Episode 94, Robin Wigglesworth, FT journalist and the author of "Trillions", Rick Ferri host

28:28So it was, you know, a difficult product. and the cost to trade back then was significantly higher huge yeah no i mean huge and and the only client they could get to join in to test this new product was the pension fund of samsonite the luggage company and that was only because one of the signs of the family who'd studied at the university of chicago under gene farmer came back to the family business saw how badly its own pension fund was doing, called up his professors at Chicago and asked, surely I learned all this efficient market stuff, random walk stuff. Surely somebody must be managing money in a sort of a theoretically sound way and was pointed in the direction of Mac and Wells Fargo.

29:16And that was the genesis, the first index fund. It later became an S &P 500 index fund that it was initially just a separately managed account with some Wells Fargo money and Samsonite money that tracked the New York Stock Exchange as a whole. But that, I think, is the tiny acorn from which this mighty oak grew. Now, these people knew each other, and they were all operating independently, all trying to get to the same spot, which is to get some sort of a commercial product out there for institutional investors, not for retail investors at the time. and this is why Jack Bogle is rightly famous today but he brought it to the the masses but did not invent the index fund in fact there were several billion dollars in index funds long before Vanguard was ever sort of imagined even and those were these three pioneers and they did know each other not fantastically well but also ironically through the ferment of the University of Chicago and the CRISP Center.

30:19So to make sure that this research that CRISP had come up with in the 60s can percolate into the investment industry in the pre-internet era, CRISP would set up semi-annual conferences where they'd invite people to speak and listen to all this new research coming out. Mac Macrown was there almost every time. Dean LeBaron was there quite frequently. Rex Sinkfield definitely went a lot. Jack Bogle also attended these seminars, essentially, on efficient markets and things like that. And he didn't necessarily believe in all that, certainly not at the time. But he was definitely drinking from that same intellectual well from Chicago that started the index fund.

31:04So he would have been. And he later on, frankly, pretended that he didn't know about all these other projects. I know, I know. I never asked him, but how could he not know? It's very Jack, right? We know for a fact he knew about it. Jack Bogle, as phenomenal a man as he was, was very keen, especially in the last 10, 20 years of burnishing his legacy. I'd argue his legacy is so immense it needs no burnishing. But he would reappraise certain historical facts to better suit the legend of Jack rather than the reality of John Clifton Bogle. But he knew about all these things. He knew about all these people.

31:44In fact, his assistant at Vanguard when he was first set up was asked to call Mac, Rex Sinkfield, and Eden Barron, ask them for help when Vanguard was researching its first index fund. I read that. I said, that's interesting. That's something that never came out. I spoke with Jack many times about the evolution of how you created this index. And it's all, well, you know, I did this analysis. I said, we need an index fund. and I went to the Wellington Board, and you never hear about the fact that he reached out to these three people, and especially Ziegfeld, who gave them a lot of information, which ironically, when Rex Ziegfeld co-founded DFA in the early 80s, there was a little help from Jack to DFA, probably in a way a little payback for helping Vanguard start their first index funds again information in your book that wasn't something jack talked about exactly and look for me finding these little intellectual linkages was one of the real delights of researching this book because i mean one of my strongly most strongly held beliefs is that we all stand on the shoulders of giants we all pretend sometimes that all our triumphs are our own and our defeats is obviously somebody else's fault but the world isn't like that even sincfield and the Baron and Mac, they stood on the shoulders of giants that went before them.

33:06They stood on the work of Gene Farmer and Harry Markowitz and Bill Sharp and others. And they in turn stood on the shoulders of other economists that went before them. I thought it was interesting that the intellectual linkages were far stronger than previously acknowledged. One of Rex Sinkfield's classmates at the University of Chicago was David Booth. David Booth went to work for John McQuown at Wells Fargo and then later on founded Dimensional Fund Advisors with his old classmate Rex Sinkfield. The first idea was to set up essentially an index fund for small companies because at the time all the index funds were S &P 500 products and at Vanguard when that was almost like a protein embryonic organization Jack Bogle maybe this is the nuance in his defense Maybe he didn't call these organizations directly, but he at least told or instructed his young assistant, his young quant at the time called Jan Twardowski, another quiet giant of the passive investing world.

