They tended to attract a higher grade of talent to work in the organization, they tended to have a higher set of enthusiasm within the organization, people were happier working longer. And they tended to make slightly better decisions.

And over time that has proved to be a very successful criterion for that organization, then they've turned into a superior record that's been terrific to see. Yep, it does, in fact, work. And same thing is true, I think most of us would believe, a really high-integrity corporation does attract better people and does keep people who are really good for longer time and doesn't make mistakes and doesn't get into difficulties. It's because they're always on alert for what could they do to make themselves better and better and better. Doing the right thing really matters.

So, I think it's a perfectly sensible case for it. But I do think we all ought to be careful that when the word gets out that there is real demand for x or y or z, the supply will come up, too. Look to be sure that the supply was going to be there for internal reasons, not for sales reasons.

Benz: You were talking earlier about firms putting stewardship over salesmanship. Let's talk about how firms are structured. Jack Bogle used to say that firms could not serve both sets of stakeholders well, that they couldn't serve their owners as well as their fundholders well, and the only structure that was acceptable that didn't have an intractable conflict of interest was the one that Vanguard had. Do you think it needs to be that black and white?

Ellis: No, you have to remember Jack was a wonderful person and did a lot of things that were really good for a lot of people, particularly the work that has now come out through the Bogleheads. It turned out to be a very nice thing, and I think you guys at Morningstar were terrifically important for getting that up and going. It has made a real contribution to the well-being of large number of people. But those were not, candidly, unique beliefs, having taught Investment Management at Harvard and at Yale, and then at the Princeton Summer Program for the profession. These are metrics or disciplines that come up all the time, all the time, all the time. So, they're widely accepted as best practices. And I think they should be.

Ptak: I wanted to go back to indexing for a moment, if I may. And I guess it's the notion that somehow indexing could become the victim of its own success if it becomes too large. There has been some sabre rattling that's gone on suggesting that if indexing were to become too big a part of the market, regulators would need to step in or otherwise intervene. Is that something that you think passive fund investors should concern them with, or is that just sort of a part of the journey that they'll be on?

Ellis: Well, first keep in mind that many people for long, long time have been making rude remarks about indexing. And the word passive is one of their most successful rude remarks. The reason passive was used at the very beginning is that the first work on indexing was done by Mac McQuown and a group of very bright people working at the Wells Fargo Bank. And they were all electrical engineers and mechanical engineers. And if you look at a socket and a plug, you'd say the socket is the passive receptacle and the plug is the active. And so, from an engineer's point of view, there is no emotional connotation between active and passive--it's just "this is one device, and this is the other device and the two work together quite nicely."

So he said, "Who in this room," and assume a very large group of people, "Who in this room would like to be introduced as 'this is so and so, he is passive'?" Then nobody raises their hand, and most everybody smiles a little bit, and he said, "Who uses their criterion for electing the next President--He's passive?" Nobody. And then he said, "Who would like to raise passive children?" And pretty soon people realize they don't want to have passive anywhere near them. Yet, that's the way--so I always use the word indexing because it's accurate, descriptive, and it doesn't have a pejorative connotation. If you said, "OK, we'll give you that on semantics, Charley, they still want you to answer the question."

Is there a limit to how much can be indexed without somehow things going wrong?

Well, first of all, I suppose there is if 90%, 80% somewhere in there were indexed, then you'd have a whole bunch of changes taking place. But I don't think you would get there unless a whole bunch of change is taking place. So, what are the changes that would need to take place? Well, we know roughly that from 1960 to today, the number of people who make a really good living by being involved in active investment management has gone from something like 5,000 to something like 1 million. So, I personally think you could get rid of half of the 1 million without changing the price-setting skills of the marketplace. How in the world you're going to get people to give up the most interesting game, most interesting line of work, highest paid compensation, where you can work--I've got a friend who decided on his 100th birthday, he said, "Charley, I'm going to do myself a big favor. It's my 100th birthday, and I'm going to stop working so hard. I'm going to cut out Saturday, only going to work five days a week." I laugh at myself. Early 80s. What am I doing? I'm working as hard as I can. I put in 60, 70, 80 hours a week, usually 70 or 80. Gee, that's interesting. “Why don't you cut back?" Because it's so darn interesting.

OK, how many people going to be able to give up something that they mastered and/or skilled at, that pays so well, and is so interesting, I think it's going to be very hard. And so far, we have more people coming into the business every year than going out of the business, even though we're at what 25%, 30% indexing so far.

