John Bogle’s Epiphany Changes The World

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Rick Ferri
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John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 10:37 am

Great disappointment often brings great change. In business, the shattering of a long-held belief can create enough clarity and vision that it leads to a great idea and benefits millions. This is what occurred in the 1970s. One man’s epiphany has changed the investment industry forever. This is a story about John Bogle's "Aha" moment - how he changed from being a stanch defender of active management to a diehard believer in low-cost indexing.

Read the entire article: John Bogle’s Epiphany Changes The World

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Re: John Bogle’s Epiphany Changes The World

Post by matjen » Mon Feb 03, 2014 10:50 am

Typo: you have stanch but obviously mean staunch. :-)
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Re: John Bogle’s Epiphany Changes The World

Post by hicabob » Mon Feb 03, 2014 10:59 am

I fully realize that many undiscovered concepts seem quite obvious after a clever person elucidates it, but I find it quite surprising that Mr Bogle's epiphany was not realized at a prior point in time - perhaps it was but was kept under the covers?

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Re: John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 11:26 am

matjen wrote:Typo: you have stanch but obviously mean staunch. :-)
Fixed. Thanks!

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Re: John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 11:28 am

hicabob wrote:I fully realize that many undiscovered concepts seem quite obvious after a clever person elucidates it, but I find it quite surprising that Mr Bogle's epiphany was not realized at a prior point in time - perhaps it was but was kept under the covers?
I'm not sure about that. Like Mr. Bogle, I was in the investment industry for a number of years before I had the Aha moment.

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Re: John Bogle’s Epiphany Changes The World

Post by nisiprius » Mon Feb 03, 2014 11:29 am

hicabob wrote:I fully realize that many undiscovered concepts seem quite obvious after a clever person elucidates it, but I find it quite surprising that Mr Bogle's epiphany was not realized at a prior point in time - perhaps it was but was kept under the covers?
Read John C. Bogle's own account, cited by Rick Ferri: The First Index Mutual Fund.. Bogle makes it pretty clear that the idea was "in the air," and that others were starting to experiment with it, notably:
The basic ideas go back a few years earlier. In 1969–1971, Wells Fargo Bank had worked from academic models to develop the principles and techniques leading to index investing. John A. McQuown and William L. Fouse pioneered the effort, which led to the construction of a $6 million index account for the pension fund of Samsonite Corporation. With a strategy based on an equal-weighted index of New York Stock Exchange equities, its execution was described as "a nightmare." The strategy was abandoned in 1976, replaced with a market-weighted strategy using the Standard & Poor's 500 Composite Stock Price Index. The first such models were accounts run by Wells Fargo for its own pension fund and for Illinois Bell.

In 1971, Batterymarch Financial Management of Boston independently decided to pursue the idea of index investing. The developers were Jeremy Grantham and Dean LeBaron, two of the founders of the firm. Grantham described the idea at a Harvard Business School seminar in 1971, but found no takers until 1973. For its efforts, Batterymarch won the prize for the "Dubious Achievement Award" from Pensions & Investments magazine in 1972.** It was two years later, in December 1974, when the firm finally attracted its first client.
It sounds to me like Bogle's "epiphany" was not so much "Eureka! An index fund," but more like the song in "A Chorus Line," "I Can Do That!" It was not so much "I have a new idea," it is "this is a good idea and it will actually work in real life and I'm the person who knows how to make it happen and I am going to do it."

Rather like the story of how Marconi just bulled ahead building bigger and bigger and bigger radio transmitters and selling radio equipment to ships, while people like Oliver Lodge were doing lecture-scale demonstrations of transmission of Hertzian waves across the room.
Last edited by nisiprius on Mon Feb 03, 2014 11:59 am, edited 2 times in total.
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Re: John Bogle’s Epiphany Changes The World

Post by dodecahedron » Mon Feb 03, 2014 11:41 am

hicabob wrote:I fully realize that many undiscovered concepts seem quite obvious after a clever person elucidates it, but I find it quite surprising that Mr Bogle's epiphany was not realized at a prior point in time - perhaps it was but was kept under the covers?
I have to wonder whether it would have been practical to run a large-scale index fund investing in a precisely calibrated index-formula mix of securities much before the advent of the kind of computational technology that was evolving in the mid 1970s? Or even to conduct really comprehensive rigorous statistcal tests.

Even a four-function calculator cost hundreds of dollars back in the early/mid 1970s. I didn't acquire a calculator until after I graduated from college. (My trusty slide-rule got me through undergrad! Plus a timeshare slow phone-line connection to a slow-as-molasses-but-behemoth-and-balky mainframe at a nearby university, which we accessed by feeding our keypunched cards with our FORTRAN programs into a cardreader attached to a modem.)

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Re: John Bogle’s Epiphany Changes The World

Post by nisiprius » Mon Feb 03, 2014 11:54 am

There's another puzzle piece I'm curious about in the history of developing the index fund. Before you could have an index fund, a precondition was to have an index. Now of course there were indexes--the Cowles Commission called their 1940 extensive compilation of stock data back to 1870 "indexes." However.

