Guest User

January 20, 2022

Index Funds, Alternative Investments

Episode 184: Robin Wigglesworth: The Story of Index Funds

Guest User

January 20, 2022

Index Funds, Alternative Investments

Robin Wigglesworth is the Financial Times’ global finance correspondent, and author of Trillions, the definitive book on the past, present and future of passive investing. He currently lives in Oslo, Norway, with his three children and wife.

We have often spoken about the book Trillions on the show, and in today's episode, we are lucky enough to interview the author, Robin Wigglesworth. We get to speak to Robin about his book and some of its central and most interesting ideas, while touching on other subjects too. Listeners will definitely come away with some enriched perspective, and hearing Robin's thoughtful and articulate answers was an absolute pleasure for us. Our guest is also the Global Financial Correspondent for the Financial Times, with his contributions to the publication being well worth keeping up with. After distilling some of the history of index investing, Mac McQuown, Jack Bogle, and the building blocks of what we do here at the Rational Reminder, Robin is generous enough to also comment on crypto, tech disruption, private equity, ESG investing, and more. This episode ties in so well with previous conversations we have had and Robin's dedication to his craft as a financial writer is truly inspiring, join us to hear it all.

Key Points From This Episode:

Simple reasons for why index funds are the best option for investors. [0:02:40.1]
Tracing the roots of the culture of stock picking. [0:05:52.7]
The initial intellectual push that the idea of index fund received from Wells Fargo. [0:10:44.4]
Touching on some of the important yet lesser-known characters in the history. [0:15:05.8]
Robin unpacks the evolution that Jack Bogle went through in the 1960s. [0:17:40.1]
Jack Bogle's real superpower and getting to grips with the essence of his philosophy. [0:22:33.4]
The important relationship between Dimension and Vanguard. [0:25:42.7]
Differentiating between factor investing and total mark indexing. [0:29:24.5]
Robin's thoughts on where we are currently with an imaginary alpha. [0:32:46.3]
Reasons for Jack Bogle's decision to avoid embracing ETFs early on. [0:35:28.7]
Why Robin stands by the idea that markets are not efficient. [0:37:31.8]
The impact of bond ETFs on the future of the market. [0:42:48.1]
Concerns around proxy votes at bigger asset managers. [0:48:34.4]
Some thoughts from Robin about ESG investing and its value. [0:52:17.7]
The skepticism that Robin still holds about cryptocurrency and its disruptive characteristics. [0:57:45.2]
The example of Albania that Robin has used in his book to illustrate a point about crypto. [1:02:47.6]
Looking at the trend towards private equity in the financial world. [1:09:23.4]
Robin's own definition of success: the feeling of doing a good job. [1:17:46.6]

Read the Transcript:

So let's start with the basics. Why are index funds a sensible investment for most people?

Ooh, well first orders, because you'll just do better, right? It's an inconvenient truth for the investment industry that the average investor will inevitably do better with the cheapest possible product. And that is generally speaking in index fund. So, you don't really need to care about whether marks are efficient or about SKU or about all these other technical arguments, you just know that as long as you minimize your costs, you'll probably do better than the most other investors, certainly in the long run. So, it's a mix of cost and the fact that active managers really struggle in the long run to beat their benchmarks.

So why has it taken so long for indexing to become mainstream?

Well, it's on the inconvenient truth, right? There's a reason why it took off on the institutional side. So pension plans, a few sovereign wealth funds before it really took off on the ordinary retail investor side or financial advisors because trying to beat markets or trying to be good or better is kind of ingrained in us, is part of our human nature, certainly among Americans, but really for everybody, right? Some of the early critics of indexing would quite candidly say, "Who wants to be operated on by a mediocre surgeon?" Nobody wants that, right? And there's always this sense that you want to do something interesting and aggressive with your money sometimes, especially men and historically, usually it was men that sort of allocated the family resources to investment products. And you're not going to be the cool person at a party if you've invested in an index fund, you want to say you have invested with Jared Tsai or Peter Lynch or Ken Griffin, now if you're a very wealthy person. And I think that human foible is very hard to get around.

So, you kind of touched on it, but why do you think it was that institutions were so quick to catch on? Like, are they not exposed to the same biases?

They are to a large extent, but they can be a little bit more rigorous. And the first adopters, the first big, really big adopter of indexing was AT&T's pension plan, pension plans really. So this was when you were split into little baby Bells, they were called and the Bell system were small pension plans. Now together, they were the biggest owner of equities, US equities in America by far. And they would sometimes get together and exchange notes and they could kind of see they've all invested in a motley bunch of mutual funds. They're essentially swapping stocks and incurring trading costs and charging a salary in the process. So yeah, Bell in Illinois might have invested in a mutual fund that was selling IBM and on the other side of the country, another Bell was maybe invested in a mutual fund that was buying IBM stock and they could see, they were generally getting the entire market return minus the cost of trading and salaries. So why not just go index it?

So, there are other people that also did this early on, but pension plans, big institutional equity investors were the first ones to really embrace it and still are the biggest backers of index funds.

I have a bit of a follow-up question on that. So you think back to the sixties when indexing was really starting, you could not know what the market performance was, it was not available, right? So how much of this desire to beat or even outperform because it wasn't about beating the market. There was no market to beat, it was stock picking in general. So how much do you think that culture was just because there was no benchmarking available?

Well, it's almost a weird thing for us today to think about this, but there were indices, but they were by any sort of modern standards, laughably, comically rudimentary. So you have the Dow Jones Industrial Average of the US has venerable history, Wall Street Journal bizarrely still quotes it even though it has a terrible construction method. It was basically to sort of measure the strength of the economy and some industrial stocks. It wasn't really until the fifties, when the S&P or Standard launched a market cap-weighted index of the 500 biggest companies that you had had a almost real time. It took a decade before they could calculate it within minutes, but at least every day, real-time gauge of what a broad swath of the US stock market did. But even then, people didn't know what the long-term return of stocks was. People literally didn't know that.

