Bogle’s plan first met with scorn and ridicule. His peers protested that “settling for average” was un-American and called on investors to “stamp out” index funds. The hating never stopped (“Indexing is worse than Marxism,” according to a 2016 broker note) but the scorn has long since turned to resentment and the ridicule to tears. Why? Because investors have seen the light and are turning their back on active management in ever-growing numbers, putting the skids on what has been called “the most profitable business in history”.
Today, Vanguard dominates the mutual funds industry. It’s become an absolute colossus with $4 trillion of assets, a 23% market share and $300 billion of cashflows in 2016 alone (more than its 10 closest rivals combined). On average, investors pay just 12 bp (0,12%) in fees, the lowest cost provider by far. As it turns out, there’s nothing more American than going after the best deal in town.
The best deal that investors can hope for is a fair deal. That’s been the overriding theme throughout Bogle’s tenure as Vanguard CEO, “a better, fairer investment experience for mutual fund investors”.
He planted the seeds of that way back in 1951, in his senior thesis at Princeton. His paper identified the four core values that would shape his mutual fund philosophy:
- the prime responsibility is always to the fund investor;
- the fund must operate in the most efficient, economical and honest way possible;
- the fund cannot claim superiority over the market;
- corporate governance should first and foremost represent the individual, disenfranchised client.
Vanguard’s strategy was born out of these ideals but also by Bogle’s first-hand experience trying (and failing) to select winning fund managers. The futility of that endeavour was confirmed by a host of academic research, from the likes of Nobel Laureate Paul Samuelson and Burton Malkiel, author of the seminal “A Random Walk Down Wall Street”.
Samuelson’s credibility was a vital factor in getting Bogle the go-ahead from Vanguard’s board to create the world’s first index mutual fund. Today, about one third of US mutual fund assets are managed this way.
A blueprint for 10X
Bogle’s investor-orientated values are almost 70 years old now, but they are still not shared by the broad industry. To this day, fund ‘fiduciaries’ side with business shareholders rather than investor clients, especially on the matter of fees.
Industry assets in the US have grown from $3 billion to $17 trillion, yet the overall asset-weighted expense ratio is higher now than it was in 1951 (despite the emergence of low-cost providers). All the economies of scale have accrued to the fund managers, none to investors.
And there’s still no discipline in the fund line up. More than ever, the industry capitalises on the fashions of the day, paying little heed to the investors’ long-term objectives. Bogle laments the elevation of salesmanship above stewardship, the approach to “make what will sell” rather than “sell what we make”.
It’s not just an American problem. These industry failings are repeated around the globe, including South Africa. It’s these failings that prompted Steven Nathan to launch 10X Investments in 2005.
He learned about the ways of the investment world when he was an equity analyst at Deutsche Bank, covering the financial services sector. Here he was introduced to the self-serving practices of life insurance and investment companies, and the ruinous impact of their complex and expensive products.
He found that these companies prioritised shareholder wealth over investor returns, with no attempt at a fair compromise, or a win-win outcome. The anecdotal evidence – the poor outcomes achieved by family and friends on their RAs despite healthy stock market returns – confirmed as much.
This was in the late Nineties, long before anyone in South Africa talked of John Bogle or Vanguard.
A stint in London introduced Steven to the benefits of low-cost indexing, and catalysed the idea of 10X, which was founded on Bogle’s core values:
1. 10X “sells what it makes”, which is just one optimal portfolio. Every client has the benefit of 10X’s “best investment view”.
2. The investment strategy – in terms of fees and asset mix – focuses entirely on the client’s long-term objective.
3. Fees are typically two-thirds below industry averages, and they scale down as the fund size increases, allowing clients to share in the economies of scale.
4. 10X uses index funds: there’s no claim to “superiority over the market”.
5. The funds are overseen by independent, professional trustees who prioritise the investors’ interest.
6. 10X runs its funds in the most efficient, economical and honest way possible by offering a single solution, simple processes and full transparency (on returns, fees and investments).
Today, Steven is the voice of index investing in South Africa, and the most public advocate of investor-oriented industry practices.
Does indexing work in SA?
In the U.S., the evidence overwhelmingly supports passive investing. The SPIVA scorecard, (published by S&P Dow Jones Indices) reports that over the 15-year period ending December 2016, 92% of large-cap, 95% of mid-cap and 93% of small-cap managers trailed their respective benchmarks. The average outperformance is 1,5% pa, a cumulative enhancement of almost 25%, simply by “settling for average”.
But does it suit the South African market? The naysayers argue it doesn’t, claiming that our market is not nearly as efficient as that in the US.
That is a red herring. The case for indexing is not premised on market efficiency, but on simple arithmetic. On average, both index trackers and active investors match the market return, before fees. But as index investors pay lower fees, they earn a higher average net return than active investors. That holds true for every market, in every country, in both bull and bear markets.
The odds of beating the market with an active manager are low, also in SA. Active investing is a zero-sum game before fees: half the invested money will beat the market average and half will lag. This means that net of fees, the majority of actively-managed money is destined to underperform. The evidence backs this up. Per the most recent SPIVA SA score card, 77% of SA Equity Funds lagged their benchmark return (the S&P SA Domestic Shareholder Weighted) over the five years to December 2016. The shortfall was 2,5% pa on average.
In any event, no market is perfectly efficient, not even the U.S. But that doesn’t matter because no one can reliably exploit inefficiencies when they do occur. This makes it impossible to reliably predict which fund managers will outperform in future, also in South Africa.
The big differentiator in the performance of active and passive funds is fees. In South Africa, that gap is massive. The most recent Morningstar study* indicated that of 25 countries surveyed, once platform and advice fees are considered, South Africa’s unit trust market ranks as the most expensive on balanced funds (c. 2,6% pa), and second most expensive on equity funds (c. 2,4%).
Comparable index funds can be had at around a third of that cost. That’s a big incentive to avoid active investing and go with a direct, low-cost index fund. Over a diligent 40-year savings life, those kind of fee savings can boost your retirement income by up to 50%.
The ultimate proof of this pudding is in the numbers. Since inception the 10X High Equity index fund has outpaced the average large manager** by some 1,8% pa, net of fees. It’s not yet a 40-year track record, but thus far this simple approach has delivered above-average returns. It appears that harvesting the market return at low cost and giving investors a fair share of that return also works in South Africa.
Final words
John Bogle retired as CEO of Vanguard in 1996. Despite his advancing years (88 and counting), he is still the most public advocate of simple, goal-orientated, low cost investing. In 1999, Fortune magazine named him one of the four “investment giants” of the 20th century. Even Warren Buffet, the world’s foremost investor, was moved to write that “if a statue is ever erected to honour the person who has done the most for investors, the hands down choice should be Jack Bogle”.
He remains a prolific writer and public speaker, forever cautioning investors to set realistic expectations, control their costs and impulses, to own the market and to stay the course.
In his words: “The secret to investing is that there is no secret. When you own the entire stock market through a broad stock index fund, all the while balancing your portfolio with an appropriate allocation to an all-bond-market index fund, you create the optimal investment strategy.
“While it is not necessarily the best strategy, the number of strategies that are worse is infinite.”
Amen.
