John Bogle, founder of Vanguard Group, passed away last Wednesday at 89. It is safe to say that his vision of low-cost, passive index oriented investing, made available to the general public was realized. Index oriented investing is now a common practice among both personal and institutional investors. Intended or not, he was a champion of the individual investor.
How he became such a champion is an interesting tale. Mr. Bogle started in the industry with the Wellington Management Company in 1951, straight from college and became president of the firm in 1967. The Windsor Fund, which Bogle helped launch in 1958, was managed by legendary value investor John Neff from 1964 to when he retired in 1995. However it was poor performance with the purchase of Invest and a poor overall investment climate that saw him fired from Wellington in 1974.
During his time at Wellington, the call for index investing was growing. A paper titled “The Case for An Unmanaged Investment Company” was published in the Financial Analysts Journal back in 1960. Wells Fargo Bank had around $6 million in an index related portfolio in 1971. Jeremy Grantham, part of a small firm in Boston, Batterymarch Financial Management, presented his work at a class at Harvard also in 1971, although they didn’t find a client for their product until 1974. By 1975, American National Bank in Chicago had several hundred million in index funds.
At that time Mr. Bogle was watching these developments as well as reading academic research that supported low cost index investing. Paul Samuelson’s “A Challenge to Judgement” was cited as a key influence of John Bogle’s vision. So after he was fired, he was able to persuade the board of the Wellington funds, of which he was the Chairman, to start a new company, Vanguard Group Inc., to pursue his new vision of a company championing low cost funds.
Vanguard’s started with the First Index Investment Trust and was formed in August of 1976. It was often derided as “Bogle’s Folly”. Vanguard initially went to raise $150 million to start the fund but were able to attract only $11.3 million. A big problem was that Vanguard was not building a business around sales or distribution fees or investment management fees. Rather Vanguard was selling an unmanaged product to the investor directly with no sales fees.
However the fund today, 42 years after its creation, has now accumulated approximately $400 billion in assets. What was once an oddity is now commonplace. Recently reviewing Charles Munger’s lollapalooza effect, I thought it instructive to review why it ultimately was successful despite a slow start from a behavioral economics perspective. Essentially Mr. Munger outlined 24 various human psychological misjudgments. When many of these misjudgments occur simultaneously, it can create a powerful effect, which Mr. Munger coined the lollapalooza effect.
* There was a strong incentive to maintain the lucrative fees of the existing managed fund structure.
* There was social proof as all other institutional investor were using managed funds thus providing safety and job security.
* The new index funds had no track record so it was easy to doubt the rational of an unmanaged fund and therefore maintain the status quo.
* There was a negative reaction to the initial Vanguard Trust as it was derisively nicknamed Bogle’s Folly” indicating at some level a reaction to the denial of revenue of business opportunities.
* There was most likely a combination of excessive belief in one’s own talents with management teams to be above average that most investment firms avoided the new products as being inconsistent with their own beliefs. This goes also in hand with being overly optimistic in their own ability to forecast the future. (Gambling also would be appropriate in this context as a misjudgment.)
I’m sure there are more misjudgments that could be identified but I think the point was made. Regardless, there was significant resistance to promoting low cost, unmanaged funds when the idea was originally promoted. Once the resistance disappeared, there became an enormous market for those funds as Mr. Bogle had envisioned back in 1975, when creating Vanguard Group. John Bogle benefited in what was most likely a lollapalooza effect.
Thank you John Bogle for your legacy.
Rest in peace