34:08The guy that frankly designed the first index fund at Vanguard, he got in touch with these three other men to ask for the device. And they were quite happy to give it because, frankly, they weren't rivals. battery march american national bank of chicago and wells fargo all targeting the institutional space and we're managing a couple of billion dollars at the time vanguard was obviously targeting retail space an area that a lot of people thought this couldn't necessarily work because ordinary people would always want the hotshot stock picker but he did that and as you say later on dimensional fund advisors and rex sinkhole and david booth were able to get their favor repaid because when they were setting up dimensional fund advisors they got vanguard to help with lots of the back office stuff introduction to lawyers advice and so on and i do think it is nice that it's the old philosophy of paying it forward right you you do you if you're kind and help people it will come back in some form or fashion at a later date i think that went on for about three years or so uh dfa using vanguard's back office what by the way that's what vanguard was set up to do.

35:15Yes. These people all helped each other. They all knew each other to varying degrees. And they all helped together, collectively, in aggregate, bring forth the greatest investing revolution we've ever seen in human history. And I think none of them could have done it alone. And that's, at least for me, as a humble journalist, that's almost encouraging. It's nice to know that it's what we do together that can be really impactful. And the naysayers about the retail marketplace not accepting indexing were correct. Yes. But there's a little twist there, too. When the first index investment trust, which was the name of the Vanguard 500, which it's now called, was first brought to the market in 1975, it was sold through retail brokers, the Merrill Lynch's and Payne Webber's back then.

36:09Vanguard was only willing to pay a 6 % upfront commission, while all the active fund companies out there were paying 8%. So as a broker selling this, you have to admit that everything you've been telling your clients for as long as you've been in this business, all the funds that you've been selling maybe don't work. Go buy this index fund. You have to get over that hurdle. but then you are going to make less money by doing it. Well, I was a broker for 10 years. What did you expect to happen? I mean, Jack thought they were going to raise$150 million. Yes. Not in this lifetime were you going to raise$150 million.

36:47Not from brokers who have very big egos and like to get paid. Vanguard raised a little over$11 million. But they were still able to launch. They weren't able to buy all 500 stocks because they didn't have enough money. That didn't happen until I think 1977 when they merged another large cap fund into the first index investment trust. And then they were able to go out and buy. But the whole history of that, by the way, I did a podcast number one. I had Jack Bogle on. It was only a few months before he passed and he had wrote a book called Stay the Course. We went over a lot of the history of the actual launching of the fund.

37:23And interesting story in there. He was talking about the person who was actually buying the stocks was, I want to say, a secretary who worked there part time. And the rest of the time she worked for her husband at a furniture store. It really is fascinating to listen to. But it wasn't successful. There was only like$110 million in the fund as late as 1981. Yes, with very little incentive to sell the Vanguard's first index investment trust, as it was called for a long time. You had no incentive to sell it. So it struggled. And I think this is part of the sort of Jack Bogle's later year revisionism, that he was always a big fan.

38:02The reality is that he launched an index fund because it was the one thing he was able to do. Yes. Under the very restrictive terms of his divorce from Wellington. I agree. His grandiose way of expressing this was that strategy follows structure. But it really, structure didn't let him to do anything other than an unmanaged index fund. And that was only because the board essentially kind of with a nod and a wink, sure, yes, this is unmanaged. You're not actually managing money. It's unmanaged. It's purely passive. Fine. Go and have your little side project. And he didn't really care about the fund or throw himself into marketing it in the way we saw later on for a very long time.

38:42I've talked to people that worked at Vanguard in the 80s. Frankly, the saving grace for Vanguard, the money market funds. But that's really what kept Vanguard afloat. They were able to start money market funds and bond funds and a few other things. They also had, you know, some very illustrious stock pickers still, right, like John Neff, who kind of kept it afloat. The index fund was, you know, it's not even the ugly duckling at this point. It's not anything that anybody really cares that much about, including Jack Bogle. But it does start to gather assets almost organically, because by the 80s, this research is starting to percolate more.

39:20There's an entire new generation of people have studied it in grad school, at business school, in economics. It just takes a long time for these ideas, especially when they're almost heretical, to get into the public livestream. So by the 80s, we are talking probably hundreds of billions of dollars globally in passive funds, in passive mandates in big... Wells Fargo became Wells Fargo, you know, eventually became a BGI, Barclays Global Investors. bankers trust battery much all these funds actually managed a lot of money passive strategies but it was only institutions because the pension funds could see this data and they realized this was clearly the optimal way for a lot of them to manage money on the public side it was just really slow ned johnson the head of fidelity famously said who wants to be operated on by mediocre surgeon like you want the best it's so ingrained in us as consumers that you know if you're going to trust somebody with your money you want the best people not somebody who's going to be lazy or perish the thought passive even the word passive sounds bad right so it had a marketing problem and yet it still started generating money a little bit in the 80s but really it's in the 90s yeah that things start going a little bit more nuts the vanguard 500 fund when that started to generate assets that's when bogle decided oh wow we have something here Right.