So the genesis moment was when Merrill Lynch wanted to sell stocks to ordinary Americans and households to a generation scarred by the Great Depression sold in the sixties was going to run an ad in every newspaper in the world and in the US saying stocks are a great long-term investment. And the SEC told them, "No, you can't do that. You have to prove that they're a good long-term investment." So, they basically handed a wedge of money to Jim Lorie, a professor at the University of Chicago and he started a new project called CRSP to research security prices, essentially Center for Research in Security Prices. And he spent years doing this because he manually had to collect, him and his colleagues had to manually collect the prices of all stocks they could find in the US equalized for different tax treatment in different countries, dividend payments. And also just the fact that some things that were called a common stock were in fact not a common stock.

And other things that maybe called a preference chair or even a bond actually was common equity. So they had to do all this work and clean up the data and it took years and costs a lot of money, but they were the first people that created this wonderful, really magical database of security prices in America that proved that stocks were a great long-term investment, but less conveniently for the investment industry that the long-term return of the stock market was quite a lot higher than the average return of active mutual fund managers.

That's wild. I knew most of the story about CRSP, I did not know that it was an advertising motivation that created that whole initiative.

Yes. No, it's odd moments, right? The sliding doors that spur a lot of these things. I always think that it would've happened anyway, probably, but sometimes fate needs a little bit of a push, I think.

So, you've compiled this comprehensive history of index funds. We're touching on bits and pieces of it now. What about the overall story surprised you once you'd put it all together?

Really how long it actually took for the idea to crystallize, maybe because for us we always assume sitting in our purchase today that the way things are is how things always have been. So, the genesis of the index fund seems entirely natural and the sixties and seventies feel so long ago that yes, sure, it's fine that that's an ancient history in financial terms. But really when I dug into the history of the thirties and forties and fifties, you realize how many people tiptoed up to the idea, but never articulated it and certainly didn't actually implement it. So, one of the first articulations of a market portfolio I ever found was a paper by a California professor called Edward Renshaw. So, died in obscurity, nobody really knows much more than this paper. And the fact that an anonymous asset management executive that wrote on the name of John B. Armstrong rubbished the idea of creating a market portfolio. This was 1960. And ironically that executive was actually Jack Bogle, who later became the leading proselytizer for index funds.

But again, it took a long time before it finally came to fruition. And that actually surprised me reading back at it how close we kind of got, but never really close enough.

Such a great story. So two weeks ago we had Mac McQuown on the podcast, which was an incredible interview. So, he was part of the brain power that went into this seemingly simple concept. Can you talk about the breath of brain power that was behind this idea?

It was huge. So, obviously success has many parents and defeat is an orphan, but in my eyes, Mac is the father of the index fund. And there are many other people that deserve a heap of credit but the very first index fund was orchestrated by Mac McQuown at Wells Fargo through his units called Management Sciences. And it was kind of an internal skunkworks, a think tank set up by Ransom Cook, the former Wells Fargo chairman, and then overseen by Dick Cooley after him. And I'm very envious, talked to Mac about this today, but essentially he was given complete blank check by two chairman in a row. He reported directly to the CEO and chairman and anything else what he got and it's amazing what you can do with unlimited budget, right? So Mac went about, first of all, buying the CRSP database. He was one of the first, if not the first buyer of that commercial user of it, but he also hired essentially a complete murderers row of famous financial economists. The biggest rock stars that the economics profession had at that time.

So just mentioning the Nobel Prize winners or the people that would go on to win Nobel Prizes. There was Gene Fama, Merton Miller, Bill Sharpe, Harry Markowitz, Jack Treynor was there as well. It was incredible. So, in the book, I call it the Manhattan Project of Financial Economics, because I don't think we've ever seen such a collection of brain power put together in finance at one time before. A lot of these people, Fischer Black, Myron Scholes as well, Nobel Prize winners. So it was just phenomenal. So it was interesting to see what they cooked up.

So, Mac told us about the story of the index fund idea going to Vanguard. And one thing I wish I had asked Mac was what was, and maybe you know this, what was the motivation behind Wells Fargo to just let it go? Was it true values we wanted to bring this idea to the masses or was it because they didn't think the idea would manifest in such a big way? Do you have any thoughts on that?

Well, the history around this is a little bit messy, but fundamentally Mac worked at Management Sciences, which was a think tank that used computers for finance and investing, but it couldn't manage money itself. So he was locked with never-ending battles with the trust department. Now in the end, they had a meeting of hearts and minds, but then again, they had battles with Wells Fargo, the bank that continued frankly for decades. All these people were expensive as well. Management Sciences to the Wells Fargo investment advisors they set up to house the first index funds. It never made money until the eighties. And they staggering, like we're talking millions of dollars at a time where millions of dollars was real money. They tried to launch something called the Stagecoach Fund that supposed to be for broader investment community, not just pension plans. The first index funds were actually not funds. Those separately managed accounts on behalf of the pension plans like Samsonite, Illinois Bell and Wells Fargo itself.

The thing is there was still the Glass-Steagall Act in place that kept commercial investment banking separate. And essentially it meant that Wells Fargo and there was a separate lawsuit that was rumbling around that time. Basically the Supreme Court rule that no, and a bank like Wells Fargo could not sell this to ordinary customers. You couldn't have commingled investments between professional investors and ordinary investors, which basically killed Stagecoach. And there were many other complications with that project, but I think the frustration around that was one of the reasons why Mac quit, for example, it was also one of the reasons why they felt fine about sharing their thoughts and insights with this young man called Jack Bogle at Vanguard at the time because they couldn't compete anyway. So they thought why not be helpful?

You mentioned Mac, who do you think is the least known one yet most impactful character in the story?

That's a great question. I often start with the godfather, Louis Bachelier because he was utterly unknown in his own time. And I think to this day, people don't always appreciate what a giant of financial economics he was before frankly there was even a field of financial economics. So he is... And Isaac Newton once said that, "If I've seen further it's because I stand on the shoulders of giants." And I think the shoulders upon which a lot of people like Gene Fama and Bill Sharpe and Harry Markowitz all stand on is to some extent Louis Bachelier. And so, I think he was inspirational.

Among the other characters, I think and this is why I think I give a lot of credit to Mac for being the father of the first index fund or the first indexed separately managed account. But Rex Sinquefield, American National Bank of Chicago and Dean LeBaron at almost the same time in different ways also got to this promised land. And I think you can't underestimate how important it was to have three different engines driving this together at the beginning, especially since Mac left Wells Fargo in frustration in 1974, I think. Just as things were starting to take off a little bit. So people like Rex Sinquefield who crisscrossed the entire country called himself John the Baptist of indexing in efficient markets has done God's work in spreading the idea among institutions and later on as well to financial advisors through Dimensional Fund Advisors, which he is a co-founder of.

