John Bogle's "Philosophical Disagreement" with Eugene Fama

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BackInTheBlack
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John Bogle's "Philosophical Disagreement" with Eugene Fama

Post by BackInTheBlack » Sat Nov 09, 2013 12:38 pm

If this has already been discussed, I apologize, but I read an interesting article on businessinsider.com discussing Bogle and Fama's dissonant views on the Efficient Market Hypothesis:
"EMH is sometimes correct and sometimes incorrect," (Bogle) added.

Perhaps the most glaring problem people have with EMH is its interpretation of asset bubbles. How can markets be efficient if we experience bubbles?

"Dr. Fama doesn't recognize bubbles," criticized Bogle. "It's not very complicated."

What I find particularly fascinating about this is the fact that Bogle's brainchild, the plain-vanilla index fund, is more suited to the efficient market hypothesis which he somewhat rejects (at least to the extent that it's universal), whereas Fama's DFA Advisors is more suited to inefficient markets, with factor-tilts and the like: if markets were totally efficient then there would be no persistent value premium for example, but for some reason, the phenomenon remains. Anyway, I thought this little article was some nice food for thought (which resonates with my own thinking), and hearkens back to the words of Benjamin Graham: "In the short run, the market is a voting machine but in the long run it is a weighing machine."

Obviously, the fact that Robert Shiller and Fama won the Nobel prize in the same year is a smacking bit or irony, and just makes the debate that much more fun. :mrgreen:

Here's the link to the article: http://www.businessinsider.com/jack-bog ... ma-2013-10
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by pingo » Sat Nov 09, 2013 1:03 pm

It is fascinating.

His brain child doesn't recognize bubbles, and his philosophy is to invest all equities at market weight (and to invest it all here in the U.S.), but his philosophy also allows him to adjust when he reasonably expects low future returns due to high price-to-earnings, low earnings, low earnings growth, low dividends and low dividend growth. I suppose that's how he recognizes bubbles while being conservative in his verbiage when he thinks it is the case.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by BackInTheBlack » Sat Nov 09, 2013 1:07 pm

pingo wrote:It is fascinating.

His brain child doesn't recognize bubbles, and his philosophy is to invest all equities at market weight (and to invest it all here in the U.S.), but his philosophy also allows him to adjust when he reasonably expects low future returns due to high price-to-earnings, low earnings, low earnings growth, low dividends and low dividend growth. I suppose that's how he recognizes bubbles while being conservative in his verbiage when he thinks it is the case.
Maybe it's his way of ensuring that the "factor models" continue to work, by spreading EMH philosophy as far and wide as possible to throw the broad investing population off the scent, thereby claiming both academic as well as financial rewards in the process - sheer genius! :moneybag :wink:
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 1:16 pm

Barry Ritholtz wrote an interesting column bearing on this topic, called How Shiller helped Fama win the Nobel with observations on how Fama's own views have evolved over time.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by baw703916 » Sat Nov 09, 2013 1:26 pm

One discussion I read some years ago (I can't remember the exact source) draws a distinction between "efficient" and accurate. Efficient implies that the market prices all assets to reflect the consensus among all participants and to quickly reflect any new information: "You rarely if ever know anything that the market doesn't." Of course the information can be misinterpreted and the consensus can just be wrong: in 1999 not every dotcom was destined to make its investors billionaires.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by umfundi » Sat Nov 09, 2013 1:43 pm

Efficient does not mean rational.

The Nobel Prize was announced during BH2013. Jack Bogle spent some time discussing his principles, and said his ideas do not depend on the Efficient Market Hypothesis. Rather, it is the "Cost Matters Hypothesis".

The Wall Street Journal published a letter from Jack Bogle about this.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by robertalpert » Sat Nov 09, 2013 1:50 pm

umfundi wrote:Efficient does not mean rational.

Keith
Efficient may be akin to reliability of information about price of securities. But given the herd behavior of buyers, that is far different from validity (the security's actual worth).

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by matjen » Sat Nov 09, 2013 2:47 pm

nisiprius wrote:Barry Ritholtz wrote an interesting column bearing on this topic, called How Shiller helped Fama win the Nobel with observations on how Fama's own views have evolved over time.
I found OP's original article and Ritholtz's article both vague and sloppy. For a little more detail without the political ex-post story telling that Ritholtz constantly employs look to Cochrane's summary of Fama's work. http://johnhcochrane.blogspot.com/2013/ ... nobel.html

EDIT:
I should add that Rex Sinquefield was very, very, very (first? Second? Third?) early on the index bandwagon as well. We can quibble about who was first and who was for the retail investor or whatever but Fama was certainly an influence on Sinquefield I would think. http://en.wikipedia.org/wiki/Rex_Sinquefield
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by bertilak » Sat Nov 09, 2013 3:05 pm

I lean towards the interpretation of EMH as "The market is more efficient than you are." It's a lousy predictor of the future but not as lousy as almost(?) any one investor.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by staythecourse » Sat Nov 09, 2013 3:27 pm

I did notice how vehemently Mr. Bogle was opposed to being influenced by Mr. Fama's work. I am wondering if it goes beyond just the EMH philosophy? Guess we will never know, but does not sound like they are good "friends"? I have seen Mr. Bogle numerous times not agree with other opinions, but he seemed extra irrate about this one.

