Index funds have humbled the financial masters of the universe. But they’re still not sexy.
That’s a shame because index funds have revolutionized the financial world. As trillions of dollars flow into funds that mimic a broad swath of assets (like a stock index) instead of those run by human money managers, investors have gotten superior returns on their savings while paying almost nothing for the privilege.
Robin Wigglesworth’s book, Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever, shows that the people who pioneered index funds are far more fascinating than they usually get credit for. The Financial Times journalist writes that French mathematician Louis Bachelier is the true godfather of passive investing. Vanguard founder Jack Bogle mutualized his company, making it client-owned, and brought index funds to the masses mainly because he lost a boardroom battle. Patricia Dunn, a gifted leader who climbed from typist to CEO of Barclays Global Investors, was one of the first to see the promise in exchange-traded funds.
Wigglesworth argues that index funds have helped bring about a golden age of investing. Quartz spoke with him about the people who spearheaded passive investing, how it has changed finance, and whether index funds risk becoming too dominant. The conversation was edited and condensed for clarity.
Quartz: On the spectrum of financial innovations—if 1 is unimportant and 10 is maximum importance—where do index funds rate?
Wigglesworth: Broadly speaking, on a scale of 1 to 10 of importance, I’d easily put index funds and passive investing at a 10.
This is one of the first products that really at its core was supposed to be cheap and simple in an industry that tends towards complexity and expense. I tend not to be as negative on the financial industry as many people are—there are lots of amazing people that genuinely do want to do great things that work there. But it is, I think, an industry that thrives on a certain amount of opacity and complexity and there is a tendency towards fee gouging. And index funds were completely antithetical to that.
S&P Dow Jones calculates that just US investors in US equity index funds in the past 25 years have saved $357 billion, and that’s the direct cost versus an active fund. And it doesn’t even include the performance difference—on average, over a 25-year period, the vast majority of active funds will underperform an index fund. Take that across the world in other asset classes, and you’re probably talking a few trillion dollars over the past 25 years.
And if you include the competitive pressures that passive investing has brought on pretty much all investment products—hedge fund fees have fallen by a third. Mutual funds fees have fallen by a third over the past 25 years, and I think a large part of that is because of index funds. Even if you don’t use them, you have benefited. So everybody in the world with any money in any sort of financial vehicle, like a mutual fund or an equity fund or a pension plan will have benefited either directly or indirectly from the index fund to the tune of trillions. And that’s going to be tens of trillions over the years.
Passive investing is cheap and simple, but your book makes the point that index funds didn’t necessarily come about because of kindness. They emerged out of boardroom battles and from self-preservation.
All humans have a tendency to glamorize their own genesis stories, right? Once you are a successful CEO or financial innovator, there is a tendency to polish a certain part of your backstory as opposed to the reality.
It was really fun to discover just how many random events were needed for this to happen. And I think index funds would have been invented sooner or later anyway. Index funds would have broadened out and been taken to ordinary investors sooner or later anyway. In some respects, the odd thing is that this didn’t happen even sooner.
The nice word for it is serendipity, but in reality it’s happenstance that brought these people together at the right time and their right own personal circumstances to do this: If Jack Bogle hadn’t merged with a Boston group of partners, this Boston mutual fund, he wouldn’t have been sacked.
And he was fired at the time when index funds were just starting to kind of gain a bit of acceptance on the institutional investor side among pension plans. So it was the only thing he could do. The mutualization of Vanguard is just a reflection of it was the only thing he could do—it was his Hail Mary to try and keep some sort of a job. And index funds, that product was the only thing they could do because they weren’t allowed to manage money.
Jack Bogle rather disingenuously argued that the index fund was unmanaged and therefore it was fine. And his old partners at Wellington who’d fired him basically thought, well, look, obviously, this is such a dumb product nobody’s going to invest in it anyway. Good, let Jack do this. And it still took decades for it to really take off.
You write that Louis Bachelier is the true godfather of index funds and passive investing. Who are some other important figures we should know about?
Well, Bachelier is one of my favorites purely because I have a soft spot for anyone who dies in obscurity and are only recognized after their death.