Dean LeBaron as well also not an efficient markets zealot at all. He was an active manager. He just felt that fundamentally what a lot of investors were actually asking for a broad diversified portfolio of blue chip US stocks with low turnover and low cost was basically an index fund, so why not just do that and sell it for cheap, just do it, commoditize. It's service. And he also, again, talked a lot about this and if you read some of his speeches about sort of foreseeing the quantitative investment revolution that came, I think they are together with Mac, the pioneers of this and hugely influential in everything that came afterwards as well. So Mac definitely a hero of mine but I always stress that we shouldn't write Rex Sinquefield and Dean LeBaron of this story either.

You mentioned Jack Bogle, can you kind of fill in some of the gaps about the evolution that he went through in the sixties? He was not a index fund zealot until later on. So there were some change that happened. Can you talk a bit about that?

Yes. And this is always gets a little bit tricky because obviously Jack Bogle was such a titanic character and his heroized and lionized by many people and quite rightly so. But frankly, I like my heroes flawed and multifaceted and Jack Bogle is clearly one of my heroes, but I think he had a tendency to burnish some parts of his legacy in favor of other things. And once he decided that he was the godfather of indexing, he reinterpreted parts of his past to fit back better. And actually I like the journey he did. I like that he changed his mind and sometimes for the right reasons, sometimes frankly for the wrong reasons, because it was expedient for him, but he changed his mind and showed a suppleness of wit and intellect and integrity of character allowed him to do this.

But yeah, so he fascinating story, right? His family was wealthy, but lost all the wealth in the Great Depression. His father became an alcoholic and his mother basically had raise him and his brothers himself. So I think this sense of fall from grace of coming from privilege and then basically falling, not quite in a penury, but certainly less comfortable surroundings really shaped him. They couldn't afford to send all the Bogle boys to university. So only Jack got to go because he was the smartest one. His grades were the best. And can you imagine what that does to your drive and how much you feel you need to prove that you earn this? So he worked his way through university and he studied economics. He struggled with Paul Samuelson's textbooks famously, but managed to turn things around just through sheer hard work.

And he wrote his thesis on the mutual fund, which was just then starting to grow after stumbling over an article about it. And that thesis was interesting and smart enough that it was given to Walter Morgan, the head of Wellington, big balanced mutual fund manager, one of the biggest in the US at the time. And he essentially gave Jack Bogle a job. So, he was to begin with not an active zealot at all. He was the wonderboy of the asset management industry. And I think there were elements of his character that was still there. He's fundamentally cheap. He always talked about how he was Scottish cheapskate and people I've talked to known him all the way back then said he was always cheap. That was always part of his DNA.

So he always liked low fees. And he occasionally later on flirted a little bit with the idea of mutualization because he could see there was this fundamental conflict between the interests of you as an investor in the fund and the fact that the fund's investment manager, their shareholders want to maximize returns. And sometimes that can be fine and sometimes they can be in conflict. But a lot of other things was sort of more part of the reinterpretation of the legend of St. Jack that happened later on because he was an active zealot and frankly he was always had a soft spot for some active managers. It was famously Steve Neff until this dying days.

You briefly glossed over earlier the paper that Bogle wrote in 1960. Can you just talk a little bit more about what he was saying in that paper? Because I think it really drives the point home.

Yeah. So, Renshaw, the California professor that had written this paper and not in a kind of index funds is better than active more. There is so much choice among mutual funds. It's so hard for ordinary investors to choose. How about somebody who sets up mutual fund that buys entire market, because it'll just be cheap and easy and people just keep some money there until they find somebody they really like. The intellectual scaffolding was not all that we now know it to be. But Jack Bogle under the pen name of John B. Armstrong just basically ripped this to shreds in one of the leading financial journals saying this was ridiculous and obviously here is the data that shows big mutual funds outperform the market in the long run. And it goes to show and Jack Bogle ironically did exactly the same study that he did in 1960, tried to debunk this paper, but reverse with a different aim 15 years later when he found the Vanguard with radically different results.

So it goes to the old point that Benjamin Disraeli, the former British prime minister wants says, "Lies, damned lies, and statistics," that you have to be aware of maybe the biases of the writer to check the veracity of the numbers as well sometimes. Amazing things what you can do with some assumptions.

Yeah, that's crazy. So, there's an online community that I'm sure you know about Bogleheads and the Bogleheads approach can be I've generalized, I think as being pretty dogmatic where low-cost, total market index funds are good and everything else is bad. We kind of touched on bits and pieces of this, but based on the research that you've done, was Bogle or what Bogle have been a Boglehead?

Oh yes. Well, not at that time in the sixties. We're all shaped by where we work and what we do. And he was a young, honcho executive, one of America's biggest mutual fund groups. Of course, he didn't like the idea of indexing. Naturally mighty have come around to it at some point maybe naturally. But I do think that quite possibly, if Jack Bogle hadn't, I'm sure we'll talk about this, hadn't been very unceremoniously sacked then would not have been a Vanguard. And I am actually skeptical that Wellington would've launched index funds if Jack Bogle stayed there. But the idea of Jack, I think as the index fund father is understandable, but really his superpower, if we think of him as a superhero here in this story and he really is, his superpower is something that often gets undersold or sometimes denigrated, but your salesmanship, it was constructing a narrative.

And when I talked about how a lot of investors don't want to go into a party and say they were invested in a boring bunch of index funds. That's not cool. It's not sexy. It's not going to get people or the opposite or the same sex attracted to you. But Jack Bogle turned indexing into something that smart, sophisticated people did. He made it cool. You were the smart person for doing this. And I think the lessons that he constructed and had all these homilies and points like the cost matters hypothesis was just still to this day completely spot on and backed up by reams and reams of data from many markets across many asset classes that actually this does work. Like a low-cost diversified group of cheap index funds, such as those espoused by the Bogleheads still actually works really, really well in the long run.

And I would say there's so many things I don't know about finance and I to my lament, I discover new things I don't know every day, but the only financial advice I ever feel comfortable giving to any friend or family who asked me about this, I say, "Look, I know nothing. Index funds just being boring. It's actually going to make you look smart in the long run." That I'd feel comfortable saying. And that is thanks to people like Jack Bogle

Was Bogle dogmatic about it though? Like Vanguard is still a massive active manager too.

