John "Jack" Bogle is an icon and pioneer in the index-investing revolution. He is regularly quoted for his investor-first views centered on the idea that attempting to beat the market is folly.
He should know. His early career days at Wellington involved work trying — and failing — to beat the market. The creator of the first index mutual fund more than 30 years ago, and founder of Vanguard, a mutual fund and ETF giant with some $4 trillion in assets under management, has long been known as a champion of indexing.
But the vocal indexer isn't really preaching the end of active management.
Speaking to an audience of 2,000-plus managers and investors at the Morningstar Investment Conference last week, Bogle said that index investing would probably come to represent 50 percent to 60 percent of the overall market someday. Active managers will survive, but only those who adapt to the times.
The recipe for survival? Well, it depends on who you ask. Many market pundits, researchers and even consulting groups have offered various takes on what active managers need to do to thrive in the face of low-cost indexing's growing dominance. Bogle cited several in his keynote presentation in Chicago last week.
Some, according to him, suggested active managers offer better active strategies, some better track records, some better business models, better value propositions, and some even better use of technology.
Meanwhile, the evidence against active managers is pretty damning. Anyone who's ever read a SPIVA report has seen firsthand the statistics that show active managers, by and large, underperform benchmarks after cost year after year. Those who do manage to eke out some outperformance only do so occasionally. Consistency in outperformance is nonexistent.
So all the suggestions on what active managers need to do are great, he says, but none really mean much to investors if fees remain as high as they are. Active management is expensive, and investors don't really share in the gains.
"Managing mutual funds typically remains an insanely profitable business, with pretax profit margins often exceeding 50 percent," he said. "During 1982-2016, we've been blessed with the strongest stock market in history. The S&P 500 enjoyed a 50-fold-cumulative gain, an average return of 12.1 percent. Few if any mutual funds earned this return for their shareholders, but no one seemed to notice because few shareholders were unhappy when they received, say, a 30-fold or 40-fold gain."
Costs are everything
In investing, Bogle says, costs are everything. And active managers would have a very difficult time outperforming the market after costs. But trimming management fees enough to compete with index funds would "decimate" profits and be "a slap in the face to the public owners who have become used to profit growth."
In other words, active managers aren't likely to tackle cost in a level that would matter. Bogle says the only real alternative to succeeding in this business is by putting investors first.
That philosophy has worked wonders for Vanguard and its shareholders, even in the firm's active strategies. Bogle's call to active managers is to embrace what he calls a "fiduciary strategy."
"I understand that all enterprises face conflicts of interest, and balancing business values with fiduciary values is no easy task," he said. In the past few decades, growing the business and reaping the profits has been more prevalent among active managers than fiduciary duty.
'Informed opinion is catching up'
But investors are increasingly aware that the focus on the business side — and not on the fiduciary values — has worked for the benefit of mutual fund managers, not the investors. As Bogle put it: "Informed opinion is catching up."
Once a true fiduciary strategy takes hold as the norm among active managers, fees will naturally decline; disciplined, long-term investing will reign; and the fund-management industry will go back to its origins of "We sell what we make" instead of the present policy of "We make what will sell," Bogle said.
Bogle says that a shareholder-first approach to doing business is the only way active managers will survive.
— By Cinthia Murphy, ETF.com