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Weekend reading: Bogle says active fund managers are the true parasites

Weekend reading

Good reads from around the Web.

With flows into index funds and ETFs soaring and articles about passive investing venturing beyond enclaves like Monevator and into the mainstream media, it’s not surprising active fund managers are getting more hostile.

Their latest wheeze has been to label indexers as ‘parasites’ who prey on the hard work of fund managers.

This is a handy line-of-attack, because it’s emotional. The data (that passive funds beat most active funds) and the logic (by definition the average active fund must offer average returns, before costs) offers them nowhere to go, but emotional appeals don’t need to be rational.

But rationality remains the best way to fight them, as Jack Bogle did this week in the Financial Times (that link is a Google search result – click through to the article. If on a tablet, switch to desktop view first).

Bogle writes:

[Index fund critic] Mr Smith describes the index mutual fund as a “passive parasite”, rejecting the value of the innovation I created in 1974. He suggests that the index fund simply takes advantage of the market efficiencies created by active manager/traders. His article assumes that my confidence in the index fund is based on the “efficient market hypothesis”.

This is not so. Whether markets are efficient or inefficient is beside the point. The cost matters hypothesis is all that is needed to explain why indexing works: gross return in the market as a whole, minus the costs of obtaining that return, equals the net return investors actually receive.

Paradoxically, it is the active manager who is the real parasite. For stock market returns are simply a derivative of the returns earned by publicly-held corporations as a group, the total of their dividend yields and their earnings growth over the long term.

Active money management, with costs averaging some 2.27 per cent a year, is the greedy parasite that eats away at the host.

At the grand age of 84, Jack Bogle is still one step ahead of the financial services industry as it throws confusion, fear, and flak in the face of his big insight.

I admire his energy and tenacity, almost as much as his achievements.

Investing ages well

If indexing was guaranteed to give me a mind as sharp as Bogle’s in my 80s, I’d go without food to buy more index trackers. But plenty of top-performing active investors are still razor sharp in their old age, too.

Sure, reaching old age in a fit state is largely down to genes, luck, and lifestyle.

Survivorship bias obviously favours the long-term compounder, too!

But as I’ve written before, perhaps there’s also something positive in the long time horizon of the true investor, however they happen to invest.

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: On Monday HSBC will launch competitive new 90% loan-to-value mortgages, according The Guardian. The range will include a two-year fix at 3.59% and a five-year fix at 4.39%. Fees seem in line with current norms, so it could be a good option for first-time buyers.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

  • Invest with Buffett’s five-year plan – MarketWatch
  • Swedroe: Emerging markets have investors panicking – Moneywatch
  • The safety-first credentials of a 50/50 portfolio – Telegraph

Active investing

  • The hidden risk of investing in stable companies – Morningstar
  • Exploring buy-to-let hotspots – This Is Money
  • Some ideas for safe dividend payers in the UK – Telegraph
  • Wealthy club together to buy commercial property [Search result]FT

Other stuff worth reading

  • How can the BOE’s Carney prick the house price bubble? – Guardian
  • Annuities: A dying breed? – Telegraph
  • Technology and games changing financial services [Search result]FT

Book of the week: If all authors treated economics the way Tim Hartford does, Harry Potter might have starred a central banker. His brand new book, The Undercover Economist Strikes Back, tackles nothing less than the entire global economy!

Like these links? Subscribe to get them every week!

  1. Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” []

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{ 16 comments… add one }
  • 1 Charlie August 31, 2013, 3:28 pm

    Bogle’s quoted average costs of 2.27% for active funds and 0.06% for passive funds look a bit extreme to me. Are they applicable to the US market perhaps?

  • 2 The Investor August 31, 2013, 3:41 pm

    @Charlie — Yes, I thought the same thing about the passive costs. The average active costs are if anything higher in the UK. Remember these are “all in” costs, so they will include spreads, trading and turnover costs, performance fees, and so on. More than the quoted TER in other words.

  • 3 Tony August 31, 2013, 3:50 pm

    Yes, both numbers seem to be a bit on the low side for the more expensive UK market.

    Add around 0.2% or so to both and you won’t be far off the mark.

  • 4 Charlie August 31, 2013, 10:37 pm

    I’m staggered by the active costs. I invest in passive funds so have a feel for costs involved there. If I look up one popular active fund, Invesco Perpetual High Income on Charles Stanley Direct, then I see they quote an AMC of 0.75%. I had completely failed to appreciate how high “all in” costs could be for active funds.

  • 5 Robin September 1, 2013, 6:26 am

    I love to read anything written by or about Mr. Bogle, who is one of the few who will call the financial industry what it is. Besides active fund managers being parasites, isn’t the vast majority of the entire industry? What about the big banks, peddling the ‘actively managed’ concept? The salesmen, excuse me, investment professionals charging up-front loads on actively managed funds?

    But as he says, ‘efficient or inefficient,’ it doesn’t matter. What is the statistical likelihood that you can find a manager that can not only beat the market return, but do it long term, and on a risk-adjusted and cost-adjusted basis. The likelihood is not good. The odds favor the passive investor.