Yes, it's a good point. Vanguard, I think is north of a trillion dollars in various active strategies, many of which are in Wellington. So Jack Bogle, like I said talked about the cost matters hypothesis. So he wasn't an efficient markets guy, but he believed in the cost matters hypothesis. And that's how he squared that circle as it were. And it is true that you can actually be ambivalent to what works best in various markets and just choose the cheapest options. I happen, despite me being a huge fan of indexing, I do believe there is such a thing called alpha. I do believe there are active managers that can in the long run, but not forever outperform markets. I just think there are very few of them and they tend to charge quite a lot of money for doing so.

So the average investor's still better off choosing an index fund. He was dogmatic, but I think he called himself, determined. Stay the course was his motto, right? And he always decide on one thing and he'd just power through and do that no matter what. And he was always interesting if you kind of chipped away one of his arguments, he'd back down and say, "Yes." He always incredibly honest about things, is, "Well, yes, yes, of course this and yes, active management can outperform, but people charge too much money." But Vanguard's been very successful and frankly made its peace with Wellington eventually.

So, most of our listeners are familiar with both Dimensional Fund Advisors and Vanguard, but their relationship is not that well-known. So, can you talk about how Vanguard helped Dimensional get started?

So, like I said, we all stand on the shoulders of giants to greater or lesser extent. Sometimes we don't even know it. Sometimes the link is overt and Jack Bogle, when he first started toying around with the idea of an index fund, he did send his assistant Jan Twardowski to ask Mac McQuown at Wells Fargo, Rex Sinquefield and Dean LeBaron for help because they had experience on the institutional side. In the same way, it's quite natural that a lot of other people that came afterwards would turn to St. Jack, not just if they were in the indexing world, but he was just known as a man of great integrity and somebody who would if it didn't sort of imperil Vanguard's competitive position, he would help people. He was a kind, helpful person.

So, David Booth who ironically had worked with Mac at Wells Fargo many years earlier, working specifically on the Samsonite on the Stagecoach Fund, he had ended up at AG Becker which was a consultancy for pension plans that collected all the data that showed how bad the active managers did. And he wanted essentially to leave AG Becker and set up an index fund for small caps, small companies. It wasn't really an index fund because there weren't any small cap indices at that time. In fact, what he was aiming to do was more of a microcap strategy, but they needed money. They needed partners. He got together with these old classmate Rex Sinquefield who was still at the American National Bank of Chicago. They left to found Dimensional Fund Advisors together with a salesman from AG Becker called Larry Klotz. And they went to Jack Bogle and asked him for help.

And Bogle said, "Well, you guys are going to be doing institutional pension fund managers, mostly. Sure, I'll help." Because obviously Vanguard was initially set up to do admin work for the Wellington Funds and only that. So they'd obviously branched out by the eighties when DFA was founded, but they still had huge expertise in admin work and paperwork. And a lot of these sort of the management boring back office stuff and that's quite expensive and difficult for a startup investment manager. So, David Booth asked Bogle to do that and Bogle did that and also introduced Booth to his lawyer who helped him run all the paperwork. So, I think DFA would've happened without Bogle certainly, but he gave a big, big helping hand to it in the first few years.

Yeah. That's fascinating. Those are details that I had never heard before reading your book. So, we just talked about Dimensional and Vanguard. How do you describe the difference between factor investing, which Dimensional does and total market indexing which Vanguard among other things, but what Vanguard is known for at least, how do you describe the difference?

Well, essentially it boils down to the work of Gene Fama and Bill Sharpe and some of the economists I talked about earlier. So, Jack Bogle knew all this theory. He later pretend that he came to the idea of index funds randomly, but that's just not true. He definitely knew about this theory, but he was not an efficient market zealot. David Booth and Rex Sinquefield are, but you can construct this in various ways that the idea that there is a market return that thanks to Sharpe is known as beta, but then later on various economists... So when DFA found it, it was founded on the idea that yes, beta works well, but the most indexes that people use don't have smaller companies and they are riskier, but in the long run that should generate a greater return. So, there's risk versus reward aspect that Fama and Sharpe and other people accentuated. Later on, after they'd founded and started, there was a lot of work done by various academics and some practitioners in trying to disentangle beta even more into its individual components.

We think of like a meal as a hamburger. Factors you buy the index fund is the hamburger, but maybe you just want the bread or just the meat. And that is actually a healthy meal. So that's what they... They disentangled the hamburger, they deconstructed it. And Gene Fama famously because for him from the efficient markets, the father of efficient markets was particularly influential that he discovered that size and value were two other factors. So size being small companies tend to do better in the long run, value that cheap stocks measured by booked value or some other metric tend to do better. And over the years there's been obviously tons of factors that generally only five or six mainstream ones that people agree on. And they can obviously go through long fallow periods like value has had an absolute shocker for well over a decade now, just abysmal. Worse run by one measure I've seen in three centuries, basically it's in stock markets existed and people disagree on why they work or whether they work or how they work.

So an efficient market zealot like Gene Fama and DFA argue that you are harnessing some sort of risk. You might not have been aware of it, but buying small caps, small caps are riskier. So you get a higher long-term return. Value stocks, again, maybe close to their cheaper stocks, maybe they're close to bankruptcy. Other people think that factors come because of behavioral anomalies and glitches. Like we do dumb things in markets and we maybe get seduced by the glamor of sexy growth stocks, for example, like such as today and ignore the dowdy ones. So people look at it in different ways, but I think it's interesting that Vanguard, although it has factor in sector funds has never accentuated that part as much whilst with Dimensional Fund Advisors, it's literally in the name. They call them dimensions, but really it's factor or the term that Bill Sharpe absolutely hates, but inspired by him, smart beta.

Yeah. So, you mentioned the explosion of factors and quantum investing more broadly has exploded in the marketplace with all kinds of different theoretical models, empirical research, ETF products. Do you think Robin, there's a risk that we end up right back where we started, which is high V concentrated funds chasing imaginary alpha?

