John Bogle is, as most everyone knows, the very conscience of the investment industry. He’s also a gifted conversationalist, so all he has to say about everything from conflicts of interest in the fund industry to the problems with ETFs comes with a fluid, extemporaneous clarity of a man who at 83 is still very much on top of his game.
Apart from the diatribe against overly trading ETFs and funds that target absurdly slim slivers of the market, Bogle has been counseling investors in the past few years to find yield in corporate credits. He built on the that view when he told IndexUniverse.com Managing Editor Olly Ludwig that investors could really use a broad “total corporate bond” index fund to help them find yield at a time when the government bond market increasingly seems to be a losing proposition.
IU.com:So what do you think the future holds? I ask that after what you said on CNBC a couple of weeks ago, mentioning the possibility of a large correction. Some blogger picked it up as you predicting some dismal future turn of events, which, in my experience speaking with you, seemed completely out of character.
Bogle: We have a pretty good idea of what stocks and bonds will do in the next decade. But there will be bumps along the way. I’m almost quoting what I said in the show. I said, “I’d be surprised if we didn’t have at least a 25 or 30 percent decline. And we could even have a 50 percent decline.” Of course we could, but that doesn’t mean we will!
IU.com:Does it bother you that your comments were taken so much out of context?
Bogle: I don’t worry about the basically nonauthoritative journalism that we get on these blogs. And some of them do a lot of work, and some of them are pretty good. But you have no way—that I know of—knowing who’s doing what. Honestly, there’s too much interest in gossip and things that don’t mean a darn thing to long-term investors, and not nearly enough focus on what the realities of investing are, which begins with investing forever—my favorite time horizon—and keeping costs at rock bottom, so that you get your fair share of market return.
IU.com:Can you comment on how you view the U.S. economy and the global economy in the aftermath of one of the worst downturns in the history of the American republic? The S'P 500 and the Dow Jones industrial average are hitting new record highs, but what are your views about how this healing process is unfolding?
Bogle: Well, this is obviously a very, very risky and challenging time for our fiscal authorities and our monetary authorities. And we have this fiscal irresponsibility on the part of our politicians, where statesmanship is not to be observed. Everybody must understand that monetary policy cannot bear the whole burden of getting us out of the fiscal mess we’re in.
IU.com:So does that imply higher taxes and more disciplined spending going forward?
Bogle: Yes, absolutely.
IU.com:Do you see any reason for optimism, that there are the broad contours of some kind of consensus-building sentiment that is emerging in D.C.? Or do you see more of the same at this juncture?
Bogle: Actually, I see some signs of hope. First, I think there's an increasing recognition that what we have been doing here in the United States is the right thing to do. Europe pretty much turned to austerity. And we turned to stimulation. And we are certainly among the first two- or three-best-performing economies in the developed world. It may not be perfect, but it’s working better.
I think the short-term problems are well within a reasonable solution. That’s just my appraisal of where we are. The other thing is that for the first time, the president the other day mentioned the idea of doing something about all these government spending programs on Social Security and Medicare. I know nothing about the medical side of things. But on Social Security, I swear to goodness, I could fix it in five minutes. It’s the political will that’s lacking.
IU.com:What are bond index investors to do these days?
Bogle: I'm absolutely convinced, and I've been talking about this a lot, that we need a total corporate bond index fund. So a total bond market index fund investor says, “Look, 70 percent in low-yielding government debt is just too hard for me to deal with. I’d rather take a little bit longer duration, and a little bit lower credit quality, and take maybe half of my total bond market index portfolio and move it into a corporate bond portfolio.”
I’ve actually talked to Vanguard about starting one, but they don’t seem interested in doing so. I'm not sure exactly why. So the aggregate corporate bond index strikes me as something that will be very much coming into its own.
IU.com:So you're counseling a further usage of corporate credits to bump up what looks relatively paltry by historical standards for, say, retirees or people generally looking for income in their portfolios?
Bogle: Yes, that’s exactly true.
IU.com:Let’s talk about dividend-paying stocks for a moment. This is a theme that I’ve heard Burton Malkiel talk about a lot, that dividend stocks or index funds are a great way to bump up income at a time of historically low yields. But people worry:Do retirees who want nothing more than to cut coupons really want to watch their beloved dividend stock just tank when the market corrects? What’s your opinion?
