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Clash Of The Index Cultures

Written by Paul Amery

 –  September 14, 2012

IndexUniverse.com managing editor Olly Ludwig talks with Vanguard founder John Bogle about his new book, “The Clash of the Cultures: Investment vs. Speculation”, the state of indexing, his ongoing reservations with overly traded ETFs and the wisdom of adding corporate bonds to fixed-income allocations in this age of financial repression.

Ludwig: Reading the book, it seemed like an extension of the 1951 thesis you did at Princeton. It’s as if you’ve been saying the same thing through the years, but each time it’s a bit more trenchant, well-organised and to the point.

Bogle: You’re very kind to say that. I guess the basic values and ideals are there. I’ve lived a long time between the thesis and the book, so I’ve had a lot of experience. And at a certain point in life, you start to get a little wisdom. So I think it’s maybe a little more impassioned now, and maybe a hair more sophisticated. But the basic value is and basic strategy has been really quite consistent throughout my long career.

Ludwig: Well it was certainly a pleasure to read. When I’m feeling dark, I think the financial world is full of mendacity and legalised theft. And then I encounter you and I think: “Hey, there is hope after all!”

In any case, there are some people who say that Rob Arnott in Newport Beach, Calif. is the second coming of John Bogle, and that this fundamental indexing thing is the next logical chapter. Do you have any opinions about that?

Bogle: Well, yes. His back-testing thing is wonderful. I never saw a back-test that wasn’t. Obviously, if you back-test and it doesn’t work, it’s never heard from again. And when after X number of tries you finally find one that works, you can brag about it. But I’m struck by the fact—I was just looking at this the other day—in a recent period looking at his returns to Sept. 1, 2012, his RAFI 1000 ETF (NYSEArca: PRF) is up 448, and our total stock market ETF (NYSEArca: VTI) is up 413. I think we can call that a tie.

But when you look at the risk involved, the standard deviation is a good 15 percent higher, at 22.8. We have a deviation of 19.8. So that’s higher risk for an indifferent improvement and reward.

Ludwig: The Vanguard fund you’re talking about is what, the ETF that would trade under VTI, is that correct?

Bogle: I can’t quite get a grip on what the system is, but he made it, and I’m sure he’s doing as best he can. All these things are much harder when you go away from market weight. A company improves its dividend by 20 percent, and you’ve got to adjust. There are a lot of adjustments. And he probably runs a significantly higher turnover than we do.

Ludwig: It’s basically a fund with a small-cap and value tilt, isn’t it?

Bogle: That’s exactly what it is.

Ludwig: So you’re going to stick to your knitting in terms of market-cap weighting until the bitter end.

Bogle: Exactly, until the last dog dies. I want to say in both cases—cap-weighting and RAFI—because everything in this business is so non-symmetrical, he can’t be a lot better and he can’t be a lot worse.

Ludwig: And you make the argument for cap-weighting mindful that at its worst, it has brought us mispricings like Cisco—which everyone always talks about when they talk about the weakness of cap weighting. You talk about in your book quite a lot that the equity rally of the past generation in many ways really was unrealistic because it’s just beyond the pale in terms of the historical pattern of returns. And that’s because it was fictitious on some level, if I may paraphrase your narrative a little bit.

Bogle: I think the point you read into is really a very good one. There are a lot of problems with cap-weight indexing. You’re going to have these big stocks—many of which are now gone after the early 2000s. And Cisco is now probably down 80 percent. And you say well, therefore, the index isn’t very good. The rejoinder to that is, if the index is lousy and it beats 55 to 75 percent of all the managers, they ought to be thankful that we aren’t starting a good index.



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Thursday, September 06, 2012 13:29 (CET)

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