Yes. And I sadly think we're there already and maybe have been for a while. So with factor funds, for example, look, the data and the studies on this are incredibly rigorous. I believe that those factors exist. I just think that actually harnessing them actually is really difficult for a lot of investors and not just talk about ordinary investors, but even big sophisticated pension plans and sovereign wealth funds. It's hard to stick in a factor when it goes through one of those 1, 2, 5, and in this with value 10-year drawdown periods. So the theorists will say that these factors only work because it has these drawdown factors. It has to work because people give up on it. But I think a factor or an investment strategy built on the idea that you can hang on for dear life longer than the next guy has its weaknesses.

Like why not just capture the entire market beta in the long run? I think that is probably the smartest and best approach for most people, whether a pension plan or an individual investor, even though I still fundamentally do believe in the factor investing side of things and other more of these of the zanier new products. Jack Bogle was really good on this. He compared the proliferation of ETFs to Purdey Shotguns, he called it. So Purdey Shotguns was a great popular shotgun in old England used for hunting big game, but also became very popular as way of killing yourself because it was so powerful and he felt that people with ETFs and some of these zanier, dumber products were overtrading and doing dumb things.

I think even that, I think a lot of his concerns about overtrading of payment in ETFs or factor ETFs even is overdone. But the ETF has definitely evolved into a broader structure that you can do all sort of stupid things with, sometimes stupid for the individual investor but sometimes also stupid for maybe the health of broader financial markets. So I do think and worry that innovation, although a good thing and maybe sometimes have some positive externalities from bad stuff, just as good stuff has negative externalities, I worry that product innovation has gone a little bit of amok in especially ETFs these days.

So, is that why Jack Bogle declined the opportunity to embrace ETFs very early on? And that was another great story in your book.

Yeah. Sliding door moment, one that Vanguard desperately tried to undo years afterwards when they pushed Jack out. Yes, and Nate Most who invented the ETF at the American Stock Exchange went to visit Jack Bogle because ironically also the chair of the new products committee at the American Exchange was Burton Malkiel, who had written in a very famous book called A Random Walk Down Wall Street and also was on the board of Vanguard. So, he introduced them. Nate Most came to Bogle and explained that he wanted to create tradeable index funds, essentially index funds that traded on an exchange just like a stock and Jack Bogle politely pointed out a few very specific logistical issues with this because he was a master of some of these aspects, but then more broadly and philosophically just absolutely detested the idea. So, as he griped to Burton Malkiel why would you want to sell the S&P in the morning and buy then in the afternoon or vice versa?

He just wanted people to buy the S&P 500 and hold it until the day they died or retired essentially. So, it was an anathema to him partially because he had grown up the era where trading was bad, that trading costs were so astronomical compared to what we see today that this was actually a bigger headwind, even bigger than the cost of a portfolio manager. It was all the trading costs. But I think on that respect and to be fair to him, Bogle could change his mind. When I spoke to him a few times just before he passed away, he had definitely softened a lot on ETFs, mostly because he saw them as a good way of broadening the indexing revolution. He said, "Look, I don't like ETFs, but lots of people do. And if more people buy index funds that way, hallelujah, God bless them. Great." But he couldn't shake off this annoying fear that they led to overtrading and people making dumb decisions. In many ways, maybe the concern, ill-founded concern I have about factor funds, for example.

You talked briefly earlier about how you think some active managers can generate alpha for a period of time. We talked about the deep academic roots of indexing and market efficiency, but I've read some of your stuff on meme stocks and retail investors and FOMO. So I got to ask, do you think markets are efficient?

No. Not at all. But I think the issue I have with this is that I feel efficient was the wrong term for what Gene Fama and his kindred spirits were describing and what they still to this day described that efficient to most people, it means perfect or really, really good. It just seems so counterintuitive when you see people do silly things day in, day out, year in, year out, right? Not just individual stocks or financial securities are blatantly mispriced all the time, but also we can see massive bubbles inflate and deflate. So I feel it's almost like a marketing issue with efficient markets, but really at its heart, the concept of it, I agree with. So one of my favorite quotes is from an old British statistician called George Box who said that all models are wrong, but some are useful. We all use mental models to simplify how the world is, because it's so bloody difficult.

And the efficient markets theory is wrong in the way that most people understand efficient markets to mean, but it's a really, really good model to describe how they function and why they are in practice so very, very hard to beat. We can see this on the data, right? Now, somebody has to make those markets efficient and they have to actually make money from doing so in the long run otherwise, they'd be out of a job. This is called the Grossman-Stiglitz Paradox that somebody has to make markets efficient. Somebody has to beat those more correct prices into the market. So, I think that all sorts of small nitty-gritty granular problems with it, but as a mental model, it still holds up incredibly well. And I think people who always point out like the financial crisis or the meme stock revolution that proves the EMH in pharma was wrong.

And I think they misunderstand what he kind of was saying and also the consequences of it because there's quite a lot of things that you would've said like Amazon in 1999, everybody said was a massive bubble and it dropped 95% within six months. And look at Amazon today. But in the same way, there are many other companies that also from the dot-com bubble as well. Cisco, everybody thought Cisco would dominate the internet, the hard part of the internet economy. And they did, they do, Cisco is a giant company. They make vastly more money than they ever did 20 years ago. But their stock is still what, 50% down from the dot-com peak. This goes to show that markets aren't efficient, but it's very hard to know before the fact when they're wrong.

Do you think index funds distort market prices though?

Yes and no. This is the one I struggle the most with because I have extremely strong opinions on both sides in that I feel a lot of passive investing funds, feel they need to sort of support their side as if it's a football match and their side is right no matter what, but this isn't the Pats, right? I don't think you need to pretend that Tom Brady walks on water just because you think the Pats are a good team and I don't think you can just because you think indexing is a fantastic innovation like I do pretend that it has no potential downsides. Now, the way I see it is so big, it's having an impact on the environment, the environment being financial markets and the broader investment industry. When you grow to the size that passive investing has, I cannot see how you can argue it isn't having an impact in some form or fashion. Where I disagree is whether that impact is any more malign or any different than the impact of any other financial investment vehicle or innovation.

