Is it just me, or has there been a series of articles specifically putting Vanguard in the crosshairs lately? Between this and the ridiculous attempt to blame Vanguard for being too efficient and charging too little in overhead, I'm starting to wonder if there's a specific campaign going on here.
Vanguard is definitely at the forefront of advocating "just put your money in an index fund and wait, don't try to time the market". There's a huge amount of money behind the alternative that will suffer if more people follow that advice. Media campaigns are, on that scale, relatively inexpensive.
In a recent Planet Money episode (#688: Brilliant vs. Boring), they talk about how when John Bogle first introduced the index mutual fund in 1975, it got a lot of criticism (and not much adoption) with people claiming that they were "un-american" and "Bogle's folly".
It's possible that there's some sort of concentrated media push going on here, but the story hasn't changed much in the last 40 years. And I would hope that if people with a lot of money were trying to smear index funds, they'd at least come up with a new angle.
> It's possible that there's some sort of concentrated media push going on here, but the story hasn't changed much in the last 40 years.
My opinion is that if there exists campaign against such investment strategies, then it is possible that this has been going on quite long time already. Like the parent postulated: media campaigns are, on that scale, relatively inexpensive.
His opinion iirc is that at some point there will be an inflection point where there will once again be profits to be had through information discovery, and the two forces will balance out.
He's also identified the narrative as a popular excuse among the poorest-performing hedge funds ("We valued the stocks properly, it is the market that is wrong." and "We aren't even trying to beat the market, we are merely offering a different risk proposition.") After over a decade of data, hedge funds must compete against the more compelling narrative, that hedge fund winning streaks are a matter of chance, and that the average investor isn't capable of picking one with prolonged better-than-market returns.
That is hard to prove, and is also not necessarily useful for anyone making a choice of where to invest, if the rare events are pretty unpredictable and "pretty hard to pull off" they may as well be treated as random by investors.
There clearly are strategies that make money at times. The majority off hedge funds do not offer these, and what they offer is hidden by their fees, which do not correspond to results, and even discourage good results as they encourage volatility.
Thank you. An important distinction. The same idea gets me going in discussions about turnover rates among football teams. (Teams tend to regress to the mean year-over-year in how often they fumble, so some writers insist fumbles are "caused" by chance.)
There are always profits, and losses, to be had through attempting to beat the market. The trick is whether anyone can consistently beat the market, time and time again, such that their long-term return reliably exceeds that of the market itself.
The point is is that it becomes easier to beat the market the more people are indexing. Thus there become more people consistently beating the market. Identification of such is still an issue, but not as difficult.
"Look more closely at those gaudy returns, however, and you may see something startling. The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years. In fact, based on the updated findings and definitions of a particular study, it appears that no mutual fund managers have."
At this point, Mutual Funds are the bottom of the barrel with respect to attracting talent for active management. There are plenty of examples of active funds that have consistently beat the market.
ex: Since Horseman's inception in February 2001, the fund has achieved annualized returns of 14.79%, according to HSBC.
According to A Random Walk Down Wall Street, there are many examples of funds that have consistently beat the market over 5-10 years, but there are very few that outperform the market over a longer time horizon, and oftentimes they underperforming in the subsequent time periods (Peter Lynch's Magellan fund is the one counterexample given).
I'm as big a boglehead as there is. Nevertheless, imagine you're the only person in the world not indexing. It's going to be quite easy to beat the market. Everyone else in existence is using market cap as the sole criterion for determining where to put their money. In this case all the other indicators for success are being ignored and not priced into the current price of the stock. In other words, if the whole world indexes the market becomes very inefficient.
> There are always profits, and losses, to be had through attempting to beat the market.
In this context the problem is that buying into an index fund does beat the market, because it simultaneously creates and then takes advantage of a bubble in the price of stocks in the index. The price of indexed stocks goes up because index funds are buying them. Then people buy into index funds because they're going up.
In theory non-index investors will then sell the indexed stocks once they're overpriced, but they can see the feedback loop. If more people are expected to invest in index funds in the future then the future demand for indexed shares will be even higher and the indexed shares will be worth even more tomorrow, so they become part of the bubble instead of correcting it.
The article and discussion confound indexes with markets with sector investment strategies.
