Investor John Bogle’s Legacy

Bogle steered many people away from the exploitation that is all too prevalent in the financial system by encouraging usage of index funds, and his legacy deserves praise for that.

Bogle’s great innovation was to minimize the cost of managing individual accounts. The key Vanguard asset is an index fund. It does minimal trading, it just tracks the market. Bogle argued, supported by much evidence, that the vast majority of investors are not going to beat the market. This means trading costs are simply a transfer to the folks running the account. Since most of us have people we would rather give money to than our stockbroker, we are better off just having an index fund.

And it does make a huge difference. Many of Vanguard’s index funds have costs of less than 0.1 percent annually. By contrast, many actively traded accounts will have fees and service charges in the range of 1–2 percent annually. This adds up over time. If you invested $1,000 that got a 6 percent nominal return, it would grow to $5,580 at Vanguard after 30 years. At a brokerage charging 1.0 percent in annua,l fees it would grow to $4,320. At a brokerage charging 2.0 percent annual fees, it would only grow to $3,240. And the gap is all money in the pockets of the financial industry.

While his low-cost index fund was a great innovation in finance, he did not personally get rich from it. He organized Vanguard as a cooperative. The people who invest with the company effectively own it.

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The Failed Investments of Ivy League Schools and the Future of Hedge Funds

If the elite universities had simply invested in index funds that matched the stock market average instead of hedge funds, there would be much more money to grant to disadvantaged youth and to valuable research initiatives. Those universities have all that prestige and influence, and they even have a tax exempt status — and pound for pound they still did worse than a good average investor would have.

The New York Times highlighted the findings of a remarkable study last week. The study, by Markov Processes International, examined the 10-year returns of the endowments of the 8 Ivy League schools. The study found that all 8 endowments had lower returns than a simple mix of 60 percent stock index funds and 40 percent bonds. In some cases, the gap was substantial. Harvard set the mark with its annual returns lagging a simple 60-40 portfolio by more than 3.0 percentage points.

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And, just to be clear, the Markov comparison was overly generous to the universities. Their benchmark comparison of a portfolio of 60 percent stock and 40 percent bonds is in fact far safer than the alternative investments they hold. If they actually equalized risk, the comparison portfolio might be 80 percent or even 90 stock, making the Ivy league endowment returns look even worse.

The Ivy League schools are not the only big institutional investors who are turning to alternative investments. State and local pension funds also play this game in a big way. The beneficiaries are more often private equity partners, but the basic story is the same: people who make themselves very rich by playing financial games. And, as with the hedge fund folks and the Ivies, they do not provide the promised returns.

And, there is considerably more money at stake with public pension funds. The cumulative size of the Ivy League endowments is just under $140 billion. While this is hardly chump change, state and local government pension funds have more than $8 trillion in assets. Most of this money is not in alternative investments, but if just 10 percent were placed with private equity funds and other alternatives, it would come to $800 billion.

There is much to dislike about the behavior of these financial actors. They routinely play games with the tax code and bankruptcy law to increase returns. It is standard practice for private equity funds to leverage their companies as much as possible to take advantage of the deduction for interest on corporate income taxes.[1]

They also strip valuable assets, such as the real estate on which stores and restaurants sit, so that they can book a quick profit while leaving the companies they control more vulnerable to a business downturn. Bankruptcy is a common tool, which they use to get out of not only interest payments on debt (presumably lenders knew the risks they were taking), but also pension and health care obligations to workers, and payments to suppliers.

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In terms of inertia, people can point back to a period where the hedge funds did produce outsized returns, as did the private equity funds. People can think that the last decade or so is just an aberration, and that the good times will return.

While I can’t predict the future, there is a simple story that would imply the opposite. Both hedge funds and private equity funds prospered by finding seriously under-valued assets and then leveraging heavily to maximize their return. When there were few actors in the field, it was possible for some number of funds to make large returns this way. But now that there are many actors, with trillions of dollars to invest, seriously under-valued assets are few and far between.

This means that most hedge funds and private equity funds won’t be able to make outsized returns going forward. The high fees to the fund managers are a direct drain on returns that would otherwise more or less match the market average.

And just to be clear, we are talking about a 10-year period in which hedge funds have failed to match the market average. (It’s a similar story with private equity.) This is a long period, it’s not just a case of these funds having a bad year or two.

UK Firm Managing $1.2 Trillion in Assets to No Longer Invest in Companies With “Bad Record” on Climate Change

It’s a needed step similar to having the banks stopping their funding of oil pipelines. The rationale of the fund manager saying “money talks” is interesting.

Legal and General, which oversees more than $1.2 trillion in assets, said it would punish companies with a bad record on climate change and strip them of their funding.

Helena Morrissey, head of personal investing, said the firm will be “naming and shaming” companies that have failed to act on climate change next week, and pull investments from those companies.

“There comes a time when talk is over, and it’s time to vote with our feet. Money talks as they say,” Morrissey said at a conference in London on Monday.

She emphasised the need for the financial sector to work together, driving change through sustainable investments, and said that these investments can produce both “profit and purpose.”

Many individuals don’t invest in the market because of fear their money will be used for purposes they disagree with, Morrissey said. She suggested sustainable investing as a solution.