I could (and probably am) completely wrong about this, but just saw his reactiong quite interesting.

Good luck.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by larryswedroe » Sat Nov 09, 2013 3:41 pm

Backintheblack
unfortunately your statements are incorrect on facts.
DFA funds are in fact based on markets being efficient, not inefficient. Value and size premiums are (in at least from Fama and French's viewpoint) based on risk, same as beta premium is. So they should persist

Second, efficient doesn't mean right or even that bubbles cannot exist. It's just that the current price is the best estimate of the right price--we don't know the right price. And it's efficient if active investors cannot persistently exploit anomalies to generate alpha after costs.

Now even Fama doesn't believe markets are perfectly efficient--and DFA has used screens for certain types of stocks for decades, clearly showing he doesn't believe they are perfectly efficient---and they have added MOM for 10 years now, and that is even in Fama's words the biggest challenge for the EMH

Best wishes
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by baw703916 » Sat Nov 09, 2013 3:47 pm

bertilak wrote:I lean towards the interpretation of EMH as "The market is more efficient than you are." It's a lousy predictor of the future but not as lousy as almost(?) any one investor.
I happened to find this old article just now which espouses this point of view (and quotes, Fama, Schiller, Sharpe, etc.) on the issue of market efficiency and how it can be reconciled with behavioralism:

Is The Market Rational? No, say the experts. But neither are you--so don't go thinking you can outsmart it.

I thought it was quite good and informative.

Brad
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by umfundi » Sat Nov 09, 2013 3:48 pm

staythecourse wrote:I did notice how vehemently Mr. Bogle was opposed to being influenced by Mr. Fama's work. I am wondering if it goes beyond just the EMH philosophy? Guess we will never know, but does not sound like they are good "friends"? I have seen Mr. Bogle numerous times not agree with other opinions, but he seemed extra irrate about this one.

I could (and probably am) completely wrong about this, but just saw his reactiong quite interesting.

Good luck.
Jack Bogle wrote:
Perhaps to my shame, I didn't even learn of Eugene Fama's "efficient market hypothesis" (EMH) until a decade after my creation of the 500 Index Fund. Rather, I was inspired by another Nobel laureate, economist Paul Samuelson, who in his 1974 essay in the Journal of Portfolio Management demanded "brute evidence" that active money managers could beat the market index. Such evidence has yet to be produced.
I'd simply take that at face value.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by JoMoney » Sat Nov 09, 2013 3:56 pm

bertilak wrote:I lean towards the interpretation of EMH as "The market is more efficient than you are." It's a lousy predictor of the future but not as lousy as almost(?) any one investor.
:thumbsup
I don't think of the market as being rational, or the result of people efficiently pricing "risk premiums"... but in an active liquid market, the price represents more than anything any individual could surmise on their own.
John Bogle wrote: http://johncbogle.com/wordpress/wp-cont ... 0op-ed.pdf
First let us put to rest the canard that the remarkable success of traditional marketweighted indexing rests on the notion that markets must be efficient. Even if our stock markets were inefficient, capitalization-weighted indexing would still be -- must be -- an optimal investment strategy. All the stocks in the market must be held by someone. Thus, investors as a whole must earn the market return when that return is measured by a capitalization-weighted total stock market index. We can not live in Garrison Keillor's Lake Wobegon, where all the children are above average. For every investor who outperforms the market, there must be another investor who underperforms. Beating the market, in principle, must be a zero-sum game. But only before the deduction of investment management costs...
http://marriottschool.net/emp/SRT/passive.html
... the argument for indexing is even stronger for individual investors if the stock market is not efficient. The game of poker provides, in some respects, an instructive analogy. Poker is a zero sum game, similar to active investing compared to indexing, and poker combines luck and skill, consistent with the assumption of a less than perfectly efficient market. An old adage among professional poker players applies to those deciding to participate in the active investing game. "If you don't know who the mark is, get up and leave the table, because it's you."
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Calm Man » Sat Nov 09, 2013 4:17 pm

I"ll go with Jack. He has no stake anymore in what he says wile Fama gets a cut of all the action he brings in.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by kenner » Sat Nov 09, 2013 4:18 pm

Seems that sometimes investor irrationality affects market prices. Eventually, Bogle's ideas are correct.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Jack » Sat Nov 09, 2013 4:22 pm

matjen wrote:For a little more detail without the political ex-post story telling that Ritholtz constantly employs look to Cochrane's summary of Fama's work.
It is worth noting that Cochrane is Fama's son-in-law, not exactly a neutral commentator on the subject.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Bradley » Sat Nov 09, 2013 4:29 pm

The following reference is an interview with Gene Fama of market efficiency which should clear up some misconceptions. Many journalists, commentators and talking heads seem to think the hypothesis claims the prices are always “correct” and forward looking. They point to bubbles/volatility in their feeble attempt to discredit EMH. It appears the video was made to address some of the criticisms of EMH brought out in the 2008 market moves. Very good video and well worth the time for anyone interested in market efficiency theory.