The SP500 is not the market or even a market, its a small sector selected by backwards view of the recent past top 500 large caps.
So buying an index fund that tracks SP500 means some churn as previously successful large companies are added, and recently unsuccessful large companies are removed.
A trivial example of SP500 beating the market (of all stocks) would be new regulations or whatever resulting in increased costs and harm to small cap stocks. Its not hard to imagine... a fixed cost of regulation that might shut down your local independent gas station might be a rounding error at BP. Imagine an accounting change that costs the same to implement no matter if you're talking about thousands or billions. Or PCI/DSS change. Anyway in that situation the small caps would drag down the market average but have no effect on the large caps in SP500, so the SP500 "would beat the market" easily.
Well you just turned the point from a financial to a semantic one.
What really is the market?
We could discuss it for hours, but the reality is that (US )"market" in finance does refer to the S&P500.
So "beating the market" always means beating the S&P500.
An index fund is not its index. The distinction is important because the latter does not include management fees, transaction costs, and financing. From here it's easy to see how an index fund might beat the market.
I agree and think the author doesn't provide a very critical look at the issue.
For one, he relies heavily on the expertise of a bank which is threatened by ETFs because it makes money in part by executing trading strategies to wealthy clients - very generally speaking, the more complex/active the trading, the more money the bank makes. Not that the Goldman guy is wrong, but the author should have acknowledged this conflict.
Also the idea that somehow the average person picking stocks can help make market efficient seems like a big stretch. It's really really hard to determine a fair price to pay for a stock. And anyway, there's an ENORMOUS amount of brainpower that already goes into outsmarting the rest of the market - probably more than ever - and it's that smart money that sets the price, for the most part.
The thing about vanguard charging too little in overhead wasn't at all ridiculous when you consider that vanguard is owned by the people that invest in its funds.
It might be wrong. It was surely a little bit weird and surprising.
It's still ridiculous. Yes, if Vanguard were owned by a different set of shareholders than those who buy into its funds, then there'd be an incentive to charge higher management fees. That doesn't make doing so "anticompetitive", though. It's anticompetitive to "dump" goods/services on a market at an unsustainably low cost to drive competitors out of business (and then presumably raise prices once you control the market). However, it's not anticompetitive to, by design, have a lower price than your competitors and keep it that way forever.
There's absolutely nothing wrong with setting up an organization owned by its shareholders and designed to not charge excessive fees. Resenting that and attacking Vanguard for it is an underhanded tactic by those who want to make money charging fees, and thus have trouble competing with Vanguard.
We were talking about two different issues, then. I was referring to the persistent complaints by Vanguard's competitors that their fee structure is "unreasonably" low, often with blustering about anticompetitiveness and "dumping". Those complaints have been floating around for years, and more instances of them arose recently as everyone scrambled to throw in their two cents on the tax lawsuit.
But yes, the tax charges weren't quite as "ridiculous" (in that they require more than a moment's thought to dismiss), though I still think they're completely baseless. (And also, "tax avoidance" is the perfectly legal and sensible practice of paying as little tax as possible; the allegations against Vanguard were of "tax evasion".)
While the details would need careful comparison to the various laws in question (which I would hope Vanguard has done), I would argue that Vanguard's structure is similar in principle to that of a cooperative. If you have an organization owned by its members, that organization serves only its members, and that organization charges lower prices because its structure makes it reasonable to operate at cost for the benefit of its members, then that organization will pay less tax because it takes in less revenue. And that's completely reasonable. It's not reasonable to argue that the organization should charge more to its members specifically so it can pay more tax. The same reasoning should apply to Vanguard, though how it may set up such a structure would require a great deal more care and complexity at larger scale.
The details of the complaint would require careful evaluation against the exact letter of the law; in particular, this isn't a comment on the separate allegation about the "contingency fund". The above is simply an argument that in principle, I don't see why this should apply to Vanguard when it doesn't apply to smaller-scale organizations operated for the sole benefit of their members.
I'm only familiar with the tax argument. It's standard-bearer is a former Vanguard employee and "whistleblower" who stands to make an enormous windfall finders-fee profit if the IRS ultimately agrees with him. (On the other side of the argument: "rules are rules, and Vanguard has to comply with all of them, even the dumb ones.")