The S&P 500 index was created in 1957. Now, I can definitely remember watching the TV news as a kid and hearing the announcer saying "Standard & Poor's five hundred stock average" was thus-and-such. Now, certainly before that there was an "S&P composite" index, but I've done a little bit of poking in old newspaper databases--but not the WSJ as I don't have access--and I couldn't find evidence that people quoted it much or followed it much. Anyone remember? I think the S&P 500 was a much more highly publicized index than any than had ever gone before. Not more than the Dow, but the Dow wasn't and was never intended to be a scientific gauge of the whole market.

The 1950s were also an era of spectacular stock market performance. And they were also the era in which mutual funds emerged. In his 1957 introduction to "Where Are the Customers' Yachts" Fred Schwed comments that he had grossly underestimated the importance of "investment companies" and their usefulness to retail investors, and comments on their now being called "mutual funds." This was the era emergence of active funds with star managers, such as Gerry Tsai at Fidelity.

So, it seems to me, you had a confluence of events in the 1950s:
  • A booming stock market and growing retail investment, propelled e.g. by Merrill Lynch (Pierce, Fenner and Beane...)
  • The emergence of mutual funds--big, professionally-managed stock portfolios with public information on their performance
  • The development of a scientific and widely-publicized index intended to measure the total market
Give it a little time for people to notice the failure of active manager to beat the index, and add some technological advances and reductions in transaction costs making it feasible to offer mutual funds with hundreds of stocks in their portfolio.

Charles Fort said "It steam-engines when it's time to steam-engine." I don't think it is taking anything away from John C. Bogle to say that maybe it was time to index-fund.

(I admit that I wonder why nobody tried to do a Dow Jones Industrial Average index fund early on--even today, the SPDR Dow Jones Industrial Average, DIA, founded 1998, has "only" $11 billion in assets).
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Re: John Bogle’s Epiphany Changes The World

Post by dodecahedron » Mon Feb 03, 2014 12:09 pm

To give you some idea of the technology that existed just prior to John Bogle's epiphany, check this out:
Harvard Business School Working Knowledge wrote:Events in the late 1960s reshaped the securities industry. Trading volume increased sharply, with the number of shares changing hands on the New York Exchange growing from five million a day in 1965 to twelve million a day in 1968.

As Wyatt Wells describes in Business History Review, this expansion overwhelmed the mechanisms brokers used to transfer securities and keep records, which relied heavily on paper and pen. They responded by purchasing computers, but these machines were expensive and demanded more sophisticated management than most firms could provide. Accordingly, many companies botched the process.

Moreover, trading volume declined sharply in 1969 and 1970, cutting deeply into brokerage revenue. These factors combined to create a crisis that had, by the end of 1970, forced nearly a sixth of the nation's brokerage firms out of business.

In this excerpt from his article, Wells describes the immediate aftermath of the crisis and the changes in the securities industry that occurred in its wake.
Excerpt from: http://hbswk.hbs.edu/archive/1719.html

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Re: John Bogle’s Epiphany Changes The World

Post by nisiprius » Mon Feb 03, 2014 12:21 pm

dodecahedron wrote:To give you some idea of the technology that existed just prior to John Bogle's epiphany, check this out:
Harvard Business School Working Knowledge wrote:Events in the late 1960s reshaped the securities industry. Trading volume increased sharply, with the number of shares changing hands on the New York Exchange growing from five million a day in 1965 to twelve million a day in 1968.

As Wyatt Wells describes in Business History Review, this expansion overwhelmed the mechanisms brokers used to transfer securities and keep records, which relied heavily on paper and pen. They responded by purchasing computers, but these machines were expensive and demanded more sophisticated management than most firms could provide. Accordingly, many companies botched the process.

Moreover, trading volume declined sharply in 1969 and 1970, cutting deeply into brokerage revenue. These factors combined to create a crisis that had, by the end of 1970, forced nearly a sixth of the nation's brokerage firms out of business.

In this excerpt from his article, Wells describes the immediate aftermath of the crisis and the changes in the securities industry that occurred in its wake.
Excerpt from: http://hbswk.hbs.edu/archive/1719.html
One of them being the creation of the SIPC. There were cases where securities held in street name could not be found in brokers' inventories. And at least one case where they later turned up somewhere they shouldn't have. And while the New York Times did not ever say organized crime had any involvement, they did report the existence of rumors of organized crime involvement.
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Re: John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 12:44 pm

Here is a the contents of an email that Jack sent to me today. It adds clarity to the 1960's article that Jack wrote supporting active managers. He wrote it under the name John B. Armstrong:

Jack Bogle wrote:I wrote to the son of one of the authors of the article that "John B. Armstrong" responded to--essentially noting that in 1960 we were comparing a pretty GOOD industry with a pretty BAD index (DJI), but, post-Go-Go, we were comparing a somewhat BAD (at least, far worse) industry with, at last, a GOOD index (S&P 500).
Thanks for the feedback, Jack, and I agree, although the S&P 500 has been around since 1957. I often wonder why the Dow 30 continued to be used in analysis through the 1960s by people such as Bill Sharpe and others given that the S&P 500 was a far superior benchmark.

