Dogs in fights

A friend recently sent me a pdf file of a piece by Yesim Tokat, Ph.D., of Investment Counseling & Research, which as far as I can tell is Vanguard’s R&D division.

Here is the link:

And here are a few paragraphs from the Executive Summary (I guess in blogland I am supposed to call these the money quotes) (edits and emphases mine):


Executive Summary

. . . [W]e conclude that:

. . .

• The ultimate concern in the active/passive decision is whether active management can increase the returns and/or decrease the risks of a portfolio, not whether it decreases the portfolio’s R2 over time or across funds. We find that, on average, active management reduces a portfolio’s returns and increases its volatility compared with a static index implementation of the portfolio’s asset allocation policy.

• The influence of security selection and market-timing on returns can be more significant. However, active strategies tend to have a high skill hurdle, less stable and less predictable relative returns over time, and higher costs.

• Unless there is a strong belief in the ability to select active managers who will deliver higher risk-adjusted net returns, investors’ focus should be on the asset allocation choice and its implementation using broadly diversified, low-cost portfolios with limited market-timing.

So I have to admit that I have not read the pdf file other than the Executive Summary (a good chunk of which is not included above), as my mind starts jello’ing at about the time all the references to R2values start swimming by, with memories of both bad and good statistics classes floating on by with them, together with the unfortunate fact that my last statistics class, at a world-renowned and very fine institution at that, was a terrible misfit of a class that helped turn even the most numbers-hungry among us away from (as Yogi would say) stat-atistics.

But I do have one comment on what I did read. Please read on.

* * *


I am an adherent of passive investing. Passive investing is a friend of mine.

So I believe that most people should put a good chunk of their financial assets into passively managed financial assets because, as the bullet above states, “active strategies tend to have a high skill hurdle,” and because I think very few laypeople have surmounted that hurdle (and only a tad more professional active managers have).

That’s why we get Dalbar studies and the like telling us that, when left to our own devices, most of us active our way into investment experiences that, overall, way under-perform the broad market — way Way WAY under-perform the broad market — so that the average investor, on his or her own, tends to do worse than average when it comes to investing.

It’s like the opposite of Garrison Keillor’s townsfolk.


* * *

As an adherent to passive investing, I have long admired Vanguard and its business model; even to this day I mostly admire Vanguard’s way of doing business.

Both it and Fidelity are private companies, in the sense that they do not allow ownership interests of themselves, i.e., shares of stock, to be sold to the public. And that, perhaps more than anything else, explains why they seem to be a bit more above the fray than the Januses and the Putnams of the world, which, in one way or another, have been divisions of publicly traded companies. (The Capital Group Companies, which puts out the American Funds, the preeminent proponent of the opposite of passive investing, i.e., active investing, is also, as far as I know, a private company.)

But when Vanguard puts out a piece like the one linked to above, I don’t give it all that much credence. Vanguard, as they say, has way too much dog in that fight.

So I would not rest too much on Vanguard’s own research; there are plenty of non-Vanguard folks out there singing the same tune who are much more objective.

Think of it this way: would Vanguard publish this fellow Tokat’s works if he came to the opposite conclusion?

Maybe. Maybe not.

* * *

Now not all that long ago (five to ten years ago?) Vanguard was led by a fellow named John Bogle. He started the company (as far as I know) and was, and always has been, pretty much the pied piper of passive investing. Much to the chagrin of all but a handful of folks on Wall Street, nearly all of whom saw active investing as Us and All that is True and Right in the World (and so what if it screws customers out of their hard earned money) and saw passive investing as The En Uh Me (and it’s a big deal when something screws us out of our hard-earned [by whose standards?] 6- and 7-figure end of year bonuses), Bogle built a mutual fund behemoth built upon passive investing .

Bogle, bless his heart, stepped right into that fray and, even better, thrived inside of it. Doing so made him (presumably) rich, put Vanguard on the (figurative) map, and made passive investing (at least somewhat) respectable. Bogle made it possible for all of us to passively invest. He was in most senses of the word, then, a rebel.

Now here and there I’ve disagreed with some of what John has to say — and I have no idea what his overall politics are; he might have voted for Bush twice for all I know — but in general I think he’s right about most things investing (he has always, for instance, been a big proponent of the idea that dividends are key to investing performance, an idea that has come back bigtime after being out of favor, for, literally, decades).


* * *


And that’s why I am always happy to recommend Vanguard to people: it’s the house that Bogle built, and it’s therefore a great house for passive investing.

But I always do so knowing that Vanguard’s heyday under Bogle is behind it. Passive investing is now too big a niche to be a niche, with Fidelity and E*Trade (a very much publicly traded company for which I once worked, and in which I still own stock) competing particularly well in that field.

And John, as far as I can tell, pretty much got booted out of Vanguard (I’ve never heard the precise story, and I can’t find one online, but as I recall his departure was a big surprise).

So when I see that Vanguard’s research folks came up with some research reaching the conclusion that passive investing is the best approach, I don’t think all that much of it: the passive investing dog in that fight is named Vanny the Guard Dog, and Vanguard the passive investing company clearly wants Vanny the Guard Dog to win.


* * *


Now if the internal Vanguard R&D folks had reached the opposite conclusion — that active investing was where it was at — and had done that when Bogle was still at the helm, my hunch is that Bogle would have gone into a weeks-long study intensive with the researchers, trying to understand their conclusions and the research, because the research was telling him that something he had always thought to be false was in fact true and that something he had always thought to be true was in fact false.

And Bogle seemed like a guy who would really want to get to the bottom of that.

But how about Brennan, the new guy (or not so new guy, I guess I should say) at the helm? I don’t get the same feeling from him. He feels more like an MBA-guy to me, to Bogle’s wide-eyed passive-investing fundamentalist.

So it feels to me like Brennan is a manager who happens to be managing a company which has passive investing as its bread and butter (by the way, Brennan looks an awful lot like the main guy in the 40-Year-Old Virgin, a movie I suggest you avoid if at all possible), while Bogle was a passive investor fundamentalist who happened to grow a very large company based upon a principal that he thought was The Truth.

Personally, I like dealing with people who do what they do because they haven’t a choice: it’s what they have to do because it is them, because it’s their truth.

Now I don’t know for sure whether Brennan has that about him or not. But he’s been in the public eye long enough for me to say that the absence of my having that feeling about him is probably an indication that he doesn’t have it. Bogle, on the other hand, had it coming out of his pores every time you saw him speak or read a paragraph he wrote. He couldn’t help himself, and that’s why I always felt confident in Vanguard’s approach when he was at the helm: it was a company founded upon a principal, with a clear touchstone to always keep its head on straight.

Come to think of it, that’s true for everyone with whom I do business: is there a joy in it for them? Do they do it because they love it, or do they do it because it pays the bills? I’ll always prefer hitching my wagon to people who do what they do because they love it.

* * *

So what’d’ya know? I start out to write an entry about passive investing and conflicts of interest, and instead I end up with an entry about a corollary to The Exquisite Balance: about having passion for our work.

January is still with us, eh?

So I conclude today’s piece with a simple exhortation: may you find passion in your work!


Leave a Comment