40:47Let's turn our mind to this. Let's turn this into a thing. They've gotten rid of sales loads. They've gone no load before quite early on. So they suddenly had quite a compelling offering. Like they were the cheap competitor in a very high cost, mediocre industry, essentially. And it's no surprise that in 1994, Jack published his first book, Bogulan Mutual Funds, which reintroduced indexing to the general public. And then from there, that was the focus. They started looking at international funds, a bond fund, which they couldn't even call it an index fund. The SEC wouldn't allow them to. And then as you wrote in your book, Jack went in to see Gus Sautter and said, Gus, what are we doing?

41:28Screwing around? Let's launch a total market index fund. now he's on to it yeah yeah it took 15 years and gus sorter you're right gus sorter is an underappreciated hero in in the past investing story i think like he was instrumental at vanguard he was one of those people that had studied the efficient markets i mean he also had an incredibly interesting career but he was the guy that really ran that and drove that in the 90s and started what is now, as you pointed out, this titanic$2 trillion fund. And that's Gus Slaughter. So Jack Bogle does get the credit. And she gets some of the credit. But I do think Gath deserves a large chunk of it too.

42:08Gus is just a really great person, a really nice guy, very humble. Okay, we need to get into the second part of the book because we're just burning up time here. And that is exchange traded funds. After the market crash of 1987, the failure of portfolio insurance, there needed to be a different way of trading a basket of real live stocks and doing it as a stock. Thus, the evolution or the creation of, they weren't called ETFs back then. It was a security that was a basket of stocks like a closed-end fund, but traded close to its NAV, its net asset value, because the fund manager could create new shares and redeem shares that were in the marketplace to keep the price close to its NAV, which was very different than closed end funds.

43:01Let's talk about very early on the players, the amount of work and education that had to take place at the SEC for them to wrap their hands around what is now called an exchange traded fund and ETF. So after 87, the massive crash, the SEC published and the Treasury and everybody got together with a big sort of blue ribbon reports laying out what they thought went wrong. And in there, the world's a section that talked about maybe if there'd been some sort of a product that essentially kind of buffered like an index product, a tradable index product that kind of buffered somehow between index futures and the cash market, that maybe this would have helped.

43:45And quite a few financial engineers, and there were a lot of financial engineers on Wall Street by the late 80s, realized this could be the kernel or something. The SEC was almost surreptitiously asking somebody to come up with something like this. I mean, you have various indexed tradable products. Obviously, futures had been around for a while. People are trading like total return swaps and things like that. But you had essentially at the American Stock Exchange a problem. They were getting squeezed by the New York Stock Exchange, the big brother, the big board, and the upstart NASDAQ. So they needed to find a new product.

44:25And they decided that maybe this is a way to do it. So the main people at the American Stock Exchange were two people, two financial engineers called Nathan Most and Stephen Blue. there were other people involved Ivers Riley, Catherine Moriarty their lawyer but essentially they decided to come up with a tradable index fund so it'd be a cash product a bit like what the SEC wanted but it would be tradable throughout the day you trade just like a stock and they set about developing it but as you pointed out it was hugely complicated both because of practical financial realities and incredibly awkward regulatory ones.

45:07And many people in the industry thought this was a terrible idea. And Nate Most actually did go to visit Jack Bogle and asked him for help. And Jack Bogle said, well, essentially, here's where I think the technical problems are. But the biggest problem is I think this is a stupid idea that should never ever happen. He called it giving gasoline to an arsonist. sounds very jack he wanted people to buy the sp500 and hold it until they retired and they were proposing something you might buy and sell within five minutes it was quite understandably anathema to jack bogle rightly so i think it was hard to go from what nate most was sketching out to him and what they were talking about in the early days and what we see in the world today but it's partially because of all the hard work they had to do to clear the regulatory thicket, as it were, to allow this to be bought.

45:59This product called Standard & Poor's Depository Receipts, or SPIDERS, was finally filed with the SEC in 1990. But there was so much regulatory burden to get through, it didn't launch until January of 1993. And it traded. It went over OK. It wasn't a huge splash, but it greased the skids for what would come in the future. It took three years before another one was launched, and that was the S &P 400 Midis. The MidCap Index. I was in the brokerage industry at the time. I started using Spiders and Midis for my clients as a long-term hold, which was almost forbidden. Oh, wow. Yeah, I'd read Jack's book and I was enlightened and I was looking for a way to move my clients over to index funds, but there was nothing available except extremely high fee, high commission S &P 500 funds through Dreyfus and other broker sold products.