Bogle: I think it is a pretty good strategy for those willing to take the market bumps. When you think about it, what’s important when you buy for dividends is the dividend. And your annual income is what you're trying to protect. And it basically does not matter—except to your brain and your behavior—that the value of the principal is going up and down, up or down, year after year. It shouldn’t matter to you. But for an awful lot of investors, it does. The long-term fixture of dividends on the S'P 500, for example, is almost without a blemish. It’s up and up and up and up and up, an exception in the ’30s, and an exception obviously in 2008, generated almost entirely by bank stocks.
Bogle (cont'd.): So I feel pretty comfortable that dividend streams aren't going to plummet. I think they should gradually ease up. So if people are going to be able to endure the temptation to get out when something goes way down, I think it’s worth doing this at the edges. Twenty percent—I don’t know how to give you a number, really, but I’ve never plunged into anything. The S'P is now yielding about 2 percent, so maybe you move the equity position partly into income-producing stock to get, say, as much as 3 percent, is one way to do it. So it’s all balancing out a portfolio that you can hold onto forever.
IU.com:Let’s talk a little bit about indexing itself. You're one of the pioneers; what are your thoughts about the indexing revolution you helped launched almost two generations ago?
Bogle: Truth be told, I have mixed emotions. Firstly, it is obvious that we are in an age of the triumph of indexing, which for me is not the triumphant investment idea, but the triumph of the relentless rules of humble arithmetic. And that is:We all know the active mutual fund managers as a group share the market’s returns. And it’s not possible to be anything else. And when they take out their costs, say, they're bound to lose—in the long run and even in the shorter run.
If you look back, say, the last six years, we've seen $770 billion go into index funds. And $320 billion go out of actively managed funds—believe that or not—just since 2007. That’s a $1 trillion swing in investor preferences in the past six years.
The triumph of indexing is everywhere. You don’t have to explain it anymore. And that’s the pro of my mixed emotions.
IU.com:So let’s go to the dark side now.
Bogle: It’s that in more than half of that $770 billion, about $500 billion is coming into ETFs. And about $260 billion is coming into regular—what I call “TIFs”—traditional index funds. And the ETFs have a very, very heavy speculative element that has never been available to these trading firms on Wall Street before:You can go long, you can go short, and you can buy them on margin. Roughly half of the ETF business is institutional trading, half of, let’s say, the SPY—by far the biggest; just great big institutional money that moves back and forth with great frequency.
That fund turns over about 8,000 percent a year. So there's not any question about it being used for speculation. For someone like me, who thinks that 20 percent a year turnover is a little bit high, I don’t know what to say about 8,000 percent.
But the other half looks to be about two-thirds people who are using, to some degree or another, ETFs for trading, and one-third that are using it, by and large, for long-term investing. Vanguard did a study that showed that they had parallel holdings of our various shareholders in the big ETFs. And they showed that it wasn’t nearly that dramatic. That it was about, I think, about 25 percent.
IU.com:So the translation there is that the Vanguard clientele is considerably better, as it relates to this speculative usage of ETFs, and yet, in your judgment, still outside of the realm where they should be—you said your outside realm is 20 percent. And you just quoted 25 percent. So you're kind of pleased, but still somewhat displeased with those data. Is that fair?
Bogle: Yes. There's also a lunatic fringe in the ETF business that I don’t follow very carefully, that is into this triple leverage, And at the beginning, there was an ETF called “Emerging Cancer” that’s gone. And now we have a Cloud Computing index—God knows what’s next, and He’s not telling.
IU.com:Well, there seems to be a measure of sobriety that’s coming back into focus. For example, last year in the ETF industry, there was an accelerated rate of closures and, at the same time, a deceleration of product launches. And many people in the industry seem to be saying, “OK, this is the sign of an industry that is beginning to dig in for steady growth in the long haul. Do you disagree with that?
Bogle: Well, I think that’s a more kind of a positive spin than I would put on it. But I just don’t really see why traditional index funds—by that I mean total stock market; S'P 500; international markets; emerging markets; total bond market funds—aren’t the right strategies for just about everybody. But there's a tiny minority in the number of funds that are in that group. I think I calculated in my new book that there were like 1,700 ETFs out there, and 40 of them were in that traditional index-fund group.
And everybody knows—studies have been done on this for years—that the more you trade securities, the worse your performance is, unit by unit.