And I think Pattie Dunn, the former CEO of Barclays Global Investors, is a really interesting character. Maybe I have a soft spot for her because she initially wanted to be a journalist. But her background—born in Las Vegas to a showgirl mom and a talent-booker father, her father passing away early, and Dunn having to quit university to support her then alcoholic mother by working part time as a secretary at what was then Wells Fargo Investment Advisors, and rising to become the CEO and chairman—is just staggering. That’s the kind of stuff that movies are made of.
Her legacy was later tarnished with stuff that happened, as far as I understand, under her watch but not at her direction, when she was the chair of HP—it was a spy scandal there if I remember correctly. But what she did at a time when American industry didn’t have a lot of female CEOs and certainly not the finance industry—she rose from part-time secretary to CEO. That’s incredible. I hadn’t appreciated her own journey and her importance in seeing the potential of this underperforming ETF unit inside in BGI, called at the time WEBS, and turning that into iShares, which is now the crown jewel BlackRock, the world’s biggest investment company.
Where are we on the index-funds-will-destroy-the-market debate?
It’s going to be a debate and has been since the birth of the index fund. And it is almost comical to see how many times the arguments that were first made in the 70s are still lifted up today. And frankly, how similar they are to the arguments against mutual funds a hundred years ago. And I suspect the arguments against investment trusts two, three hundred years ago. No industry likes being disrupted, whether it’s journalism or financial services, and this is a profoundly disruptive invention.
Now I do think it is important even for people like me who are fans of index funds to not therefore treat it as if it’s some facile football game where we have to pick a side and pretend our side is perfect and the other side is evil. There are aspects to passive investing that I think even fans need to admit could be issues, or are likely to become issues, in the coming years. It’s just so big now. And the trend lines are so unambiguous that I think the footprint that it has on markets is going to grow. Where I disagree with a lot of the index funds skeptics and the enemies is that I really don’t see any evidence so far that the effect of index funds on markets and the financial industry today is any more malign than the effect of any other financial product out there.
For example, hedge funds. When hedge funds were invented, that changed the market ecosystem. When mutual funds were invented, that changed the market ecosystem. When ETFs were invented, that changed the market ecosystem. Jack Bogle hated them. But fundamentally, it’s a fairly dynamic, adaptive system that, broadly speaking, I think is trending towards being better for most people.
That is not popular to say today—that this is a golden era for anybody who wants to save or even, dare I say it, trade money in financial markets. People used to get stiffed left, right, and center, and they might still get stiffed on the right and left today. But broadly speaking, it’s never been cheaper to save money in financial markets.
And that is at least partly thanks to index funds. So whilst I think there are things like the concentration of power that the economics of indexing bring, that there are individual idiosyncratic issues that can come up with how indices are constructed and how index funds therefore trade, I think it bears watching. I think there’s probably too much innovation in index funds now, and people are getting sold all sorts of silly or useless or maybe even dangerous products under the guise of an index fund. Broadly speaking, things are pretty good. And I think things are getting better.
What is your take on ARK Invest? Stock picking appeared left for dead by the passive strategies you write about, but Cathie Wood seems to have reinvigorated active management.
I actually think ARK Invest is to an extent the future of active management. If you’re going to charge fees for managing money actively, then you have to make sure that you really are active. You’re not just an index-hugger that takes slight overweights and underweights. Well, if you’re going to do that then you charge way lower fees.
There is increasing pressure from big pension plans and sovereign wealth funds that if they’re going to invest in an active fund, they actually monitor that it is truly active, and that can be around certain themes or specialists in certain areas. They have very strong, deep domain expertise in biotech or South African stocks or whatever. That is the future of active management.
That said, we’ve seen versions of ARK in many, many, many cycles past across many countries. Some fund latches onto something that is disruptive or they say is the future and the market agrees with them. They get lots of money, they start believing their own hype and at some point, the market regime changes because we know that is always true. And the tide goes out, and some people are swimming naked, as Warren Buffett puts it. Whether that is what’s going to happen to ARK, I have no clue.
The more I learn about finance and investing and markets, the more I realize how little I really know. And I’ve seen people who are wildly smarter than me, they’ve dedicated their entire lives, every sinew, every iota of their being to beating the market, delivering the fabled alpha, and they still struggle.
So it just has made me humble, but also a little bit cynical about people that think they’ve discovered some sort of new secret sauce that by just buying disruption, they can do really well. It might be true. I’m humble enough to know that I have no clue. But I can say that we’ve seen this movie before. And broadly speaking, it doesn’t end well.