47:08And this was a solution. And so I started putting clients in Spiders and Midis to replace U.S. actively managed products. And that did not go over well with my bosses. Okay, moving along. It took a while before other exchange-traded funds came out. And they came out in batches. The first group was called WEBS. So tell us about WEBS. in the same way that the first ETF, SPDR, was born out of a sort of an alliance of necessity between State Street and the American Stock Exchange. In the same way that essentially Webbs was born, it was actually Morgan Stanley had set up a index joint venture with Capital Group on the West Coast.

47:59It was called MSCI for Morgan Stanley Capital Investments. And MSCI had all these indices. They were creating lots of indices, but they realized, well, we kind of need some products to go along with them. So Morgan Stanley tapped its relationship with Barclays Global Investors, BGI, out on the West Coast. So this was the old Wells Fargo, in fact, that had pioneered pioneered the very first index fund and was by then a giant of indexing although it only solely in the institutional space they'd also done all sorts of cool and funky things with systematic equity strategies and so on so they were big and had been first after a joint venture with Nikkei in Japan they'd been acquired by Barclays the UK bank and they'd become a giant one of the biggest asset management firms in the world.

48:49But frankly, even BGI did not get enormously excited about this idea of a joint venture with MSCI to start these new ETFs, as people would start to call them then. They just weren't that crazy about it. It's kind of a retail product. They thought it didn't really fit with what they do. They were complicated. And frankly, it wasn't as if the first ETFs were a roaring success either. But they did it almost as a favor to Morgan Stanley. and there's a reason why Morgan Stanley essentially offloaded its share in this Webbs joint venture to BGI for a purely nominal sum. Nobody really believed in this and the name Webbs, it was a world equity benchmark, the idea were the way international ETFs was really just like a cheeky way of a nodded to spider, spider and Webbs, right?

49:39That was like that's a far, that's how far name conventions go in the financial industry and nobody really cared about for a long time until you suddenly had a few executives at BGI that realized that, you know, Barclays was already a giant of the institutional investing space and ETFs and this webs could be the kernel of the becoming a giant in the retail space as well. I recall the day that iShares, they changed the name to iShares. Exactly. Launched, I want to say, 16 ETFs and they were all to these different indices, small cap, large cap. I think they were using Russell indices, if I'm not mistaken.

50:23And it was huge. All of a sudden, it was no longer just the S &P 500, the S &P 400, and country baskets. It was now Stiles. And they came on the market. And to me, this was the beginning of the revolution that took place with exchange traded funds when iShares launched the style indices. Well, so the two crucial people at BGI at the time, I think, were Patricia Dunn, the CEO, and Lee Cranefuss, who took over what became known as iShares. they were the ones that you know crane first was the slightly mad genius i've heard him described uh who had immense drive and ambition and patricia dunn was the one that could see this and frankly back him and got money from barclays and from the board of bgi to essentially what was lost probably a ton of money to begin with because it's a you and i know how hard it is to just go into something adjacent but going from being a purely institutional relationship manager essentially Selling to pension plans, sovereign wealth funds, private banks, and then selling to the retail world.

51:38It's just a huge leap. It requires a whole change of mindset, which is why iShares was set up to be something different. And Lee Cranefoss, I think, saw quicker than almost anybody else, certainly at places like State Street that had pioneered the ETF, that the future of the ETF wasn't just like a tradable index fund, essentially like the S &P 500, but actually being able to carpet bond the entire investment landscape with tradable products. So styles, sectors, sizes, the whole panoply of potential investment products you could package up. Because in reality, you and I know that it isn't just the fact that active managers underperform in the long run in the stock market.

52:23It's in every single subsector as well. And a lot of the fund managers that do outperform really always have done so by having some sort of secret style tilt. That's only explicitly or explicitly embraced. So this is why style ETFs, the iShares, they started and then Crane first basically signed up all the biggest indices. He signed for exclusive use of their brand because the indices had become kind of the shorthand for these styles, for these markets. And like the Russell 2000 was the small caps index. is actually, I'd argue, actually a really bad small caps index. I agree. But it was the small caps index.

53:00It was the shorthand. So he signed an exclusive deal to basically have that. So he essentially squatted like an intellectual property toad over all these different parts of the investment world and systematically built this up. And it must have cost a ton of money because you have to build the sale forces. You have to do all the marketing. And people of our generation remember how aggressively iShares used to market itself. And they had to do so because they had to catch up, right? They had no retail cachet. Nobody knew who they were. Nobody knew who BGI was. They suddenly then, people realized that ETFs can be just a tradable index fund, but they can also be an investing tool.

