Christine Benz: Hi I'm Christine Benz for Morningstar. As part of the annual Bogleheads conference, I recently sat down with Vanguard founder Jack Bogle to get his views on the growth in indexing products.
Benz: Let's talk about the growth of ETFs and passive products. You've talked about how it's been stupendous, but there has been some hand-wringing going on on the sidelines about whether the growth of passive products has the potential to change how the market is behaving, or some people have asserted that in fact it is changing how the market is behaving. What's your take on that question?
Jack Bogle: Like all questions, it's not that simple and the biggest caveat I would say posing the question in that way is [traditional index funds] TIFs are different from ETFs. They are not traded nearly as rapidly. Our index funds, I think it was something like a 12% or 13% redemption rate, traditional mutual funds, and our TIFs turnover, S&P 500 in this case around 600% a year and the SPDR turns over around 3,300% a year. So, what happens in a market where that kind of trading is so dominant? I don't know the answer to that. I do know there's been a revolution in the market in the sense that not quite this high now, but something as much as 35% or 40% of all the trading in U.S. stocks is in ETFs. That's a totally different market dynamic.
So, people are trading ETFs with one another, which I must concede is probably safer and cheaper than trading stocks with one another, but that's not a very great compliment. So, I think the potential is there for great market, substantial market disruption on smaller segments. Say high-yield bonds would be a good example. We've seen a little bit of that. And some of the other narrow ETF sections which in the May of 2010, that mini crash or whatever it was called...
Benz: Flash crash.
Bogle: Yeah, flash crash. Fund with an asset value, ETF with an asset value of 8, they gave an automatic sell if it goes below 7, say, and they got $2 a share. Because the marketplace just fell apart for the more specialized. I do not believe that happened in the Standard & Poor's 500 either the SPDR and it certainly didn't happen in ours.
Benz: How about on the governance front. I know you and I have talked about this over the years, about whether passive products are more limited than active managers from the standpoint of influencing corporate governance of the companies they own. What do you say to that assertion that passive products because they can't walk away from some of these companies altogether don't have that ultimate weapon that active managers do have?
Bogle: I'd say traditional index funds are the last, best hope for corporate governance.
Benz: And why is that?
Bogle: That's because they're the only true, long-term investors. Corporate governance should be based on long-term factors affecting the corporation, not a bunch of traders who want you to report higher earnings, gonna try and get on your board for a minute, and in a moment ... I don't know how they're this smart to do it, but realign the entire company and then all will be well. It just doesn't happen. In fact, the reverse is more likely to happen.
So, I don't see ... The old Wall Street rule was if you don't like the management, sell the stock. The new index fund rule is if you don't like the management, fix the management because you can't sell the stock.
Bogle: It's something people really haven't read enough about to know about, but if you read Benjamin Graham's first edition of the Intelligent Investor, he had probably 20% of the book devoted to what investors do when the corporation isn't performing. It was a big thing for him and that's all the way back in 1949. I thought I was ahead of my time in 2001, 2002 when I tried to form a confederation or a federation, I should say, of long-term investors. They were almost all index funds and those that weren't index funds, good managers with a long-term time horizon. There aren't that many of them, but you know who they are. And I couldn't get anywhere with that. And now we're really having that, not in a formal federation, but we've come a long, long way.
Vanguard has come a wonderfully long way in not only taking an active interest in voting and evaluation and talking to corporations, but in publicizing it. They have a booklet, came out here about a month ago, showing all aspects; [it's] probably, I don't know, 10 pages long. So, we're getting good disclosure. We're getting good activity, and that is the wave of the future. I think that's the responsible way, but also think it's good business. Your shareholders are out there and they don't know what quite to think about governance. How could they? How could I even? But as Bob Monks said, the great Bob Monks said, corporations without governance will fail and somebody has to watch the watchers.
So I think I'm an optimist about corporations being more driven by large institutional investors, largely index funds who really don't have any vested interest in buying and selling a stock. Getting it up for a little while and then selling it and buying it back when it's low. That's not the game. So, I think we've made good progress there.