For example, the birth of the mutual funds. A lot of the things that people say about index funds and ETFs today, they said almost verbatim about mutual funds, 100 years ago, or hedge funds or private equity or venture capital, right? We all love having bug bears to point the finger at, and these days it's either index funds or central banks. Now, do I think in some isolated market corners, stock-specific or sector-specific, there can and be some weird *** that happens because of ETFs and ETF flows or index fund flows? Unambiguously, yes. You can see tons of small examples of this, but from a macro top-level, is this having a terrible effect on market efficiency? No, I think it's actually driving out a lot of mediocre money managers and investors out of the market and actually helping make the markets overall a little bit more efficient in the long run, which is also why we tend to see active management performance is actually getting worse as passive grows, not getting better.

Are bond ETFs going to make the market implode because of the illiquidity of the underlying holdings?

Ooh, another one of my favorite topics. So, this is one where I've changed my mind, not quite 180 degrees, but if you'd asked me before I started writing my book, what I thought about credit ETFs, I said, "Broadly speaking, they're kind of fine, but I have severe concerns about how they're going to hold up in a major stress environment." Now, in the process of writing and well, mostly editing the book, we had one of these major stress events in March 2020. I can dive in more, but it gets pretty nerdy quickly. But I actually think that credit ETFs did way, way, way better than I, and certainly almost all the skeptics would've expected beforehand. If you described to me what March 2020 would've been like a few months earlier, I would've predicted havoc in large swathes of the ETF ecosystem, especially when it comes to less liquid securities.

Now I think not only are ETFs way more resilient than I frankly gave them credit for, and I was not like an ETF doom-monger, I just thought that would be something to watch. I now think that ETFs could actually be a superior vehicle for less liquid strategies than mutual funds. Now, I haven't quite married myself to that theory yet, but I'm definitely flirting quite heavily with it because I think there are all sorts of technical aspects around the creation of redemption in the secondary trading of the shares that make them first of all, better for the individual investor and fairer, but also probably a better thing for the solvency of the financial system than a classic US 40 Act mutual fund, for example. So, maybe all hell breaks loose tomorrow and I look like an idiot, but I'm getting prepared to die on my hill that credit ETFs are not nearly as bad as even I thought two years ago.

We talked to Dave Nadig about this a while ago and he said something along the lines of ETFs, bond ETFs, or ETFs in general will create another pricing vector for assets that are otherwise illiquid. So it's really like the ETF price is right. The underlying asset just isn't price at that time. And so it's not a bad thing at all. I thought that was a pretty neat perspective.

Yeah. Ironically, this was why ETFs were initially envisaged. They were sort of indirectly surreptitiously commissioned by the SEC after Black Monday, the market break reported to Black Monday in 1987, they wanted something that could cushion the hit between futures and futures started selling off and individual stocks. The cushion side, I'm less convinced in that. I think this is an entire ecosystem. There's always people can arbitrage and if X falls and everything else it's going to fall. So I don't think there's that much to that. And I definitely think that the transparent pricing you get from ETFs in a lot of markets, not equities, like you wouldn't look at Spider to see what the S&P 500 was doing. But in, for example, in credit and large parts of the fixed income universe, definitely ETFs were really good, instant, real-time gauge of what the market thought was going on there.

And I think that is a valuable service for policy makers, investors, the market system as a whole. But I think the reason why I've become way more of a fan of them is because of the secondary trading that it changed the incentive around withdrawals. So, if you're invest in a traditional bond fund, and if you pull your money out of that in a stress environment, bond funds typically don't sell what they want to sell, certain up in stress environment, but they sell what they can sell. And that's usually the high-grade, most liquid paper that they take the lowest markdown on. So over time, let's say in a March 2020 situation, this fund is suffering torrents of outflows, or lots of funds are suffering torrents of outflows, they can't sell all the crappy stuff, the junk bonds. So they sell all the high-grade stuff. So eventually the quality of those funds deteriorates until they're left with stuff that they literally can't sell in some cases, or can only sell at like half, like a 50-point markdown.

Now, investors know this. So, you have an incentive to try to be the first person out the door, because you'll get all your money back at the NAV, but the guy behind doesn't. So it kind of entrenches a bank run like dynamic in a bond mutual fund in one day liquidity. With ETFs, you have this creation, redemption process that's supposed to work all the time, but in practice we know like in March 2020, it does break down, but then people trade those shares. And yes, if you sell, let's say JNK or HYG, and you take a 10% markdown from the NAV at sale, that's the price for liquidity and you as the seller bear that. You have to pony up to get money now. Well, the remaining people are penalized from your decision from getting out of Doge.

So that's why I think for illiquid strategies, I think... There are many sort of nuances around this, around how the creation, redemption situation can happen in portfolio trading around that, but I actually think more and more I'm team David Nadig that he's been quite right and I've been unduly enormous of instinctively, but wrongly skeptical of credit ETFs. Now there could be something else that was revealed in the next crisis, but as it happens, I was really, really, quite positively surprised by how they performed. And we can see in the flows that's gone into fixing income ETFs since March 2020. You can tell that institutional investors are also positively surprised by the same.

Great answer. I have a question for you about proxy votes. Do you worry about the concentration of proxy votes in some of these huge asset managers like Vanguard, State Street, BlackRock?

Yes. This is what I'm most worried about, but it is unambiguous the most kind of soft ephemeral concern, right? Like the impact on market efficiency is a hard concern that I just don't think is true. It doesn't hold up to empirical scrutiny. I think credit ETFs, there are many other issues around index funds and their growth that I think is very concrete, but I just don't think the data's there yet and might never be there. When it comes to concentration, that's a soft one because this is an oligopoly or a groaning oligopoly that actually benefits us given the scale of economics of indexing. And I broadly speaking think that actually, despite the bad rap that the finance industry often gets and increasing asset managers, I think BlackRock and Vanguard and State Street and Fidelity, they broadly want to do the right thing. The problem is we can't always agree on what the right thing is. And I have an instinctive nervousness around any massive concentration of power.

So the investment industry is more balkanized than let's say like arms manufacturing in the US is or many other industries. But the asset management industry because it pools corporate power is unique in that it's not actually that big in value, in revenue as in the investment industry as a whole. But given that they basically control our collective savings of the entire world, they have disproportionate power because of that. If they use it, abuse it or even don't use it, because sometimes even the absence of a decision to use this power is a decision with consequences. So quite a lot of people have for many years attacked the index fund giants for being not just passive investors, but passive owners, they encourage corporate slough because they're not engaged enough.