53:38They can be used strategically and tactically. And that meant that actually a lot of people started embracing them that frankly would never have been considered potential users just a few years earlier. So now enter Gus Sauter. So Gus is looking at this, and Jack unfortunately had to retire because he had a heart condition and had a heart transplant, so he steps down. Gus is watching this and saying, okay, first of all, we can't use those indices. I mean, we can't launch ETFs against those because they're locked up. So Gus creates his own methodology. And I remember when the paper was published.

54:20It was like 2000 or 2001. And he takes this methodology, small cap, large cap, and how to migrate from small cap to large cap, and how to migrate from value to growth. He takes this whole methodology, and he goes to CRISP, and he says, create indexes out of this. The paper explained how to do it. They take it, and they create the indexes, and then Vanguard comes in with what they called vipers. It wasn't a great name. They ended up dropping it. Yeah. But they come in with style and size ETFs. And they also get a patent on the funds that they currently had, like the Total Market Fund and the S &P 500 Fund.

55:03They create a patent where they can create a share class of ETFs within that fund. And the patent was for like 20 years so that no one else can do this. And now, because of Gus Sauter, in my belief, Vanguard is now in the ETF industry, which allows Merrill Lynch and Payne Weber and Wells Fargo advisors to use Vanguard funds, which is a thing Jack never got. I remember talking to Bert and Malkiel about this. I mean, he was at the board of Vanguard for a very long time, was a good friend of Jack Bogle and huge fan. Bert was very articulate in explaining why he supported the ousting of Jack Bogle from Vanguard.

55:44The reality is that sometimes you need a founder, a certain person who's perfectly suited for that era. And Jack Bogle was Vanguard. I mean, his spirit is still very much in the walls there. But increasingly by then, it was very clear that the organization had started to grow or needed to maybe have a different type of CEO. And that was obviously very awkward to do and very painful, frankly, for everybody involved. I mean, I've talked to a few people. They're all, frankly, emotionally scarred from that era. But I think Jack Brennan changed the organization, made it more professional and could see the benefits.

56:21But still, this is an organization formed in such Jack's image that I think even with Gus Sorter championing ETFs, they were very slow to appreciate its power. But I think they needed to manage Jack fully out, unfortunately, to truly embrace their index fund 2.0. A couple of other companies who missed the boat on ETFs. Fidelity. Boy, did they miss the boat. I mean, you talk about vipers, but Spartans were even worse, right? That's just, it really shows how little Fidelity didn't want it to tarnishing their active brand, as it were. We can't even call them Fidelity funds. And it's very easy to make excuses for them.

57:07I think like the really the one that like, hard to say they missed the boat, but State Street should be massive. Oh, yeah, they had it. They had it. Oh, yeah, absolutely. Absolutely. Even after it was already very obviously a big thing, State Street kind of slept on it for a long time. You know, the funny thing was when Barclays got into a little financial trouble after the financial crisis, and they had bought Lehman Brothers back then, and they needed to spin off iShares. They needed to find a buyer for iShares. That was Fidelity's opportunity right there. And Vanguard. Vanguard sniffed around as well because they knew their ETFs were underpowered and they realized they had to catch up.

57:51And this was a potential way. But for Vanguard, given its ownership structure and Barclay's need for cash up front now, it meant that the advantage was always going to be to almost a de facto cash buyer. And buyer eventually, not Fidelity and not any of the other people that came sniffing around or the private equity firms that actually had bids accepted for iShares was BlackRock. BlackRock's trump card was that he was obviously listed so he could pay in shares and fairly liquid shares. And they would buy all of BGI, all of Barclays Global Investors. And I think that was the genius move. It was.

58:28You did a good job with Larry Fink and talking about how he was instrumental in bringing on iShares and growing that brand. He saw the value there. He put building an institution before building his own personal wealth. and we elevate the inventors, the Jack Bogles, the Mack McCrowns. These are people that I also love. But sometimes you do need people who's just going to get shit done. And Larry Fink is somebody who's very commercially minded, is extremely brilliant. I've talked to lots of people that even don't like him and will say he has complete mastery of every part of his business. And we could go on for two hours here because we can get into all kinds of things that you have in your book.

59:09But we've run out of time. Thank you so much, Robin, for being on Bogleheads on Investing. Thanks so much for having me on, Rick. And I'm really looking forward to digging into the history of the bottom market next. This concludes this episode of Bogleheads on Investing. Join us each month as we interview a new guest on a new topic. In the meantime, visit Boglecenter.net, Bogleheads.org, the Bogleheads Wiki, Bogleheads Twitter, the Bogleheads YouTube channel, Bogleheads Facebook, Bogleheads Reddit. Join one of your local Logalheads chapters and get others to join. Thanks for listening.