Fama on Market Efficiency in a Volatile Market ( Go to DFA website, Fama/French Forum, Videos..............Fama on Market Efficiency in a Volatile Market )

Widely cited as the father of the efficient market hypothesis and one of its strongest advocates, Professor Eugene Fama examines his groundbreaking idea in the context of the 2008 and 2009 markets. He outlines the benefits and limitations of efficient markets for everyday investors and is interviewed by the Chairman of Dimensional Fund Advisors in Europe, David Salisbury.


Q. So if I can sum up in layman’s terms-what you are saying is that EMH is not a perfect explanation of everything that happens in the markets-but it is the best working proposition for use by investors in a practical sense-that most investors should presume that the only way in which they can reliably effect the expected return from their portfolios is by verifying the level of risk they are prepared to take.

A. Absolutely true.

Q. And nothing that has happened in the last 12 months that has altered that in any way?

A. No, I don’t see any informed opinion to the contrary on that. There are some people claiming that markets are not efficient-but they are not claiming there are easy profit opportunities out there, which seems like a conflict to me – it is either one or the other.
You can sum up any active fund manager’s presentation at an investor conference in one sentence: “We’re doing well, all things considered.”

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by umfundi » Sat Nov 09, 2013 4:42 pm

There are some people claiming that markets are not efficient-but they are not claiming there are easy profit opportunities out there, which seems like a conflict to me – it is either one or the other.
Fama misses the point that there are legions of people like me who are too stupid to take advantage of the inefficiencies.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by matjen » Sat Nov 09, 2013 4:47 pm

Jack wrote:
matjen wrote:For a little more detail without the political ex-post story telling that Ritholtz constantly employs look to Cochrane's summary of Fama's work.
It is worth noting that Cochrane is Fama's son-in-law, not exactly a neutral commentator on the subject.
Fair enough, though I don't think there is any overt bias in that write up. He did the same thing for Shiller and Hansen. Good overviews of their work it seems to me. Here is the Shiller one: http://johnhcochrane.blogspot.com/2013/ ... nobel.html
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by staythecourse » Sat Nov 09, 2013 4:55 pm

matjen wrote:EDIT:I should add that Rex Sinquefield was very, very, very (first? Second? Third?) early on the index bandwagon as well. We can quibble about who was first and who was for the retail investor or whatever but Fama was certainly an influence on Sinquefield I would think. http://en.wikipedia.org/wiki/Rex_Sinquefield
Don't want to steal the thread, but I also read in a book about talking about Mr. Sinquefield that he was in fact the originator of the first index fund. It was sold through ?first bank of chicago or something like that. It was for instituional players and was a small cap fund. He started one and I believe Mr. Booth did as well around the same time. They were both students of Mr. Fama at UofC B-school. The, of course, soon got together in an apartment and formed DFA. Or something like that.

If it is true I am always surprised that he is not upset at Mr. Bogle getting the credit for the first index fund when it should have been him.

If someone knows better please correct me because I have always been interested in who really did create the first index fund just out of curiosity.

BTW, I never hear Mr. Sinquefield (who is with DFA of course) talk publicly in interviews. Does he not give out interviews?

Good luck.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by larryswedroe » Sat Nov 09, 2013 5:32 pm

staythecourse
Bogle created the first MUTUAL fund that was index fund, not the first index fund.
Sinquefeld created it for a pension plan, and he and Booth created the microcap (9-10 fund)
Larry

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by matjen » Sat Nov 09, 2013 5:35 pm

Here is an excellent new video where EMH is summarized by Prof. Cochrane. Fast forward to 33:45. He goes for 10 minutes and I think much of what he says will resonate with Bogleheads. Prof. Moskowitz follows with 10 minutes on the Fama French Model. Factor investing.

http://www.youtube.com/watch?v=-7CnFC6iUSo&noredirect=1

Staythecourse. I think people like to distinguish Bogle as the first for retail investors. I think the others were for pension funds/institutional types. I saw Sinquefield present at CFA meeting in Chicago a few years back. He was quite good.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 5:44 pm

staythecourse wrote:...BTW, I never hear Mr. Sinquefield (who is with DFA of course) talk publicly in interviews. Does he not give out interviews?
I think he's a prominent politician in... is it Missouri? Yes. So I think he surely must "talk publicly in interviews" about something. I'm not aware of much in the way of public statements by Booth, either.

I'm very curious about "sibling rivalry" between Vanguard and DFA but I don't think I'm ever going to have that curiosity satisfied. As noted in the Wiki article on DFA, Sinquefeld's involvement was in the Samsonite Luggage Fund, a private pension fund, that was originally to hold an equal dollar amount of every stock listed on the New York Stock Exchange. Bogle responds sharply to any suggestions that this was the first index fund, or that the Vanguard 500 Index Fund was merely the first "retail" index fund. His blog here includes two back-and-forth letters in the Wall Street Journal.

