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Learning the Wrong Lesson from Bogle.

Human Life Expectancy today is 79 years. Most of us live out the lives in a fashion that none other than family members can remember one after we pass away from this world. Those who achieve greatness in their lifetime are generally remembered for at least one more generation before the memory stats to fade away.

Peter Houston, invented the first roll film camera but it was George Eastman who was well known thanks to he being the licensee of the patent on roll film and starting Eastman Kodak Company. Anyone born in the last couple of decades will barely remember roll film based cameras while the coming generation will mostly know camera as something that is part of a phone.

Throughout history, very few innovators have also been able to make a name by building a business around it. Exceptions to the rule are people like Henry Ford who founded the Ford Motor Company in 1902. Thomas Alva Edison was another for who hasn’t heard about General Electric.

John C. Bogle who passed away recently will be someone who will be remembered for a very long period. But will he be remembered right is the question that haunts me today as I read through the Eulogizes.

Yes, he was not just the founder of Vanguard which today ranks among the top fund houses in the world. He is celebrated for founding and popularizing  “Index Funds”.  Today, his view that rather than attempt to beat the Index, it’s far better and wise to just mimic the index performance through Index funds and Exchange Traded Funds is fast becoming mainstream with even Warren Buffet, the guru of active investing advising investors to go “Passive”

But is that what Vanguard stands for today? While billions of dollars have flown into passive funds in the recent past, Vanguard as of June 30, 2018 was managing just over One Trillion Dollars invested in active funds. Yep, you heard that right – the apostle of Passive Investing runs over 80 active funds.

Recently, one of the better writers of our time, Morgan Housel came to India to deliver a lecture at the India Investment Conference. He is a fantastic writer with focus being on behaviour finance. In one of his earlier interviews with Vishal Khandelwal, he mentioned that his investment consisted of only Vanguard Total Stock Market Index. He talked about the same in an interview to ET Now a few weeks back as well.

Morgan works at Collaborative Fund. Collaborative Fund is a Micro Venture capital that has through 4 funds raised $250 million from investors for investing into start-up’s. If active investing were to be graded based on the risk profile of the investment, active investing would be right up there along with Private Equity and other new age investing beliefs.

“Don’t look for the needle in the haystack. Just buy the haystack!”  wrote John C. Bogle in his book, The Little Book of Common Sense Investing.

David Swensen, the chief investment officer at Yale University writes,

“Understanding the difficulty of identifying superior hedge fund, venture capital, and leverage buyout investments leads to the conclusion that hurdles for casual investors stand insurmountably high. Even many well-equipped investors fail to clear the hurdles necessary to achieve consistent success in producing market-beating active management results.”

In his book, Unconventional Success, he presents the following table;

In other words, most investors in PE funds, Hedge Funds and Venture Capital funds will generate sub-par returns. Yet, Trillions of Dollars chase the fantasy of being able to invest in the fund that may fund the next Facebook or next Alibaba.

I am a great fan of Morgan Housel’s writing yet wonder if he truly believes in what he says & I quote  “I don’t think investing needs to be complicated so I keep it as simple as I possibly can” – needs to be dished out to investors of their own funds.

I think the biggest contribution of Bogle was not the fact that its impossible to beat the market – its tough, but not impossible but showcasing the fact that fees has a very high impact on returns. Lower the fees, higher the returns – its that simple.

Vanguard’s own active funds charge a median fee of just 0.05%. This low fee ensures that the fund manager need not take unnecessary risks to generate Alpha.

Just to give a comparison with mutual funds in India, most of them charge on an average around 2.05% for regular funds and 1.20% for Direct Funds (Asset Weighted). Easy pickings in the past have meant that even post high expenses, many a fund manager has been able to handsomely beat the benchmark.

New rules combined with huge inflow of funds seem to rock the gravy train as funds will find it extremely tough to outperform the passive indices. Cutting down on fees is the easiest way to generate better performance, but why bother when funds are flowing into active funds like no tomorrow.

“Kitna deti hai?” was a campaign launched by Maruti to showcase our obsession with mileage. Then again, how can we be blamed given the high cost of fuel thanks to loads of government taxes. Every car manufacturer wishes to maximize the miles per litre. While a lot of savings come from optimizing the engine, one of the ways to add mileage is by reducing the drag of the vechile.

The higher the resistance a vehicle offers to the wind, lower the mileage. Car Manufacturers spend big money trying to optimize the design that reduces the same while still adhering to the overall design concept. A Formula 1 for example has the lowest amount of wind resistance but is unlikely to in favors if introduced as a family vehicle.

Friction in finance eliminates returns – higher the friction, greater is the reduction in return for every unit risked. Ritholtz Wealth Management offers Financial Planning and invests their clients money into cheap, low fee products.

But much of the savings they produce to the client are eliminated by their own fee which is a percentage that is many a multiple of the fees charged by actual money managers. This again is friction and the client finally ends up with much lower return.

The biggest fear of Universities and Research Labs are of their best and brightest weaned away from Campuses and Labs to Wall Street. After all, no University or Lab can compete when it comes to the pay Wall Street is willing to offer.

This pay though comes straight out of the pocket of investors. In good years, the fund manager takes not only a management fee but part of the profits as well. In bad years, he is more considerate and takes away just the management fee.

Do that for decades and the investor ends up with just a small part of the overall profit that has been generated using his capital. Mutual Funds aren’t that bad, but their Alpha contracting, the fees over time will eat up into significant returns.

Warren Buffett charges a minuscule percentage for managing the Billions he is in charge of. It’s been calculated that if Buffett had charged what is charged by much of the fund industry – 2% management fee and 20% share of profits, his investors would have stood to lose a lot.

Eliminating friction is a step towards achieving your financial goals faster. The lower the costs, better the return – its as simple as that. The reason to choose an Index Fund rather than active fund lie in the fact that identifying active fund that shall be the winners of the future is incredibly difficult.

Low Fee Active Investing is the path forward. Everything else is secondary.


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