Other people, especially these days think they're too engaged. So, I have a lot of sympathy for them in this predicament that it's kind of like is the porridge too hot, too cold, just right. But it's just the consequence of their size and not just the size today, but the size they're going to grow to almost inevitably over the next 10, 20, 30 years. Even Jack Bogle was concerned about this. Even he didn't feel that it was in the national interest as he put it that even his baby Vanguard become so gargantuan.

Yeah. That's an interesting problem.

It's a hard one to deal with as well, right? What do we do? We don't want to break these up. This is also again an oligopoly. If there is one that benefits us. Do we do like a half-arse one where we just divide them into legal entities? So it's still BlackRock, but they have different governance teams that in theory don't talk to each other? Broadly speaking, I think this is one of the hardest things to deal with, because it has no clean, obvious and simple answer or even people can't agree on exactly what the problem is because we tend to look at it through the prism of our own political biases. Like some people think that BlackRock is the embodiment of woke capitalism and horrific and basically kind of people... Larry Fink using his client's money for his political grandstanding. Other people think that Larry Fink is ruining the planet, not doing enough to save the world. I have a lot of sympathy for him and the other people that kind of get pushed backwards and forwards on this. It's the hardest problem as well and potentially one of the biggest ones.

Yeah. So, speaking of Larry Fink, trying to save the world, do you think ESG investing is good for the world?

Probably not. And I'm on the fence on and whether it's bad for the world.

Oh wow.

So this is the argument that, so take a why I think it's probably not good for the world in that I was a fan of fan, but I thought ESG made sense to an extent to begin with that you tilt and use your power as shareholders to kind of push, nudge companies maybe in the right direction within reason. I think that made sense and was actually a positive thing. But now first of all, it's become this sort of game one-upmanship between asset managers on who can sound the most ESG. And sometimes it's backed by concrete things and sometimes it's just marketing, but I worry that first of all, it's not really doing anything to attack the core issue. Let's say just taking the E to make things simple, but the environmental issue and the climate crisis. Forcing university A's pension endowment to divest or pension fund to divest from coal or a dirty energy, doesn't do anything. That asset still exists. As long as it's producing money and it's profitable, somebody's going to own it.

And in reality, what we are now seemingly doing is just basically forcing dirtier assets or more controversial assets out of public markets and into private markets where the gains will accrue sometimes through the same pension plans, through private equity or big industrial owners or oligarchs. We're not really doing anything to attack the core issue that we just need to pollute less and probably spend less energy. So, I feel it's not helping that much in the core issue, but I think like on governance and encouraging a little bit more diversity and just kind of telling people to kind of try to nudge the world a little bit, I'm okay with, and I think it's probably a good thing. The argument recently has been that ESG is actually bad because it gives us this false sense of action that the classic travesty of, "We must something. This is something, ergo we must do this." And it distracts from the actual serious issues that need to be grappled with. I don't really see that as a danger right now.

I don't think anybody, any government or any people are saying, "Well, Larry Fink's got this. We're okay. We don't need to think about this. BlackRock is going to handle this." I just don't think that is how is playing out. I think he's just one of many people that wants to do the right thing. And for the investment industry, that's why I think there is an argument why it's a dangerous thing, but I'm not convinced by it yet. I think in the more short term, what the investment industry needs to grapple with is that I fear that in their pursuit is sell something for a slightly higher fee they have contorted themselves into pretending that virtue can come without any cost or might even be rewarding that they say that, "Well, yes, if you invest in forward-thinking electric companies and renewables, this is where the world is heading, stranded oil is going to die."

And right now it kind of flows begetting performance begetting flows. So it becomes true, but we know this doesn't always last. So, I worry that a lot of pension plans, asset managers, financial advisors have maybe kidded themselves or missold to investors the idea that they can do this without some ultimate financial cost, because at some point I think virtue sometimes has to be its own reward. And if we want to do the right thing, we have to do that without expecting that we're also going to reap a above market gain from that. In fact, the only reason why divestment campaigns and such that can actually function is if they actually do the opposite. They lower returns by raising the cost of capital for dirty companies. And therefore we get less of that activity, but right now, and we can see some asset managers are being embroiled in some scandals already where people point out the gap between the rhetoric and the reality. I think that is going to be a live wire issue over the next few years.

I totally agree. I think theoretically, if you want to feel good about your ESG investment, you have to expect lower returns. It's a requirement.

Yeah. If I had an ESG investment, it was doing really well. I'd go to my broker and say, "What the hell's going on?" You can do it as a tactical trade as we discussed, like timing markets, getting these things right is really difficult. Yeah, you would've done really well with just Tesla, but I suspected one of the reason why ESG has looked like a really hot thing for the past decade is because if you look at how various ESG screens function and the ESG data is an absolute, sorry to say *** show it is just awful. It's so messy and it's so... People don't agree on things, but technology tends to screen well on ESG measures and banks and energy for example do not. And lo and behold, the past decade has been unusually favorable for tech companies, has been really bad for energy companies. So, therefore it looks like ESG is a factor that screens well, does well. That could hold for another 10 years, it could hold for another 50 years, but I wouldn't bet on it personally that way.

So your focus at the FT includes among other things, market trends and technological disruption. Crypto is $3 trillion roughly in market cap today, probably a market trend, I think at that magnitude. Is it a disruptive technology though?

Not yet. So being nakedly obvious with my biases, I'm still very much a skeptic despite being instinctively pro-technology and pro-new things. I often get teased by my colleagues that I've never seen a point strategy that I didn't instinctively think, "Oh, that sounds really cool." Or new technology or anything like that. Crypto is something that I kind of want to be true in some respects, but I've yet to see any actual use cases, both practical that exists today or theoretical. It just seems to be massive piles of hype laid on a very big selling scheme where the fundamental industry of crypto is to get more people to put money into crypto. Now, some good things could come out of that. The crazy thing about markets and bubbles is that bubbles can actually lead to all sorts of productive booms that we don't always appreciate, famously railways, right? Lots of railway companies went bust and investors lost a ungodly amount of money, but they helped basically forge the United States into a United States.

