TRILLIONS - THE PEOPLE BEHIND YOUR ETFS (BOOK REVIEW)
Who is this book For?
Trillions, how a band of Wall Street Renegates Invented the Index Fund And Changed Finance Forever, by Robin Wigglesworth is a fascinating insight into the people who made the Index Fund revolution happen.
The stories about the people often start with some of their biggest failures.
But beyond the stories, Robin also argues that every revolution brings its fair share of non-issues and sometimes real issues, such as concentration of power.
A rare moment in history of finance
The picture from the 5th Solvay Conference held in Brussels in 1927, is probably the finest collection of human brain power in the history of mankind.
17 of the 29 attendees, including Einstein and Skłodowska-Curie, were or would go on to become Nobel Laureates.
This is a powerful picture, not just for the contributions the attendees would make to physics but also for how selfless these efforts were.
Unfortunately, the world of Finance lacks these selfless figures.
Advancing human progress is secondary to amassing personal fortunes.
A disappointed Paul Volcker, former Chairman of the Federal Reserve, remarked that the invention of the ATM was probably the finest hour of the Finance Industry in recent times.
He is probably right except that the 1970s saw the advent of the low-cost Index Fund.
THE PEOPLE BEHIND YOUR ETFS - THE LEGENDS
Success has many parents
When reading Il était sept fois la révolution by Étienne Klein a few years ago, I realized how much the combined brain power of a number of people can advance mankind.
Étienne described the lives of seven of some of the brightest minds of the 1920s, that defined Relativity and Quantum Physics.
It also made me aware of how much we simplify history by retaining just a few names.
Standing on the shoulders of giants
Sir Isaac Newton, ever so humble that he would observe apples falling off trees for research, attributed his success to the work of those before him.
“If I have seen further, it is by standing on the shoulders of giants”.
In this case, the giant on whose shoulders Index Investing stood was Louis Bachelier.
Bachelier - The Godfather
Louis who? Precisely.
Bachelier, a Parisian academic, lived and died in obscurity. This was until his work was discovered by an American professor in 1954.
Bachelier would prove to be the godfather of Modern Finance with his mathematical framework that laid the foundation of, the Random Walk Theory for stock prices.
Finance's Manhattan Project
Just like the Manhattan project which delivered the atomic bomb and ushered in the age of nuclear energy, Index Funds too had their own age of discovery in the 1960s.
McQuown - The Father
McQuown was probably the first quant in modern investment history. McQuown argued for a scientific approach to investing. He had obtained an unlimited budget from Wells Fargo to explore his ideas.
John McQuown’s team created the world’s first Index Fund. First for Samsonite’s managed account and then for Wells Fargo’s own pension plan.
If Bachelier was a theoretician, John McQuown was the concertmaster.
McQuown assembled the biggest all-star team that finance has ever seen.
Unfortunately, there is no picture taken of McQuown’s team, that would have been the finance equivalent of Solvay.
Just look at the below names, all Nobel Prize in Economics Laureates, that worked for McQuown.
McQuown's Nobel Prize Rockstars
Father of Modern Portfolio Theory. Markowitz demonstrated the irrelevance of stock returns, on a stand-alone basis. What is important, is their impact on the portfolio.
Markowitz laid the groundwork for the passive investment revolution.
Thanks to Sharpe, we now use two greek letters in the investment industry – alpha, the excess return and beta – the market return.
He came up with Capital Asset Pricing Model (CAPM) that simplified the Markowitz framework by using a single factor – the market portfolio, in other words – an index fund.
Father of the Efficient Market Hypothesis. He inspired the theory behind passive investing.
Famously quipped that likening traditional money management was akin to pornography: “Some people like it but they’re not really getting better than real sex. If you’re willing to pay for it, that’s fine. But don’t pay too much.”
Black laid the analytical groundwork for Wells Fargo’s efforts to set up a passive fund.
He is the only person on this list that was denied the Nobel Prize in Economics, due to his death in 1995. His colleagues Myron Scholes and Robert Merton would win the 1997 Nobel Prize in Economics for the Black, Scholes and Merton mathematical model to price derivatives – the mainstay of our financial world today.
At the time of his engagement with Wells Fargo in 1968, Scholes was just 27 years old but already a professor at MIT.
Outside his contribution to option pricing, he laid the analytical groundwork with Black for Wells Fargo’s efforts to set up a passive fund.
THE PEOPLE BEHIND YOUR ETFS - THE KINGS
Back To Earth
Wells Fargo’s foray into scientific investing proved more than an expensive novelty project.
They were able to bring to market an index fund offering for managed accounts.
However, the industry mocked their efficient frontier approach and scoffed at their aim to settle for average returns. From being declared un-American to being labelled unfit for mother-in-laws, they were subject to every kind of derision. At large though, there was indifference.
The boys at Wells Fargo had the brains to deliver a product but lacked the ability to execute in bringing it to the masses.
BOGLE - THE KING OF MAIN STREET
Bogle was the Edison to the work of Bachelier and later the Wells Fargo boys and their rockstar consultants.
Unlike Edison though, he was no inventor.
Bogle’s foray into Index Funds was not a premeditated strategy. Instead, it was a “strategic gambit” to relieve himself of the pressure of his partners at Wellington and free Vanguard of their shackles.
