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

Tom Burroughes

10 September 2012

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.