Can you provide a link to the "dumping" argument, posed well, or by any credible market participant?
> I'm only familiar with the tax argument. It's standard-bearer is a former Vanguard employee and "whistleblower" who stands to make an enormous windfall finders-fee profit if the IRS ultimately agrees with him.
As far as I can tell, that case got dropped: http://articles.philly.com/2015-11-19/business/68386489_1_da... . Though it's still entirely possible that the IRS continues to pursue it separately (they haven't commented on the status of that), it no longer appears possible for the so-called "whistleblower" to pursue it directly or to collect.
> (On the other side of the argument: "rules are rules, and Vanguard has to comply with all of them, even the dumb ones.")
Granted; it's possible there's a "letter of the law" problem here, hence my comment that the tax argument isn't quite as ridiculous. However, in terms of actual justice being served, I don't think it's reasonable for an argument along these lines to apply to Vanguard but not to any random local co-op that serves its members. (I'm ignoring the second half of the complaint here about the "contingency fund", and focusing on the "not charging enough" argument, which seems far more obviously wrong in principle.)
The difference, as far as I can tell, is that co-ops have just the one legal entity owned by the individual members, whereas Vanguard involves a second corporate legal entity, due to the nature of how the funds own Vanguard; it's the same logical structure, but the legal entity topology differs, and that may make a difference. As far as I can tell, the laws trying to say "must charge market rates" (because charging less would mean paying less tax, and we can't have that...) refer to B2B transactions, not B2C transactions. I wonder why Vanguard structures its funds using two legal entities in this way, rather than a single legal entity directly owned by the funds it itself manages?
> Can you provide a link to the "dumping" argument, posed well, or by any credible market participant?
I can't seem to find a good isntance of it at the moment. I saw a few more recent instances of it in stories associated with the tax lawsuit, mentioned by random other fund representatives commenting on the suit. They struck me as the kind of comment made offhand, rather than a careful legal argument of any kind; however, I've seen that complaint in various contexts ever since I started following (and using) Vanguard myself, before I'd heard about the lawsuit.
The end of http://www.bloombergview.com/articles/2016-02-10/vanguard-is... makes a comparison between Vanguard's low fees and Costco members; that comparison isn't quite as accurate, since Costco charges its members a fee rather than being owned by its members, but it seems like the right line of reasoning at least.
Do they charge too little though? The list of cheapest ETFs is far from being completely dominated by Vanguard http://etfdb.com/compare/lowest-expense-ratio/ Schwab makes a point to undercut Vanguard on everything, and iShares joined the game recently with its "core" ETFs.
My favorite (obliquely) anti-Vanguard argument is the "research" that goes around every few years purporting to demonstrate that a few companies "control everything":
It's a self-correcting problem: as more investors place money in passive funds, fewer eyeballs look for opportunities where the consensus price is wrong. That means that there's less competition for these opportunities, which both increases your chances of finding them and increases the returns to finding them. Eventually, active investing becomes fashionable again, because the returns are real and measurably higher, and the cycle repeats.
It may be contributing to greater wealth inequality, though: if you look at basically anyone who has become fabulously wealthy in the last couple decades, it's because they saw a profit opportunity that others were unwilling or unable to exploit. The primary form of unwillingness is "It's too risky..."
The fear is that prices won't correct because passive investors are the market. Also, there may not be anyone to take the other side of a trade because passive investors don't trade very often.
That just creates the conditions that lead to Warren Buffett's rise: a conservative market that often wildly mispriced securities. And you can trade against it the same way Mr. Buffett did: identify underpriced securities and buy & hold them until the market realizes their value, or if the market never realizes it, just end up owning a large fraction of American business and reinvest the profits from it.
Usually, once it's become apparent that some people are getting fabulously wealthy by breaking away from the herd, jealousy and Dunning-Krueger take over and you get a large number of people that are suddenly true believers in active investing.
3. Businesses are affected by the markets their shares trade in. Earnings can be depressed by increased costs of capital, sentiment and anti-competitive pressures from shareholders who hold the entire market.
The first one isn't even a real argument. That is claiming new initiatives just won't happen - if you stop being passive for exploiting this new market, not everyone is passive anymore. And about disposing, well, this is where the profits come into.