Bogle says, with some justice I think, that the Samsonite fund's equal weight was so ill-conceived, given the technology and trading costs of the era, that it shouldn't count. Bogle writes "That index strategy was a failure. It relied on a price-weighted — not market-cap-weighted — index, and was thus overwhelmed by frequent trading and its attendant transaction costs." It does seem as if someone could have anticipated this before creating the fund.

Even today, there are products that implement an equal-weighted S&P 500 index, but is anyone aware of any that implement equal-weighting farther down into small-caps than the S&P 500?

I've also been curious about the comments in Burton Malkiel's 1973 edition of A Random Walk Down Wall Street. After the famous passage, "Whenever below-average performance on the part of any mutual fund is noticed, fund spokesmen are quick to point out "You can't buy the averages." It's time the public could," Malkiel then goes on to say that "if the New York Stock Exchange (which, incidentally has considered such a fund) is unwilling to do it..." I'd very much like to know more about the NYSE's considering such a fund.

Charles D. Ellis' article, "The Loser's Game," appeared in 1975.

It seems pretty clear that indexing was "in the air" in the early 1970s.

It also seems pretty clear that the creation of the first index fund was motivated both by its intrinsic merit, but also as a ploy on Bogle's part for sidestepping a contract restriction on what Vanguard could and could not do. Some legal language that restricted the creation of an actively managed mutual fund, the only kind then known, but allowed the creation of an index fund because it did not involve "management." Something like that.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 5:51 pm

A YouTube search on "Rex Sinquefield" turns up numerous hits. Few of them could be discussed in this forum, however.

Maybe this one, which I have NOT viewed:How Well Do Financial Markets Work?
In the final Show-Me Forum of 2011, Missouri Bankers Chair John Howe and Show-Me Institute President Rex Sinquefield discuss the "efficient markets hypothesis," the idea that it's impossible to "beat the market" because stock prices reflect all available information.
Sinquefield appears at about 38 minutes in.

He says you should buy index funds. He just says "index funds" and doesn't qualify it to deal with the technicality of DFA's funds not being index funds.

He says, approximate quote, the big question is how much risk you should take and that's the tough question, one which the academics have never been able to answer and ultimately it comes down to intuition and sad experience. He says that he likes to compare active managers to astrologers, but it isn't right to bad-mouth astrologers. He dumps on ads, magazines, etc. "It's been known since the 1950s that this is all hokum." I listened only to that scrap, so I'm not sure if he says anything about tilting, factor-based investing, and DFA's NOT-index funds...
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by kenner » Sat Nov 09, 2013 6:02 pm

nisiprius wrote:A YouTube search on "Rex Sinquefield" turns up numerous hits. Few of them could be discussed in this forum, however.
Why not? Are Sinquefield's opinions too biased?

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 6:07 pm

kenner wrote:
nisiprius wrote:A YouTube search on "Rex Sinquefield" turns up numerous hits. Few of them could be discussed in this forum, however.
Why not? Are Sinquefield's opinions too biased?
1) They are not about investing. 2) They are not actionable for anyone living outside Missouri. 3) They concern various issues of Missouri politics. Perhaps I can say that Wikipedia has a profile of Rex Sinquefield, and that he's closely identified with the Show-Me Institute, of which he is president.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by HurdyGurdy » Sat Nov 09, 2013 6:11 pm

Jack Bogle refers to Paul Samuelson's short article "Challenge to Judgement", The Journal of Portfolio Management, 1(1): 17-19, 1974.
http://www.iijournals.com/doi/pdfplus/1 ... 974.408496 , as an inspiration.

In that paper, Samuelson says "when investigators --like Irwin Friend, William Sharpe, Jack Treynor, James Lorie, Fischer Black and Myron Scholes [...] --- look to identify those minority groups or methods endowed with sustainable superior investment prowess, they are quite unable to find them. The only honest conclusion is to agree that a loose version of the 'efficient market' or 'random walk' hypothesis accords with the facts of life" .

At the end, Samuelson gives references to his own couple of papers on the subject,
"Proof that properly anticipated prices fluctuate randomly", Industrial Management Review, 1965, 6, 41-49, (http://stevereads.com/papers_to_read/pr ... ndomly.pdf)
and
"Proof that properly discounted present values of assets vibrate randomly", Bell Journal of Economics and Management Science, Autumn 1973, 4, 369-374. (http://www.e-m-h.org/Samuelson1973b.pdf).

Notice how Samuelson does not cite Fama -- perhaps he did not know about him, but Samuelson was on the EMH side.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by 209south » Sat Nov 09, 2013 6:52 pm

I am a huge admirer of Mr. Bogle and have the bulk of my portfolio in index funds at Vanguard. Having said that, it is unimaginable that Vanguard would have grown to the extent it has without the Fama influence. Fama's landmark study of market efficiency was completed in 1965 (with constant improvement continuing to the present) - everything changed with Fama's work, and his Nobel Prize was long overdue. Efficient market theory is the critical underpinning of index funds (i.e. if markets are efficient, active trading is foolhardy...thus index to capture market returns while minimizing transactions costs...)