Let’s assume, for purposes of this argument, that half of each stock in the S'P 500 is owned by long-term investors who don’t trade, and the other half of the shares of each of the stocks in the S'P 500 is owned only by traders; you come out with the following essential conclusion:The traders who don’t trade capture the entire market return as a group. They get the market return less nothing, because they don’t trade. And the traders, who by that definition can only trade with one another, get the market return, less all their trading costs. So, long-term investors win, mathematically speaking, chronologically speaking. And short-term traders lose. There's just no way around the math.
IU.com: There seems to be a Vanguard-esque battle that’s shaping up at the heart of the pure beta section of the ETF industry, with regard to price. I’m talking about Charles Schwab and BlackRock’s iShares—for-profit enterprises that have what appear to be credible offering of funds that are among the cheapest in the industry. It appears that the Vanguard dream, if you will, is materializing in ways that perhaps weren't foreseen. How do you regard this whole trend? Is it good? Is it bad? Do you not take seriously some of these other companies’ efforts? Are they loss leaders?
Bogle: Once you talk about index funds and costs, you run into the essential conflict that this industry faces, and that is, those are publicly owned companies:BlackRock, Schwab and so on. To serve their public shareholders of the management companies, they have to charge what traffic will bear.
In the old days, they would say, “We’ll make it up in performance.” The fact that they didn’t is another story. These days, they can't make it up in performance. All index funds essentially will give the same performance before cost. So now they face this “no man can serve two masters” dilemma; that is, if they want to keep their earnings up for their public shareholders—to whom, curiously enough, they have a fiduciary duty—they are operating against the interests of their ETF shareholders to whom they also have a public fiduciary duty.
And Larry Fink has really mentioned a couple of times that it’s very painful. When people are operating at cost, he doesn’t like that much. He said it was stupid. And I guess I'm just stupid. More power to him. And I like the guy, by the way, and I respect him too. But they have a dilemma:Which set of shareholders comes first? It’s said that no man can serve two masters.
IU.com: Steering clear of that conflict describes the arc of your entire career, right?
Bogle: Exactly so. But when you get into an index fund, it just simply cannot be any clearer.
IU.com: The translation is, we haven't heard the last of this tale? They made it look good in terms of headlines, cheap prices and funds. But as institutions, as publicly traded companies, they still have a problem on their hands that hasn’t been definitively addressed? Is that what you're saying?
Bogle: Yes. And what they did at BlackRock is create sort of similar ETFs, at very low cost, of three or four funds that exist in more expensive forms there too—and with the hope that the shareholders in the high-cost version will not move. But if they move, BlackRock shareholders will not be happy. Eventually this has to be reconciled against the interests of the company shareholders and in favor of the interests of the ETF shareholders, because that’s where the marketplace is.
IU.com: Apart from the pure beta section of the indexing world that Vanguard inhabits, what do you think of the WisdomTrees of the world or Rob Arnott’s Research Affiliates, which are serving up what they're calling “enhanced beta,” or say, PowerShares with its low-volatility version of the S'P 500. This is not quite the Cloud Computing Index that you were talking about a moment ago.
Bogle: You're getting close, though. You're getting close!
IU.com: Well tell me about that. If it’s not quite cloud computing, yet it’s not the full S'P 500, what is it, in your judgment? Is it legitimate? I often wonder why Vanguard hasn’t moved a bit in that direction.
Bogle: I don’t have any input into the management here, whatsoever. So I can't speak for them. But I hope we will not do it. It would seem to me to go against the basic philosophy of simplicity and even low cost that we’ve pushed all these years. It doesn’t seem to have done us irreparable harm. Sometimes these competitive things that come and go tempt you if you're in the marketing business, which is what this business has become out there, to follow others and to maintain your share of markets. That is a terrible idea.
I said to someone the other day that just about every lousy decision that I’ve made—and I’ve made an awful lot of bad decisions—was made for marketing reasons, regrettably. And it’s short term in nature. It’s letting you think you know more about the world ahead of us than anybody can possibly do. I remain in the group that says if the job is, as Dr. Samuelson put it, to retire with greater wealth than your neighbors, there is one and only one strategy that guarantees that. And that’s the low-cost index fund.
The Arnott strategy (PRF) may do well for a while. It’s about equal to the index in its first five years. And so is the original dividend index from Jeremy Siegel and WisdomTree. And they're both reasonable numbers. They're going to look a lot like the index. They own all the same stocks, pretty much, just in different weights. So I just can't see why anybody would want to take the risk of doing better, because you have to accept the risk of doing worse. And you probably have a lot of temptation in front of you.
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