The third is mildly concerning. If a few companies are swimming in money, they may disturb every market around. Historically this don't last for long, every time the market gets like this, there comes a crisis and destroys those big players. Worth keeping an eye to a "this time is different" event.
With high-frequency and algorithmic market-makers, there is no such thing as low liquidity. Bid-ask spreads are at all-time lows as algo market makers try to one-up each other to squeeze spreads and provide liquidity.
Passively investing people still buy and sell. It's just that the triggers are based on their personal finances (got a windfall / need to buy new car...) rather than how the market is doing.
The second won't happen because there will always be a demand for market making traders, and at this point the cost of automated trading technology is low enough that it's worth making a market even in small/emerging exchanges.
The first can't happen because you can't answer what is the correct price of a stock. :) That's a bit glib, but the only reason passive investors are said to not correct is because there are plenty of active investors to move the prices of stocks.
It's more like HFT which wipes him out. He can't possibly react on the timescales involved, and the market is unlikely to reflect actual business realities compared to the current disposition of several automated financial instruments internal state.
The value of the stock is divorced from the underlying value of the business. HFT algorithms trade across the breadth of the market - I.e. whether they buy or sell a particular stock is correlated not to expectations of a businesse's books but things like Twitter, news, estimates of other firms positions and the like.
So if you're actually trading rather then just collecting dividends (and even then), then whether a stock moves is based less and less on the actual position of the business.
Holding them is fine, but index funds are the exact same thing: they're an exercise in cheaply diversifying to the broadest possible scale, which is the only way the little guy beats the algorithmic traders.
HFT algorithms trade across the breadth of the market - I.e. whether they buy or sell a particular stock is correlated not to expectations of a businesse's books but things like Twitter, news, estimates of other firms positions and the like.
That's the Castle-in-the-Air theory of investing, and it's been popular for much longer than even digital computers, let along HFT (Keynes is said to invest based on it, and as described the logic in his Beauty Contest analogy). It's why many thousands of investors over a century have been poring over stock price and volume charts, looking to predict where the other investors will put their money and beating them to it.
There are certainly algorithms nowadays doing this, but they are certainly not limit to HFTs, and have been around for much longer.
Many of them do, actually. When I had actively-managed funds the graph of their performance usually looked exactly like the graph of their benchmark, except minus a few basis points for fees.
No argument. I shifted over to passive investing by the time I was about 3 years out of college. (I worked in financial software for the first 2 of those years, so holding actively managed funds gave me an added benefit of helping to understand what my industry looked like and how end-consumers experience all the complicated algorithm/decision products we were working on.)
Critics of index investing always overlook the fact that there are many different indexes out there. The criticism always hypothesizes that everyone will put their money in an S&P 500 or a total stock market fund, while the reality is that indexers do all sorts of slicing and dicing with their index funds.
By reading just a few posts at the bogleheads.org forum one will quickly see that a ton of people overweight small caps and value stocks (and often the combination of those two factors, small cap value stocks). Some use an S&P 500 index, some use total market. Some hold international indexes (in their different flavors too - developed markets, emerging markets, total intl market, intl value stocks, etc.). Some overweight REITs in their portfolios. The combinations are infinite.
I personally believe that even if everyone indexes we'd still see significant activity in the market because not everyone indexes the same way. Also, a lot of indexers like to dedicate a portion of their portfolios to active investing once they reach a certain net worth - I myself plan on doing so.
The bottomline is that criticisms of indexing are either made out of ignorance or fear, or they have an ulterior motive behind them (such as promoting a firm's actively managed mutual funds).
Seriously? First you get rid of pensions and force young workers into private retirement funds and now you want to eviscerate the one fund that actually has it in its mission statement not to fleece its members for all that they have.
Tell it like it is. The private retirement system was rigged to begin with, with sole purpose to line the big banks' pockets with management overhead uncorrelated to the performance of the funds.
Quote Goldman Sachs more. Let's see how seriously your source holds up the next time they orchestrate the collapse of the global economy and come to the taxpayers for handouts.