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Jack » Sat Nov 09, 2013 7:02 pm

209south wrote:Efficient market theory is the critical underpinning of index funds ...
This may be your opinion, but Jack Bogle strongly disagrees and has said so many times.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by FafnerMorell » Sat Nov 09, 2013 7:10 pm

If economics is a science, then I would expect proponents of the "bubbles exist and can be predicted in advance" theory would publish a reproducible method by which this could be proven. I haven't seen that (and no, the Hindenburg Omen doesn't count).

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 7:11 pm

BTW Sinquefield has retired from DFA... but YouTube search on "David G. Booth" also turns up many interviews with David G. Booth, Chairman and Co-CEO of DFA, which look as if they're mostly investing-philosophy related... the listing being intermixed with videos of ice hockey player David Booth of the Vancouver Canucks.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by umfundi » Sat Nov 09, 2013 7:13 pm

FafnerMorell wrote:If economics is a science, then I would expect proponents of the "bubbles exist and can be predicted in advance" theory would publish a reproducible method by which this could be proven. I haven't seen that (and no, the Hindenburg Omen doesn't count).
Kondratiev waves?

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by stlutz » Sat Nov 09, 2013 7:35 pm

it is unimaginable that Vanguard would have grown to the extent it has without the Fama influence. Fama's landmark study of market efficiency was completed in 1965 (with constant improvement continuing to the present) - everything changed with Fama's work, and his Nobel Prize was long overdue. Efficient market theory is the critical underpinning of index funds (i.e. if markets are efficient, active trading is foolhardy...thus index to capture market returns while minimizing transactions costs...)
It is true that everything changed with Fama's later 3-factor work. Whether one is an active or a passive investor, the whole investing world is based around that--for example, the Morningstar style-box. Note that most managers who rely on these boxes believe in active management. In short, the structures that Fama created were more influential than his actual philosophies were.

Vanguard as an entity really didn't take off and become dominant until more recently. Back in the 1980s, they were dwarfed in size by Fidelity. They never participated in any mutual fund "supermarkets" and thus weren't collecting assets when those really took off.

Vanguard really started making more sense to people in the late 90s when active managers who were usually tilting at least somewhat to small and value stocks kept getting beat by the S&P 500. That is when indexing as a strategy really took off. Nobody was convinced by the EMH or anything like that--they were simply performance chasing.

With the advent of ETFs, the cost war really got going and indexing became much more prevalent. Largely because of Bogle, VG was late to the ETF game but quickly caught up because of their low costs.

In short, Fama is hugely influential. That wasn't particularly relevant to Vanguard's success, however.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by bertilak » Sat Nov 09, 2013 8:12 pm

To understand Mr. Bogle's statements about EMH and index funds read chapter 18 of his book Don't Count On It.

SUMMARY of discussion of superiority of indexing in Chapter 18...
  • Mr. Bogle's basic point is that indexing is superior because of costs and that is true without any dependence on EMH. He calls this the CMH (Costs Matters Hypothesis). It goes like this:

    According to Louis Batchelier: "The mathematical expectation of the speculator is zero." Mr. Bogle agrees with this as far as it goes. He reformulates it as "The mathematical expectation of the speculator is a loss equal to the amount of transaction costs incurred."

    He expands this to "The mathematical expectation of the long-term investor also is a shortfall to whatever returns our financial markets ... provide." The shortfall is the sum of all the costs involved (advisory fees, marketing expenditures, loads, commissions, etc.).

    Mr Bogle goes on to say that CMH is enough to explain the superiority of indexing. "Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur." (his emphasis)
Elsewhere in the book he talks of empirical evidence that backs up the above.

MY MISGIVING about the above...
  • I question the above in one respect. We investors care less about the overall average than about whet we, personally, can achieve. Someone must be above average! Why can't it be ME? We all want to be among the winners, not the losers. I think it is EMH that tells us we don't have the skills to be above average. Sure there will always be some (actually, about half) who are above average at any given time but EMH tells us that is the luck of the draw and therefore can't be relied on for consistency. It will average out over time.

    I don't know what Mr. Bogle would say about that directly, but in his Common Sense on Mutual Funds (page 300, Chapter 9) he says: "[F]und managers are mere mortals who operate in highly efficient markets."
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sat Nov 09, 2013 8:13 pm

stlutz wrote:...It is true that everything changed with Fama's later 3-factor work. Whether one is an active or a passive investor, the whole investing world is based around that--for example, the Morningstar style-box. Note that most managers who rely on these boxes believe in active management. In short, the structures that Fama created were more influential than his actual philosophies were.
I don't know quite where it came from, but the general idea that mutual funds were generally underperforming the S&P 500 was pretty current by the early 70s. Well, come to think of it, the S&P 500 index itself was only created in 1957 and it's not at all clear to me what its predecessors really were or how much attention was being paid to them. I think the idea of an index fund would have popped up soon even without any theoretical backing.
Vanguard as an entity really didn't take off and become dominant until more recently. Back in the 1980s, they were dwarfed in size by Fidelity. They never participated in any mutual fund "supermarkets" and thus weren't collecting assets when those really took off.