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Re: John Bogle’s Epiphany Changes The World

Post by Lee Saage » Mon Feb 03, 2014 1:49 pm

Nice article, Rick. Sort of reads like the abstract for a biography.
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Re: John Bogle’s Epiphany Changes The World

Post by arcticpineapplecorp. » Mon Feb 03, 2014 2:49 pm

nisiprius wrote:(I admit that I wonder why nobody tried to do a Dow Jones Industrial Average index fund early on--even today, the SPDR Dow Jones Industrial Average, DIA, founded 1998, has "only" $11 billion in assets).
I can't seem to find it on the internet (maybe someone here knows), but I thought I remember reading that the SEC required a mutual fund had to hold a minimum number of securities, 40 or more. If correct, the dow 30 couldn't be a mutual fund then. Is this true or did I misread?
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Re: John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 3:01 pm

No, that's not a rule. When a mutual fund files, it must make a disclosure about being a diversified fund or non-diversified. There isn't a minimum number of holdings.

A diversified fund has three primary rules to which it adheres:
- 75% or more of its assets are invested in securities
- No more than 5% of its assets are invested in any one security
- Contains no more than 10% of the outstanding shares for any one security

Non-Diversified Fund
- Any mutual fund that does not adhere to the above criteria.

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Re: John Bogle’s Epiphany Changes The World

Post by arcticpineapplecorp. » Mon Feb 03, 2014 3:09 pm

Rick Ferri wrote:No, that's not a rule. When a mutual fund files, it must make a disclosure about being a diversified fund or non-diversified. There isn't a minimum number of holdings.

A diversified fund has three primary rules to which it adheres:
- 75% or more of its assets are invested in securities
- No more than 5% of its assets are invested in any one security
- Contains no more than 10% of the outstanding shares for any one security

Non-Diversified Fund
- Any mutual fund that does not adhere to the above criteria.

Rick Ferri
thanks, I thought you would know! Interesting article, btw.
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Re: John Bogle’s Epiphany Changes The World

Post by Bustoff » Mon Feb 03, 2014 3:39 pm

Hopefully Defined Maturity Bond Funds will become the next "great idea".

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Re: John Bogle’s Epiphany Changes The World

Post by neurosphere » Mon Feb 03, 2014 4:21 pm

Rick Ferri wrote:No, that's not a rule. When a mutual fund files, it must make a disclosure about being a diversified fund or non-diversified. There isn't a minimum number of holdings.

A diversified fund has three primary rules to which it adheres:
- 75% or more of its assets are invested in securities
- No more than 5% of its assets are invested in any one security
- Contains no more than 10% of the outstanding shares for any one security

Non-Diversified Fund
- Any mutual fund that does not adhere to the above criteria.

Rick Ferri
Just to clarify (and not to get the thread off topic), A "diversified" mutual fund CAN have more than 5% of it's assets in any one security, but no more than 25%.

I.e. OF the 75% portion (the "diversified" portion), it is true, there can be no more than 5% of any one security. Of the remaining 25%, it can indeed invest in one security. So a diversified mutual fund can own: Stock A at 25% and then stocks B through P at 5% each, for a total of 16 stocks. That would hardly meet a Boglehead's definition of diversified, but it meets the SEC definition. :D

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Re: John Bogle’s Epiphany Changes The World

Post by Levett » Mon Feb 03, 2014 5:48 pm

Honestly now. Mr. Bogle, whom I respect greatly, did not change the "world."

That kind of excess is off-putting.

He helped to change the world of investing. That's it.

Keep finance and investing in perspective.

Lev

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Re: John Bogle’s Epiphany Changes The World

Post by Rick Ferri » Mon Feb 03, 2014 6:06 pm

I think that's a little harsh. "John Bogle’s Epiphany Changes The World" is just the title of the article. I clarify what "World" means in the first paragraph.

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Re: John Bogle’s Epiphany Changes The World

Post by Levett » Mon Feb 03, 2014 7:28 pm

Proper words in proper places--that's what I learned about writing.

Lev

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Re: John Bogle’s Epiphany Changes The World

Post by arcticpineapplecorp. » Mon Feb 03, 2014 7:36 pm

He certainly changed my world. Thank you indeed for everything you've done Mr. Bogle.

By the way, a very smart person once said, "If you change yourself you will change the world." --Ghandi

By that definition, Mr. Bogle did change himself and his views regarding active management. That change lead him to in fact "change the world" in which index funds were born and have gained followers over time. And we have benefited immensely as a result.
"Invest we must." -- Jack Bogle | “The purpose of investing is not to simply optimise returns and make yourself rich. The purpose is not to die poor.” -- William Bernstein

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