  • 6 Robert Harrison September 1, 2013, 11:53 am

    Hello Everyone,

    This article cites some interesting research that suggests that the spoils go to the “smart” passive investor and the “smart” fund managers.

    http://wealthmanagement.com/mutual-funds/investors-not-so-bad-picking-active-funds-after-all

    Bob 🙂

  • 7 Tufty September 1, 2013, 11:59 am

    Hi all,
    If theres one thing Ive learnt about myself over the past 3 years of investing in active funds its that (apart from having the great ability to pick bad funds) Im a ‘lazy’ investor. I just dont have the time or the interest to keep logging into my Hargeraves account to check how badly theyre performing, reading their crappy news articles etc… And to be charged a lot of money for the privilege pains me.

    Ive been keeping an eye on Monevator for a year now, and from the articles Ive read it seems that passive investing is the way to go. Im a complete newbie at this, could someone point me to a really simple page of “this is what you need to do and this is how to do it”. I have all of my ISA allowance to throw at this (in the most prudent way of course). I guess – for the sake of diversification – I need some exposure to overseas markets too.

    As I say, I have no interest in the markets/blue chip companies/investing. I just want to hold my savings in one place (mostly), try to beat inflation and only need to log into my account a few times a year to see how its performing and tweak if needed.

    Could someone point me to a ‘layman’s guide’ page that could help? (Ive heard of LifeStrategy funds which sound like the sort of thing Im after).
    Many many thanks.

  • 8 WestCountryEscapee September 2, 2013, 11:08 am

    The whole thing is a scam:

    1. Companies make a profit by selling stuff for more than it costs to make
    2 (a) You buy a share of those companies so that you can get a share of their profit
    or
    2 (b) You pay someone else to look at all the companies and choose to only keep shares in ones that are doing better than average
    or
    2 (c) You pay someone else to pay someone else etc. etc.

    See:
    http://www.johnkay.com/2012/07/25/the-parable-of-the-ox

    It doesn’t take a rocket scientist to work out that the person doing the choosing not only has to continually choose companies doing better than average (which is tricky), but has to pay his own salary and all the costs for buying and selling.

    Tufty – I’d recommend John Kay’s book ‘The Long and the Short of it’ and then either going for LifeStrategy or looking at a few DIY ‘lazy’ investment portfolios (Google for examples).

  • 9 The Investor September 2, 2013, 12:59 pm

    @Tufty — Save yourself some Googling, as I believe we have as good a roundup of examples of lazy portfolios as anyone for UK investors. 🙂

  • 10 Tufty September 2, 2013, 5:22 pm

    Thats great – thanks guys! 🙂

  • 11 Mike September 2, 2013, 9:32 pm

    what do you think is the best Bogle book ? I’ve just started reading Bogleheads guide to investing which I’m enjoying – can you recommend any others ?

  • 12 Paul S September 3, 2013, 8:57 am

    @Mike,

    Bogle’s “The Little Book of Commonsense Investing” is very neat and concise. His retelling of Warren Buffett’s “Gotrocks Family Parable” is priceless.

  • 13 martibab September 7, 2013, 10:19 am

    Great post, as usual.

    I posted something similar to this on the 9 lazy portfolios page, but I haven’t had a reply and it’s also relevant here.

    How many index funds do you think are adequate for a passive portfolio? For clarification, I am a UK citizen. Also, I am looking at ethical funds and I am aware that there is not a lot of choice, and both performance and cost need careful scrutiny.

    The particular ones I am looking at are: L & G Ethical Trust and Vanguard SRI Global Stock Acc.

    The L & G Trust purports to hold 225 stocks, mostly UK, and appears to be benchmarked to the FTSE 350 Index (can this be the case, since it only invests in companies selected according to ethical and environmental guidelines?).
    The Vanguard Stock invests in 1869 of 2037 stocks in the FTSE Developed Index.

    A quick look at the top 10 holdings of each showed no overlap as far as I could see. Would either of these be sufficient in your opinion, or would you go for both or even more?

  • 14 The Investor September 7, 2013, 10:32 am

    I’d get both and even more, but I am a paranoid so and so. 🙂 The risks are ones of counterparty risk and fraud — both tiny but present — as well as the fact that by going down this ethical route you risk underperformance (with some chance of outperformance) too versus a straight tracker fund. So I’d want to dampen that down too if pursuing this path.

  • 15 martibab September 7, 2013, 10:53 am

    Thanks for the comments, Investor.

    I may have not given enough info, in that these were only the equity funds I was considering. Tying this back to your article on 9 lazy portfolios, Several of those 9 only had one or two equity funds.

    I am about to retire at 67 and I am also thinking about the following spread:

    Legal & General Ethical Trust 20%
    Vanguard SRI Global Stock Acc 20%
    Blackrock UK Gilt All Stocks Tracker 20%
    Vanguard UK Government Bond Index 20%
    Blackrock Global Property Securities Equity Tracker 5%
    iShares Physical Gold ETC 15%

    Tying this back to your article on 9 lazy portfolios, Several of those 9 only had one or two equity funds.

    Any comments?

  • 16 The Investor September 7, 2013, 11:26 am

    You’ll probably be fine with those equity funds if you’re going down this ethical route (I wouldn’t). Some noted passive investors have just one equity fund! (E.g. Mike at Oblivious Investor).

    But I am paranoid and see no downside in spreading my risks as widely as possible. Doesn’t cost much more (maybe slightly less optimal TER) and not much extra work to buy and hold.

    That’s my feeling. You’ll have to make you’re own choice. From a pure index strategy perspective one diversified global fund is a respectable choice.

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