Trillions: How a bunch of Wall Street renegades invented the index fund and changed finance forever. 2021. Robin Wigglesworth. Wallet.
Some 50 years ago, the index fund revolution has begun in the financial markets. Like many revolutions, it opened quietly, without fanfare. As he began to attract attention, many of his ideas were reprimanded by the establishment. But the revolution was kept alive by a number of smart, passionate outsiders who were looking for a way to apply the academic research they had studied to real-world investing. Today, index funds have gone from being a fringe investment idea to becoming the establishment.
In Trillions: How a bunch of Wall Street renegades invented the index fund and changed finance forever, Robin WigglesworthTHE FinancialTimes global financial correspondent, wrote an illuminating history of the index fund industry. With his gifted writing style, Wigglesworth took what might be a dry and boring account of the financial markets and weaved together a compelling story of the characters who created one of the greatest financial revolutions of the past 50 years.
The book reads much like a good novel, with interesting characters you meet along the way. Wigglesworth begins by introducing the main players with short blurbs about their backgrounds. Everyone will know Warren Buffett and John Bogle on the practitioner side, and finance students will know Harry Markowitz, William Sharpe and Eugene Fama. However, many of the founders of the indexing revolution are lesser known, even to those familiar with academic finance. Some may be unaware that the intellectual development of indexing did not begin with the aforementioned academics, but rather with Louis Bachelier, a French mathematician whose early 20th century work on random walk laid the foundation for Fama more than half a century later. . Unfortunately, Bachelier was in the wrong field and ahead of his time, so his work languished in obscurity for many decades.
trillion tells how a number of academics created the theoretical basis of indexing and how their followers established an industry based on these principles, but it is also the story of several random events that led to the revolution of the indexing. Readers wonder what the path of finance would have been without some of these serendipitous developments. If the mathematician Jimmie Savage had not discovered Bachelier’s work, would Paul Samuelson and others have studied the random nature of stock prices? If Markowitz hadn’t had a chance conversation with a stockbroker outside his adviser’s office, would modern portfolio theory have begun in the 1950s? Without the foundation provided by Markowitz, would Sharpe have been attracted to finance, or could he have taken up the research he conducted at Rand on a smog tax? If Fama had chosen to attend Harvard rather than call the University of Chicago to inquire about his candidacy, would Harvard now be the home of market efficiency? And what of the students Fama inspired in Chicago, like David Booth and Rex Sinquefield?
It is widely believed that indexing began with Bogle’s introduction of Vanguard’s flagship 500 index fund in 1976. In reality, passive investing originated several years earlier with Wells Fargo Investment Advisors’ management of a portion from the pension fund of luggage manufacturer Samsonite.
The beginnings of passive investing met with considerable resistance and extremely limited acceptance. By the end of 1976, Vanguard had only managed to raise $14 million for its first fund offering, an S&P 500 tracker. Today, Vanguard manages over $5 trillion.
This dramatic growth reflects how time has proven the validity of the concept. Wigglesworth Tells It Now Legendary story of Buffett’s bet with investment management firm Protégé Partners. Buffett bet that a fund that tracked the US stock market would beat any group of hedge fund managers in the decade ending in 2018. Protégé Partners chose five funds of funds, Buffett, the Vanguard 500 Index Trust . Ten years later, the Vanguard 500 Index Trust had beaten funds of hedge funds, from 125.8% to 36.3%. Not a single fund beat the S&P 500.
The author continues the history of indexing through the development of Standard & Poor’s Certificates of Deposit (SPDR) and exchange-traded funds. Although exchange-traded funds (ETFs) have gained great notoriety in the financial markets, their origins and creators are not as well known as those of indexing. The idea for ETFs came from Nate Most, head of product development at the US Stock Exchange. Familiar with the concept of traders buying and selling warehouse receipts for commodities rather than physical products, Most applied it to a basket of securities. Like index funds before them, ETFs have faced harsh criticism, including Vanguard founder Bogle.
Wigglesworth points out several distinctions between ETFs and traditional indexing. Unlike index mutual funds, rapidly proliferating ETFs straddle and, in some cases, cross the line between passive and active investing by shifting indexes in various directions. For example, Robert Netzly’s Christian Wealth Management has designed ETFs to align with Christian values. Among the many other ETFs that deviate from the concept of liabilities is HACK, which buys shares of computer security companies.
No book on indexing would be complete without a discussion of the indices tracked by the funds. Wigglesworth reminds us that the composition of an index is not magically transmitted from heaven. Rather, it is the construction of a committee that decides which companies are included in the index and even determines how companies are ranked for the purpose of assignment to the various indices. For example, the tech industry has come under political fire from left and right for a number of reasons, but some of the most frequently criticized companies are not classified as tech. Index builders categorize Amazon as retail, while Google and Facebook are considered communications companies. On the other hand, financial payment companies, such as Mastercard and Visa, are classified as technology stocks. Index committees wield additional market power due to the price impact that occurs when a stock is added to or removed from an index.
The indexing revolution likely saved investors billions of dollars in fees and shook up the investment industry. These changes were not without cost, however. They have put pressure on the revenues of a financial industry that does not exist simply to line the pockets of analysts and portfolio managers, but rather supports an entire ecosystem. This includes functions such as providing active managers with research reports and executing transactions, all of which are necessary for the survival of the indexing industry.
Wigglesworth also makes provocative points about the pitfalls of indexing, including the inability of index funds to adapt to new economic or social conditions. The February 14, 2018 shooting at Marjory Stoneman Douglas High School is an example. In the aftermath of this deadly incident, index fund providers, such as Vanguard and BlackRock, were unable to sell gun maker stocks, prompting a boycott. Similarly, index funds that are not expressly designed for this purpose cannot divest stocks that do not meet the standards of the environmental, social and governance (ESG) movement.
Other challenges that index funds face stem from their own success. The explosive growth of the industry has endowed the largest providers of index funds with substantial percentages of shareholder votes. They may therefore end up exerting an outsized influence on governance policy, facing criticism from both sides of every issue.
With Trillions: How a bunch of Wall Street renegades invented the index fund and changed finance forever, Wigglesworth has produced a historic, entertaining and thought-provoking book. It is a tool that finance professionals and interested laypersons alike will appreciate.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect the views of the CFA Institute or the author’s employer.
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