Vanguard really started making more sense to people in the late 90s when active managers who were usually tilting at least somewhat to small and value stocks kept getting beat by the S&P 500. That is when indexing as a strategy really took off. Nobody was convinced by the EMH or anything like that--they were simply performance chasing....
I think you're right about that. Sad, but probably true. One of the anti-indexing arguments is the straw man that indexers expect index funds to outperform active funds consistently.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by JoMoney » Sat Nov 09, 2013 8:21 pm

stlutz wrote:... Fama is hugely influential. That wasn't particularly relevant to Vanguard's success, however.
If you look at how his research is used to sell non-index funds and alternative strategies to the total-market approach, he's probably been more of a hindrance to Vanguard and traditional indexing, and a boon to "helpers" looking to sell some better way.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Calm Man » Sat Nov 09, 2013 8:37 pm

Fama influential among the populace? You have to be kidding. Maybe in small circles. I am well read and very educated and until a year or 2 ago I never heard of him and only did because of reading about DFA and tilting at this forum. I suspect less than 1/2% of the population has ever heard of this guy.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by pkcrafter » Sat Nov 09, 2013 10:08 pm

Both MPT and EMH were developed under the prevalent theory of the day--Expected Utility Theory. The core premise of Expected Utility Theory is investors as a group use rational judgement to come to the best conclusion. If this theory were correct, Fama would be correct in not believing in bubbles. But EUT has now been thrown out in favor of Prospect Theory. Prospect Theory is largely based on investor behavior, which at times doesn't appear to be rational. One interesting thing about Fama is he (and DFA) have embraced momentum as a forth factor, and momentum can only be the result of investor behavior.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by pingo » Sun Nov 10, 2013 12:21 am

nisiprius wrote:I'm very curious about "sibling rivalry" between Vanguard and DFA but I don't think I'm ever going to have that curiosity satisfied.
Me, too. It never occurred to me that there was any. I don't recall where I read it, but I thought I once read John Bogle claim that he could be perfectly happy investing with Dodge & Cox or DFA, if those were his options. I could be mis-dis-remembering, though.
Last edited by pingo on Sun Nov 10, 2013 2:26 am, edited 1 time in total.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by kenner » Sun Nov 10, 2013 12:22 am

nisiprius wrote:
kenner wrote:
nisiprius wrote:A YouTube search on "Rex Sinquefield" turns up numerous hits. Few of them could be discussed in this forum, however.
Why not? Are Sinquefield's opinions too biased?
1) They are not about investing. 2) They are not actionable for anyone living outside Missouri. 3) They concern various issues of Missouri politics. Perhaps I can say that Wikipedia has a profile of Rex Sinquefield, and that he's closely identified with the Show-Me Institute, of which he is president.
Thanks, Nisi.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by tadamsmar » Sun Nov 10, 2013 9:05 am

Bradley wrote: Fama: No, I don’t see any informed opinion to the contrary on that. There are some people claiming that markets are not efficient-but they are not claiming there are easy profit opportunities out there, which seems like a conflict to me – it is either one or the other.
I think this is the crux of the matter, if Bogle is not claiming that there is a systematic way to profit by timing bubbles, then he has some definition of "bubble" that's not a definition that Fama will accept. For Fama, if "bubble" has a definition, it must include a proven method for prediction. Otherwise, one is just slapping the label "bubble" on trailing fluctuations in prices.

Of course, the Nobel web site's own write-ups on the recently awarded economics prize claim that markets are medium-term predictable, which is something that Fama consider's unproven.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nisiprius » Sun Nov 10, 2013 9:58 am

My personal views, utterly uninformed by economics, is that

a) obviously there are bubbles;
b) I really think it is even possible to tell that one is in a bubble, AND YET
c) I do not think it is possible to profit from that knowledge.

How can b and c both be true? I'm not quite sure. But there is a vague analogy from thermodynamics--one that hung up people for a long time. If you have a bucket of water at a temperature of 68 degrees, you can calculate that there is a lot of thermal energy in that water. The amount of energy doesn't depend on the temperature of the bucket's surroundings. Nevertheless, if the surroundings are at 68 degrees, there is no way to extract any of that energy.

In the case of a bubble, maybe whether there is a bubble or not depends on where you draw a line around the system. Perhaps the bubble itself is a "thing" and your ability exploit the bubble is governed by the efficient market hypothesis--you can't guess any better than the rest of the crowd when the peak will occur or how high it will be, based on publicly available information.

Since there are winners and losers in a bubble, the question is then, who are the winners and how can I become one of them (or why can't I become one of them?) I have two potential answers for this. One is that it is pure chance, a gambling game. I think this is probably true for most of the investors that participate. The other is that the winners are, in fact, those who start the bubble. They have the equivalent of inside information.

A colleague of mine once paid good money to self-publish a rather expensive book, full of color pictures, of antique marbles. Not the junky little glass marbles kids play with, but big glass spheres with beautifully sculpted little animals and things inside. Do a Google Images search on "sulphide marbles." When I asked him about it, he said that his chief motivation was to increase the value of his collection. Similarly, for the right kind of entrepreneur, I am sure there is money to be had in collecting some kind of asset--whether it be as "simple" as launching a slightly novel kind of mutual fund--and then publicizing the value of that kind of asset.