So, it's going to be a long time before people give up on that. Another way was you make it illegal for securities firms to provide research services. That would cut back a fair number of the people who are in the field, but it also would make it harder to get the information. So maybe that would make a difference.

What if you required people to retire at 40? That might make a difference, but is there any chance it's actually going to happen? No, not a chance in the world. You'd have to change the mechanics in the machine in the engine in order to get a real change in the number of people who are actively involved in price setting through active investing. And candidly, that's really, really hard to imagine--if it could happen. If you were to call me and say, "Charley, I've got some amazing news for you. 95% of the world is now indexing. And prices are jumping around all over the place without rhyme nor reason." I'd roll up my sleeves and go back into active investing. Because if there is not too much competition, it's a wonderful, interesting way of spending your time and it might work.

But the way things are today, I don't think there is very much chance at all of--we're not going to give up all the computing power, we're not going to change the regulations to make it easier for people to do things we don't know of these days, we're not going to send millions of people home saying you can't do this anymore. The changes would just be so hard. It's just not going to happen sociologically. And I suppose psychologically, it wouldn't happen.

So, until you get a pretty good indication that it is happening, I think you can pretty much count on it. There is very, very, very talented group of people who are not successful at what they're doing and they keep doing it. Well, why don't they stop? That's a really good question. And that's a really good reason to stop. But they don't stop. OK, it's got to be something else. OK, what is it? Well, it's fascinating work, intellectually challenging, it's spiritually challenging. And it's competition with the best in the world. That's part of it, you can't change that. And the compensation, as I say, is terrific. Can't change that. And it's not just that year-to-year compensation--it's that extra 10, 20, 30 years that you can continue to practice the same profession, marvelous. Why somebody going to give that up? And until they give it up in droves, there is not going to be a change in the fundamental character of the investment management world.

Benz: Wanted to ask about this push into private investments. Vanguard is moving into offering a private equity offering for some of its clients, and the SEC has also been looking at opening private markets to smaller investors. What do you think of this trend?

Ellis: Well, those are two very, very different questions. Now, Vanguard happens to be an exceptionally sophisticated organization that has the ability to deploy a very large number of people to work out whatever answer they want to get. And they've got a very tough-minded board of directors that they would have to get approval from, did have to get approval from, and they've got a reputation for high reliability that they are determined to maintain. So, by the time they have done all of their due diligence on their capabilities and on the capabilities the organizations they might consider working with, I think you've got about as good an opportunity to be doing the right thing as you'll ever find anywhere. So, I just can't tell you how much I would put emphasis on the reality that Vanguard is a very careful organization, and its focus always is do the right thing, always do the right thing.

So, I would bet that they will have a pretty good success in what they're trying to do. I think my understanding is that the reason for moving in that direction of having private equity is—first, there is a lot of private equity activity that many institutional investors--and I emphasize institutional investors--want to have that as part of their portfolio. And I know from personal experience a couple of times Vanguard has been not chosen as an investment manager for an institution of some substantial size because it didn't happen to offer private equity. So, I would assume that primarily for institutions and primarily to meet a long-term belief, rational reason for having private equity, given that I am very confident that the way in which they would go about doing it would be careful, careful, careful. It’s the old joke about porcupines.

Ptak: You mentioned David Swensen earlier, with whom you've had a very long and fruitful association. I'm curious: The most valuable lesson that you feel he has imparted to the investing community? And then also what of his various writings you think, has been most, I guess, misunderstood by the investment community, whether in sort of how they've implemented, their embrace of alternatives? It seems that, while he has championed and justifiably so, there is also some aspects of what he has written and done that have been maybe misunderstood and misapplied in institutional circles. So, I wonder if you could offer your thoughts on both aspects.

Ellis: David is a profoundly original thinker. It's worth keeping in mind: He is the first person ever to do a major derivatives transaction. It was between the World Bank and IBM, fixed-rate versus floating-rate debt. And when he proposed the idea, his colleagues at Solomon Brothers said, "David, you'll never ever get that done." David said, "I think it's a logical thing to do." So, anybody who could be that disciplined and creative, and I would emphasize both the word discipline and creative, is someone that all the rest of us would want to pay attention to, even though we might find it difficult to reproduce what he can do.

Next thing is when he got to Yale, the Yale endowment was about $1 billion. And he was chosen not because he'd had any experience managing investments--he had had none. But Bill Brainard, who was serving then as the provost, which is a chief financial officer and chief academic officer--very important responsibility--responded, "You'll figure it out." Bill Brainard is an extraordinarily gifted economist and marvelous human being who understood David and David's character and his brainpower quite well. So, when David arrived at Yale, he started thinking from the very beginnings of every dimension of what Yale was doing. And out of that has come a set of beliefs about what Yale can do about investment management.