> banks whose shares are often packaged in index funds tend to offer higher fees and rates for such services as account maintenance and deposit certificates than banks whose stocks are rarely or never included in index funds
Obvious explanation: the banks packaged in index funds are the largest banks. People don't tend to switch banks all that often, so larger banks charge larger fees to take advantage of their existing customers whilst smaller banks offer better deals to get customers. The explanation in the article makes no sense; it's in shareholders' interest that the banks they own shares in make as much money from customers as possible. (Also, since either outcome could be used to justify their conclusion, this is not science.)
There's a larger context here - the dearth of owner-operators. Perhaps Google and Facebook are exceptions, but the mind-numbing risk avoidance and Wall Street cadence quarterly earnings mentality are not always good.
This author shows little knowledge of how the stock market actually works:
> A market with more passive investors than active ones will continue to push money into the largest firms, whether these companies are actually performing strongly or not.
When I buy an index fund holding the S&P 500, none of those businesses get my money, My money does not go into any of them. I have bought an already existing asset from another person who is selling it.
At a primary level, you are correct. But the effects of passive investment are more subtle.
1. More investment dollars chasing big companies allows those companies to issue more stock without having to worry about pushing prices down (since there is this extra upward pressure of increased flow.)
2. Increased stock prices from increased flow gives the company more stock value for acquisitions
3. If money keeps flowing into particular stocks, it encourages companies to be lax about dividend growth, since the prices rise regardless.
All excellent points. As a random company moves from being active-investor-owned to passive-index-find-owned, what corporate governance mechanisms are there in place as far as board structure and management compensation? Feels like the management is getting a blank check with no one else being in charge.
The much hated, not much understood, legal obligation for CEOs to always act in the interest of shareholders comes as a result of just the situation you describe.
It would be nifty if there were a proxy mechanism whereby index fund shareholders could vote their underlying shares. It's technologically feasible, I have no idea if there are any legal hurdles, or if it's simply something no funds have bothered to implement yet.
The issue here is that in order to intelligently vote such shares, passive investors would need to invest time and effort to understand how board members voted, what their interests were, etc. What percentage of passive investors are going to make that kind of effort?
I feel like targeted index funds solve this problem. People make coarser judgements about what "the market" actually means and which markets they actually want to buy into... It's sort of semi-passive. You make decisions on the timescale of financial strategy sessions, which is fine.... You can be an infrequent signal, as long as you are a rational signal you are good for the economy.
I'm sure there are some legitimate points to be made on this front (indexing methods and such), but this piece reads to me like a giant justification for active brokers and their fees.
> But perhaps we shouldn’t be shocked if an investment method that encourages us to use as little discernment as possible ends up being too good to be true.
... are we just not going to mention that no one beats the market forever, so the intentionally simple, though counter-intuitive, decision might be the right one?
According to the author, the passive investors are buying into indexes regardless of valuation. However, we know the private unicorns have gotten higher valuations than public companies, which is the opposite of what we'd expect. Further, real estate prices have been going up, and real estate is not a passive investment.
It seems like funds like this would be relatively predictable in what and when they buy and sell. If they're doing it at a large enough scale and you can predict it ahead of time...
I'm glad people are starting to realize that the moral hazard with index funds is far larger than the moral hazard at the core of the last recession. Everyone goes into index funds expecting somebody else to do the homework, so the few quants actually doing homework increasingly figure out how to make money at the expense of the market instead of in a way that boosts the market as a whole.
Everything has two sides. We are going to see the other side of ETFs one day. And it is not going to be pretty. I read an article in WSJ over last weekend about problems with Blackrock gold ETF that was suspended. Apparently some believe that etfs can get in big troubles one day. They can have either liquidity issues or crash significantly more than their underlying securities. There could be a run. http://www.bloomberg.com/news/articles/2016-03-07/blackrock-... Not first time. This was last year: http://www.barrons.com/articles/the-great-etf-debacle-explai...
Once everyone and their grandmother started investing in index funds, I knew it was time to pull out. I do Greenblatt's magic formula [0] strategy now, it's doing pretty well even in this down market.
Vanguard is definitely at the forefront of advocating "just put your money in an index fund and wait, don't try to time the market". There's a huge amount of money behind the alternative that will suffer if more people follow that advice. Media campaigns are, on that scale, relatively inexpensive.