The warnings of the man who popularised index investing have proved eerily prescient.
Jack Bogle, late founder of the world’s second-biggest asset manager, Vanguard, was notoriously opposed to exchange-traded funds (ETFs), which he called ‘the greatest marketing innovation of the 21st century’.
ETFs, invented in the early 1990s, now manage a collective $8trn in assets.
But Bogle’s anti-ETF stance was not due to the underlying investment policy of these funds; after all, most ETFs track indices, like the index mutual funds that Bogle pioneered after he set up Vanguard in 1975.
And Bogle wouldn’t have minded anyone buying ETFs and locking them away.
Instead, his gripe was with the easy trading that ETFs enabled. Basically, he did not trust investors to use their own judgment sensibly.
“Investors are not acting in their own best interests”
“We have evidence—strong evidence—that exchange-traded funds, because of the timing that goes on in them, are not acting in the best interest of investors; or, that investors are not acting in their own best interests, which may be a better way to put it,” Bogle said in a 2009 interview, thirteen years after he retired as Vanguard CEO.
The ex-founder’s views—which he repeated consistently over the succeeding years—didn’t go down well with those who replaced him at the head of the firm. Vanguard launched its own ETF business in 2008.
“I can’t say anything else other than I disagree with Jack,” Vanguard’s then-CEO, Bill McNabb, said in 2015, responding to an editorial Bogle had published in the Financial Times.
“As investors trade stocks with one another, the zero-sum game (before costs) of striving to beat the market becomes a loser’s game (after costs are deducted). The only sure winners are the brokers and dealers of Wall Street,” Bogle had written.
“This seems to be his most concerted attacked on ETFs,” McNabb said in response.
“[But] ETFs are a great investment innovation, lowering the cost of investing for millions of individuals around the globe.”
Bogle, who passed away two years ago at the age of 89, can no longer share his views.
But if he had seen the recent events surrounding share-trading app RobinHood, with its retail gambling frenzy exacerbated by social media, it’s hard to imagine he wouldn’t have added, “I told you so”.
Just a few weeks ago, before it was forced by the US equities clearing house to rein in its punters, RobinHood helped contribute to the busiest trading day in Wall Street history.
RobinHood rose to prominence by promising its clients zero-commission stock trading via mobile apps. But the winners from its technology are clear. It’s not the users of the app that are succeeding, it’s the intermediaries.
Just as the users of Facebook were never told that they are the product, the small traders using RobinHood to punt on a near-defunct electronic goods retailer called GameStop probably weren’t aware that their data footprint was a goldmine to third parties.
But the numbers proving the case are stark.
For 2020 as a whole, RobinHood alone made over $600m from market makers as a reward for providing order information from its retail clients. And, according to the Financial Times, Wall Street trading firms paid almost $3bn last year for information on such orders.
Fast thinking can lead to out-of-control gambling
Bogle’s central argument—that if allowed, human beings will gamble too much—is backed up by academic theory.
According to Nobel prize-winning psychologist Daniel Kahneman, human brains combine two systems of thinking, one fast and one slow.
Fast thinking is associative, intuitive, automatic, metaphorical, and impressionistic and can lead to out-of-control gambling.
It’s the slow-thinking brain that, if it’s allowed to take over, will impose more rational decision-making and lead to awareness that gambling, especially with leverage, is likely to lose you all your money.
Unfortunately for humans, our brains are easily dominated by fast thinking. Kahneman and his fellow-researcher Amos Tversky set out a variety of rules of thumb that we often use unconsciously, but which cause us to make sub-optimal decisions.
These rules of thumb—called heuristics—include biases that any self-reflective gambler will be aware of.
The anchoring bias causes humans to attach meaning to a totally random point, such as a stock market level or exchange rate. The sunk cost fallacy causes people to display irrational determination to justify an original decision, instead of cutting their losses.
In recent years, near-zero interest rates and repeated central bank interventions to prop up asset prices have led to an explosion of gambling.
This is true both in the traditional financial markets of shares and bonds, and to an even greater extreme in the new cryptocurrency markets, where traders have proved willing to apply leverage of 100-to-one to already volatile underling assets, with a predictable outcome.
“He didn’t try to beat Wall Street at its game. He simply led investors away from a game that they cannot win.”
While apps like RobinHood have proved false friends to the retail investor, claiming to democratise finance while leading many people to financial ruin, the founder of Vanguard saw the game for what it was—and said so.
“Bogle was the one person who succeeded in ‘sticking it to the man’ and changed the investment industry for the better,” Jason Hsu, founder of Rayliant Global Advisors, said on LinkedIn yesterday.
“He didn’t try to beat Wall Street at its game. He simply led investors away from a game that they cannot win and helped them invest their wealth in a way that minimised self-harming driven by behavioural biases.”
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