Vanguard Group founder John Bogle, the icon of index-based passive investing, is proud of the revolution he helped launch when he created the first index-based mutual fund more than 40 years ago. In fact, the theme of the “index revolution” was prevalent throughout the presentation he gave on Tuesday at the CFA Institute’s annual conference in Philadelphia.
Speaking in a clear, strong voice that belies his 88 years, Bogle emphasized his belief that buy-and-hold indexing is here to stay. But Bogle, whose indexing tastes run towards vanilla market cap-weighted strategies, isn’t a fan of some of the jazzier flavors of indexing that stray from that orthodoxy.
“The index revolution is not without its flaws,” he said, taking aim at smart beta indexing strategies that replace market cap-weighted portfolios with methodologies employing fundamental factors such as value, low-volatility and momentum.
“As a concept, smart beta is not a terrible idea,” Bogle said, before setting up the reasons why he evidently doesn’t think it’s such a great idea, either. “It suffers from the assumption that past data—heavily mined—will identify factors that provide sustainable performance and leadership in the future. Mark me as being from Missouri on that because it ignores the principal of reversion to the mean, or RTM, one of the most important things you need to understand about financial markets and stock returns and market returns and mutual fund returns. It’s a huge mistake to ignore RTM.”
Lumping smart beta together with what he termed popular investing fads from decades past, he added that “popular fads drive product creation in the fund industry. That’s great for fund sponsors, and awful for fund investors. We’re reminded of the time-honored principal that successful short-term investing strategies are rarely, if ever, optimal long-term investment strategies.”
He put up a chart that highlighted the significant outperformance of value over growth in equities last year, which provided a tailwind for smart beta funds employing the value factor. But, Bogle pointed out, growth has gained more than 12 percent so far in 2017 versus the 3.3 percent gain in value.
“Don’t forget RTM,” said Bogle as he put a slow cadence on the acronym letters for emphasis.
Too Big?
From that first index mutual fund in 1976, originally named the First Index Investment Trust and now known as the Vanguard 500 Index Fund, Valley Forge, Pa.-based Vanguard has become a juggernaut thanks to the popularity of its index-based mutual funds and exchange-traded funds (it also has a decent amount of actively managed mutual funds, too).
But the company isn't the only beneficiary of the indexing wave, as BlackRock and State Street have also mushroomed in size thanks to their index-based products. And that concerns Bogle.