Is it possible to get rich by trying to invest in lots of bubbles when they are in the embryo stage? I suppose that is exactly what angel investors and venture capitalists do. The problem is how to figure out which bubbles will really expand. Maybe it's even possible to have skill that that, but it's not a game you can play unless you have very shrewd entrepreneurial instincts AND, how many zeroes after the one? dollars at your disposal.

At any rate, I think an adequate explanation of bubbles has to somehow explain how they happen AND why it is not easy to profit from them.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by pkcrafter » Sun Nov 10, 2013 11:01 am

a) obviously there are bubbles;
b) I really think it is even possible to tell that one is in a bubble, AND YET
c) I do not think it is possible to profit from that knowledge.
a/b) Yes, there are bubbles, and I think it's difficult to tell when a legitimate rise in prices/valuations ends and a momentum (bubble) run starts.
c) DFA, and Fama, thinks you can profit from momentum. It may be hard to start a bubble just for the idea of capitalizing on it, at least at the market level, but it is done with penny stocks. True bubbles are purely driven by behavior. Buy and hold investors do profit from momentum, but they also get hit when the bubble bursts. On the other hand, market timers don't seem to be able to profit from bubbles because there is no way to know when to move in or out.

Are we in a developing bubble now? Maybe. There certainly is some momentum present and the number of posters who are upping their equity allocations is a troublesome sign. The question is how long can it run. Probably not long because there is no underlying driver like the concept of the internet changing everything in the late 90s. However, I do wonder about the increasing practice of companies buying back stock for the purpose of making earnings look better.

No sibling rivalry between DFA and Vanguard. DFA is actively trying to beat the market, Vanguard is not.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by nedsaid » Sun Nov 10, 2013 11:16 am

For me, markets are efficient enough. For all practical purposes, they are efficient for the average individual investor. The professional traders and arbitrageurs scoop up much of the market inefficiencies. So there isn't so much left for the average Joe.

Bogle's comment about bubbles is brilliant. I have commented many times about paying attention to valuations and paying attentions to extremes in market sentiment. "Staying the course" with absolutely no changes during the times of market bubbles seems to me to be overdoing a normally solid approach. When shoe shine boys on Wall Street are bragging about their huge gains in stocks, it should give investors pause. To me, an investor should seek to be rational when the market is losing its mind during bubbles and panics.

But other than bubbles and panics, the markets are mostly efficient and as another poster pointed out, not always rational. I do believe in the performance factors that are discussed here like small, value, profitability, and momentum. It is harder than one might think to capture them.

So this is why I have no quarrell with buy, hold, rebalance index fund investing. I am slicing and dicing myself.
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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by pingo » Sun Nov 10, 2013 11:41 am

I have always had the impression that John Bogle, like William Bernstein, doesn't speak in terms of bubbles, except perhaps in hindsight. When looking each speaks of lowering their expectations of future returns, which is not speculation or market timing…I think. Bogle, Bernstein, Ferri and Swedroe all look at reasonable, projected, long-term returns for purposes of portfolio planning.

In the case of Mr. Bogle, it has always appeared to me that he adjusts his expectations (and even his allocations) as a matter of weighing the pros and cons of lower stock returns versus the risk one takes for investing in them versus whatever expectations or trade-offs may be reasonable to accept in the bond market. Why have extra risk of stocks when one expects low premia going forward?

I've never had the impression that he believes that he is taking advantage of market conditions for outsized gains or alpha, not that anyone has claimed it.
Last edited by pingo on Sun Nov 10, 2013 12:28 pm, edited 1 time in total.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by VictoriaF » Sun Nov 10, 2013 11:50 am

BackInTheBlack wrote:
pingo wrote:It is fascinating.

His brain child doesn't recognize bubbles, and his philosophy is to invest all equities at market weight (and to invest it all here in the U.S.), but his philosophy also allows him to adjust when he reasonably expects low future returns due to high price-to-earnings, low earnings, low earnings growth, low dividends and low dividend growth. I suppose that's how he recognizes bubbles while being conservative in his verbiage when he thinks it is the case.
Maybe it's his way of ensuring that the "factor models" continue to work, by spreading EMH philosophy as far and wide as possible to throw the broad investing population off the scent, thereby claiming both academic as well as financial rewards in the process - sheer genius! :moneybag :wink:
Are these two paragraphs referring to the same "he"? It seems that pingo is referring to Jack, and BackInTheBlack is referring to Fama.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by VictoriaF » Sun Nov 10, 2013 12:00 pm

staythecourse wrote:I did notice how vehemently Mr. Bogle was opposed to being influenced by Mr. Fama's work. I am wondering if it goes beyond just the EMH philosophy? Guess we will never know, but does not sound like they are good "friends"? I have seen Mr. Bogle numerous times not agree with other opinions, but he seemed extra irrate about this one.