One of the sad realities is that most people who look at it say, "I got it. You put a lot of money in hedge funds, a lot of money in private equity, a fairly large amount of money in venture capital, almost nothing in bonds, and a lot of your equity is internationally diversified." Well, that's correct. But it's not the truth, it just happens to be correct. And if you said, "That's it, I've got this recipe" and go out and try to make the same success that David's had, you won't come close to it. Because other things that he is too modest to describe include he is a wonderful human being and almost anybody who has ever met him says he is one of the nicest people I've ever met and one of the smartest. What a combination.

Second thing is he is devoted because of his childhood experiences with his family. And his brother is a senior physician at Mayo Clinic. Mother and father were devoted to academic institutions during their careers. It's part of that culture that he grew up in. He's committed to Yale and deeply committed to Yale. And you think, "Well, that's really nice, but is that all he wants?" Candidly, I think that's really it. That's his focus.

So, what's he doing at Yale that makes it unique? Well, a couple of different things. One, Yale's Investment Committee is a group of pretty able people who understand that their job is as an Investment Committee to provide a disciplined sounding board for David Swensen and his very talented team of investment managers, as they go through the process of selecting investment managers and structuring a portfolio. And they're looking for--is there any way they can help by finding any imperfection in the process? Not second-guessing the decision, but in the process, and if there is, terrific.

Another part is--David's whole approach is best characterized as disciplined. It's very creative, but it's also very disciplined. And the discipline requires extra efforts and due diligence that most people would imagine putting in, more rigor on what are your screening criteria and policies than most people could believe would be appropriate or useful, and tougher discipline with an investment manager when Yale is getting to the position of choosing to work with that investment manager. It's really very, very formidable experience to see from the bleachers. And you realize: You get in that room with David Swensen, and it's one on one, what is your long-term policy as an organization of investment managers? What is your strategy of achieving your objectives? What do you want to accomplish? And if you ever declare, "These are my goals and these are my policies," and don't follow them, you can count on it, you're going to have a really quick trip to the woodshed with David Swensen because he asked those questions expecting complete and fair and permanent answers. And while he is doing that, of course, he is looking for character, character, character. So, it's easy for people to misunderstand and mis-appreciate that kind of rigorous discipline. But it is formidable in play, and it's been going on for now three dozen years, and the accumulation over time has been just wonderful.

Another dimension that most people don't really think of is--Dave has been doing this for long, long time. And his team has been together for a long time also. So, what's he been doing all this time? Setting a terrific example, doing things the really right way, achieving very nice results, and integrating them into Yale as a university and setting an example for all others to follow.

One of the things that he has been doing at the same time is building and establishing a network of friends who, like me--I would rather do David Swensen a favor than anybody I know. A favor that he would accept, that he would say, "Thank you. I appreciate that." That would to me be a thrill. Have I been able to do that? No. Would I love to do it? You bet, I would. And so would large, large, large numbers of other people all over the world. Sure, the investment managers that have worked with Yale have exactly that feeling. But many, many other people have exactly that feeling also. So, scuttlebutt network, David Swensen's got far and away the world's best, and it vibrates. And he gets most of his suggestions for possible new investment managers from current investment managers who say, "David, I hear that so and so and so and so might be getting together to start a new firm." David very often sits down in the kitchen with them and works out how they're going to design that new firm to be sure it's very, very successful. And if he gets his confidence level in them really high, he'll then be a founding investor and sometimes a very large founding investor. If they wobble after that, they're going to be brought right back to the woodshed again, and they know that, or they certainly should because it's been in the play for years now.

So, a lot of different dimensions that go into what really happens, not one of which gets mentioned in David's book on institutional or endowment management. So, people read the book and study it carefully and say, “I got it. I know what to do now” may have left out some of the things that are actually in the long run cumulatively even more important.

Benz: Well, Charley, this has been a really illuminating conversation. Jeff and I have a couple more pages worth of questions, but we want to be respectful of your time. Thank you so much for taking the time to sit down and talk with us today.

Ellis: Well, I've had a wonderful time. I'm sorry if I went on too long on some of your questions, but it's your fault--those questions are just wonderful. And the way in which you set this whole up has been just terrific. Thank you very, very much.

Benz: Thank you so much.

Ptak: Thanks again, Charley.

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts. You can follow us on Twitter @Christine_Benz.

Ptak: And at @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis or opinions or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)

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