While he maintained Indexing to be his idea as early as the 1950’s when he wrote his University dissertation, the fact is that it was Paul Samuelson’s column in 1974 in the Journal of Portfolio Management titled “Challenge to Judgement” which lit his fire.
Prior to setting up his own fund, he had reached out to McQuown to understand how to navigate his way.
Where Wells Fargo failed and Vanguard succeeded was Bogle’s salesmanship.
No matter the theory or the reams of data, Bogle was able to build a narrative around Index funds.
It was a smart, sophisticated and cool thing to do and the general public latched on to the idea.
While “not a commercial success but an artistic one” as Bogle would reminisce, the First Index Investment Trust tracking the S&P 500 is a breakthrough achievement as being the first index fund targeted for retail.
However, what would come to define Bogle’s legacy, in the eyes of purist indexers, was the 1992 launch of the First Index Total Market Fund.
He would drop the S&P 500 as a benchmark and expand the universe to the total stock market.
He failed to see the idea behind ETFs despite being offered early access to move on them.
“Why would anybody want to buy the market at 10:30 in the morning and then sell it at one o’clock in the afternoon?”
This is a mistake that Vanguard took years to undo especially after the departure of Bogle from the firm.
State Street would become the first firm to launch an ETF. The S&P 500 ETF also known as the Spider.
But even State Street wouldn’t capitalize on it as much as BlackRock did through its acquisitions.
Bogle was the typical Robin Hood character who saved millions of people money worldwide.
At the launch of the FIIT, the fee was already 1/10th of the industry’s average and has only come down since.
That alone has saved investors hundreds of billions of dollars.
When you add the fact that he went no-load (aka no up-front fee) in the late 1970s when typical loads were 6%, you can picture how selfless a character he was.
FINK - THE KING OF WALL STREET
While Bogle built on the work of his predecessors and contemporaries to democratize access to investment through his index funds, it was Larry Fink and Blackrock that truly built an investment empire banking on all the inventions – including ETFs.
In one sense, with Fink, the seed that Bachelier sowed, blossomed into multi-trillion tree.
Deal-making and analytical focus through the Aladdin platform transformed Blackrock from a small fixed-income shop to a market leader with a market cap higher than that of Goldman Sachs.
In the middle of the 2008 crisis, he orchestrated the most successful M&A deal in asset management history, and perhaps in finance overall.
And this achievement comes in an industry that has witnessed more M&A ‘car crashes’ than success stories.
Fink did so by navigating the 2009 acquisition of Barclays Global Investors, or BGI, and its iShares ETF unit.
The deal would not only make Fink the de-facto manager of $2.7 trillion in assets but also gave him access to the best financial factory in the world, BGI.
Before becoming part of BlackRock, BGI has:
- Absorbed Webbs, or today’s iShares, that copied State Street’s S&P 500 ETF concept but applied it to various asset classes. It almost always benefited from the first-mover advantage.
- Absorbed decades of financial engineering savoir-faire. That came through the merger with Wells Fargo Advisors, the unit that created the world’s first index fund.
Today, Blackrock manages $ 9.5 trillion in assets and is the largest asset manager in the world.
THE PEOPLE BEHIND YOUR ETFS - ARE THEY TOO POWERFUL?
$16 Trillion in the hands of Just A few
According to Morningstar, by 2020, Index Funds had $16 trillion in assets.
The biggest equity fund in the world is now an Index fund and so is the biggest bond fund.
The largest gold fund has 1,100 tons of gold holdings which is a quarter of that of Fort Knox. Practically, these funds are larger than the economies of many nations.
However, the problem is that this is a highly concentrated industry with three large US fund managers dominating – Blackrock, Vanguard and State Street.
Democratic power shifting to private firms?
The concentration of decision-making power on trillions of dollars of assets in the hand of a few asset managers gives them a lot of clout.
This could be deemed negative as it means that these asset managers may hold sway over some public policy issues normally reserved to democratically elected politicians.
Often, detractors have pointed to common ownership conspiracies whereby Index fund managers have been blamed to influence the business decisions of the companies they invest in to fix prices at an industry level.
Such behaviour would be an anti-trust matter.
Other critics pointed to Bond ETFs as potentially vulnerable during market stress periods. But these have done fairly well throughout the last decade, including March 2020. This problem is also not isolated to ETFs.
Traditional Bond Mutual Finds have been around for a century and are often frozen, whereas ETFs allow for price discovery.
There are even some upsides.
During a market crash, the cost of liquidity was historically borne by the remaining investors in a Bond Mutual Fund. You had every incentive to get out the door before the next guy, just like with a bank run.
With ETFs, the cost of liquidity is borne by the seller, which is fundamentally fairer.
The Potential Issues
In Bogle’s own words, proxy voting advisors are a bigger threat emanating from the growth of Index funds.
The fact that proxy voting is being outsourced to specialized firms means that there is every chance that sub-optimal decisions are being taken which may or may not be in the best interest of shareholders.
This is complemented by the threat posed by index providers who are in the driving seat for key decisions including which country qualifies as an Emerging Economy.
The book is an excellent walk down the halls of financial history to correctly attribute the contributions made by each individual.
Just like Einstien could not have known the full impact of his theorems on physics, Bachelier too died an unaware man.
It is down to those who carry his legacy and that of McQuown, the Nobel winning rocks stars and Bogle to ensure that the average investor continues to be championed.
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