I could (and probably am) completely wrong about this, but just saw his reactiong quite interesting.

Good luck.
Look at it from the Jack's point of view. Jack did not invent index funds; but he has created them, and innovated, and persisted against an enormous backlash from the industry until index funds started to flourish. In the meantime, Fama was sitting in his ivory tower developing his theories.

When Jack was creating index funds he did not know who Fama was; Fama did not invent index funds. Jack was doing the hard work of making index funds available to us.

Now, that Fama has won his Nobel, people simple-mindedly and sloppily give him credit for index funds. Worse, people now imply that Jack has learned from Fama, which he did not. Jack needs to use strong, decisive language to distinguish his achievements and get decoupled from being bundled with Fama.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by Rob't » Sun Nov 10, 2013 12:19 pm

umfundi wrote:
staythecourse wrote:I did notice how vehemently Mr. Bogle was opposed to being influenced by Mr. Fama's work. I am wondering if it goes beyond just the EMH philosophy? Guess we will never know, but does not sound like they are good "friends"? I have seen Mr. Bogle numerous times not agree with other opinions, but he seemed extra irrate about this one.

I could (and probably am) completely wrong about this, but just saw his reactiong quite interesting.

Good luck.
Jack Bogle wrote:
Perhaps to my shame, I didn't even learn of Eugene Fama's "efficient market hypothesis" (EMH) until a decade after my creation of the 500 Index Fund. Rather, I was inspired by another Nobel laureate, economist Paul Samuelson, who in his 1974 essay in the Journal of Portfolio Management demanded "brute evidence" that active money managers could beat the market index. Such evidence has yet to be produced.
I'd simply take that at face value.
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I have to agree with staythecourse here; Jack's response seemed personal and persistent. I suspect he has more than truth impacting the choice of those he purports to be influenced by. If I am to take Jack's explanation at face value, I insist on doing so with a grain of salt.
Calm Man wrote:I"ll go with Jack. He has no stake anymore in what he says wile Fama gets a cut of all the action he brings in.
This is silly. I read Jack as having significantly more stake in this than Fama. Jack is about honor, reputation, and influence; if he were about money Vanguard would be privately held like Fidelity.
pkcrafter wrote:
a) obviously there are bubbles;
b) I really think it is even possible to tell that one is in a bubble, AND YET
c) I do not think it is possible to profit from that knowledge.

No sibling rivalry between DFA and Vanguard. DFA is actively trying to beat the market, Vanguard is not.

Paul
?? Wellington, Equity-Income, Windsor, Windsor II, Primecap, Primecap Core, Capital Opportunity, Morgan Growth, Explorer, Selected Value, Strategic Equity, International Growth, International Value ... ??

More silliness? I'm not sure if there are any DFA funds as actively managed as those Vanguard funds listed above.

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Re: John Bogle's "Philosophical Disagreement" with Eugene Fa

Post by staythecourse » Sun Nov 10, 2013 12:41 pm

VictoriaF wrote:
staythecourse wrote:I did notice how vehemently Mr. Bogle was opposed to being influenced by Mr. Fama's work. I am wondering if it goes beyond just the EMH philosophy? Guess we will never know, but does not sound like they are good "friends"? I have seen Mr. Bogle numerous times not agree with other opinions, but he seemed extra irrate about this one.

I could (and probably am) completely wrong about this, but just saw his reactiong quite interesting.

Good luck.
Look at it from the Jack's point of view. Jack did not invent index funds; but he has created them, and innovated, and persisted against an enormous backlash from the industry until index funds started to flourish. In the meantime, Fama was sitting in his ivory tower developing his theories.

When Jack was creating index funds he did not know who Fama was; Fama did not invent index funds. Jack was doing the hard work of making index funds available to us.

Now, that Fama has won his Nobel, people simple-mindedly and sloppily give him credit for index funds. Worse, people now imply that Jack has learned from Fama, which he did not. Jack needs to use strong, decisive language to distinguish his achievements and get decoupled from being bundled with Fama.

Victoria
I get all that and it makes sense.

What I don't understand is him saying that he never heard of Mr. Fama's "EMH" until a decade after he started his later to be VFINX. That I have a HARD time believing. Mr. Bogle is a Princeton grad, went up the chain at Welllington, and later built Vanguard. He is intelligent and always well read, even at his current age, of all major articles in the field of finance. So did he really not hear of something as big as the EMH by Dr. Fama written in circa 1965 well into the mid 80's (10 yr. into his index fund inception as he states)? That is just hard to believe.

Saying it did not inspire him is fine, but twisting the knife saying he didn't even know about it does not seem genuine and more of a back hand slap at Mr. Fama groundbreaking work in the field of finance. That is the same as if Mr. Fama said I have not heard of Vanguard and Mr. Bogle's index fund until the mid 80's when it was already out for 10 yrs. Just doesn't sound genuine.

Maybe he is a bit miffed he has not won a Nobel Prize himself for the first mutual index fund? Of course, not sure how he is going to get that award either as Mr. Sinquefield started his before Mr. Bogle for the instuitional players through First Bank National Trust of Chicago.

Good luck.
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