Florida real estate, Florida was a massive swamp until somebody decided they were going to pave it all over. They all lost their money. But again, Florida is now Florida. Dot-com boom right as well. So that's why I'm open to the idea that something will come out of crypto, something profoundly disruptive, but so far, it still seems to be me to be kind of Rube Goldberg machines that overly convoluted solutions to stuff that we already have in existence, or that essentially only functions if you pretend there is no financial regulation in the world. What I don't get is that regulatory arbitrage is a real thing that people do like tax arbitrage is not what I think I'd like to spend my life doing or my kids, I like them to do something valuable in their life rather than taking advantage of regulatory of tax glitches. But right now I think a part of that universe only exists and is allowed to exist because they can pretend there is no KYC or AML.

At some point, regulators are going to get a little bit more zealous with that, I expect because most countries do have laws on the books that prevent alternative parallel currencies from circulating for many, many historical reasons that we've seen, yeah for well over a millennia now.

So when your writings are critical of the whole crypto, Bitcoin movement, what sort of pushback do you get and can you learn something from that pushback?

So, it's a good question. And I tend to think, I learn... There's a temptation when you write to almost be deliberately provocative because quite often in the pushback, you learn way more. It's a truism that you learn more from criticism than you do from praise. I try not to do that. I think like performative contrarianism is pointless and is more about the writer's ego than anything else. But quite a lot of times, when I've learnt the most is when I've written something that people have a very strong opinion on the opposite side from. And sometimes I can still think I'm right and sometimes I've been proven right and sometimes not, but criticism is good. I think one of the reasons why I think the crypto world, because the reaction to other opinions is fairly cultish. Now, the reaction to openness of Tesla or many other aspects can also be fairly cultish. Cults sometimes are in the eye of the viewer.

So I try not to be too carried away with that, but there are, I think fairly clear cult-like characteristics around crypto, especially around Bitcoin, but some of the others as well. So it's become kind of fun, but if you write something about crypto, even if you write something positive, you get hated by all the people saying, "Well, why didn't you write mentioning my favorite crypto coin?" Right? "Why didn't you mention this NFT or something," but broadly speaking, it's a collection of never going to make it, have fun staying poor. The have fun staying poor, I think is like never going to make it. It is actually kind of funny. Salty critics that have fun staying poor is just like, it's the worst sort of part of the CD Bitcoin bro culture that I just think like they should just retire that. There are other expressions of the reason you can aim at, no coin is like me that doesn't basically insult everybody who is not rich and blame it from themselves essentially. But yeah, the feedback can be fairly salty put that way.

Can you talk a little bit about the story that you wrote about Albania and what we can maybe learn from their history with respect to crypto?

Yeah. So this was, I'm going to say deliberatively provocative, though I knew it would be provocative, but I thought the parallels were fascinating. So Albania after the fall of communism went through a very sort of actually successful transition to sort of more a market-based economy and they were the one-star peoples of the IMF and the Eastern block that the banks were an ungodly mess. They were just massive state run banks, stuffed the guild with dodgy bad loans that they made to various of communist potentates. So they couldn't make any loans. So, there was an alternative financial system that sprung up to service people, both to take deposits and make loans. And they attracted people by offering pretty high interest rates compared to the state banks. At the beginning, there were some frauds among them, but broadly speaking, these were mostly FX exchanges that often also handled inflows from Albanians working abroad, remittances, but they were a complete full payment system.

But then people started, the competition started, people started promising higher and higher interest rates and greater and greater returns and it just went completely nuts. So, it just became this pyramid scheme of just unimaginable proportions. So the IMF reported in this post, its postmortem into this later on that there were times where you go into Tirana and apparent the entire capital stunk of dead animals because all the farmers had taken the cows in to slaughter them, to put the money into these schemes. Like everybody was involved from the prime ministers, local governments, the central bank governor apparently and everybody knew there was some dodgy, there some bad eggs. So, also the IMF, the World Bank felt initially that this was a positive thing. It helped in financial inclusion and thought that the problem was just in the obvious Ponzi schemes.

The problem was that yes, the obvious Ponzi schemes had zero value, but like essentially all the others also had no real value as well. So in the end, the results was civil war, full out civil war, thousands of people dead and a complete economic cataclysm. Now, the reason why that isn't going to happen here, touch wood. The reason why I see the parallels is the idea that regulators didn't want to stifle something that was initially seen as a valuable, innovative, alternative part of financial system that actually served a use case. And even if it didn't, maybe it could in the longer run and then eventually these guys were allowed to advertise so they got more money in and like essentially all the advertising in Albania was for these various schemes. So it started getting this flywheel and then the local prosecutors starting investing that meant that they didn't want to clamp down on that.

So, I'm not saying that regulators are investing heavily in Bitcoin, but you can see some of the tendencies in other countries as well, above all in the US where like money begets more money and attention and clout until it starts feeding on itself and starts spinning. And I don't think we are nearly at that point now, but my point with the article was that if regulators think, and I know that some of them are profoundly concerned about this, they need to put up or shut up. Either crack down completely, go nuts, go full on jihad against the entire crypto world or at least introduce with the industry enough regulations that once things collapse or if things collapse that is done in a fairly orderly fashion or the parts that collapse don't then infect the entire world. Because like you say, this is a $3 trillion industry now. A collapse of that will have serious ramifications for a lot of people.

Yeah. You mentioned the sort of civil unrest idea, I read something, I can't remember what it was about 2008 and how people were pretty worried about civil unrest and the Fed kind of saved the day by putting liquidity back into the system. But in this case, we're talking about something that's outside the financial system. So, that's actually kind of scary. And you think about the kind of people who are really into this, they tend to be more libertarian anyway. I don't know. That's a little scary.

Yeah. And I tend to think that if crypto has like a 50% down day or something or like something happens or... Right now, I do actually think even though I'm very skeptical so far, I haven't seen some of any serious use cases yet. I think it's here to stay, but what does that mean? Does it hit to stay at half the price? I think what happens in crypto won't cause a systemic issue outside the finance industry, because right now the mainstream finance industry is pretty regimented and keeping out of that side of things. What I do worry is more that civil disorder side not full on outright civil war, but clearly this has been several generations that feel that the system is not working for them. And if crypto ends up being a bit of a disaster and it was allowed to inflate for a decade or several decades and drawing in lots of money from a lot of poor people that basically are kind of doing this because they don't have many other options they feel, and then are wiped out.

I worry that people aren't going to blame themselves for making these decisions. They're going to blame somebody else. That's what we tend to do. In the same way that when people were yellowing AMC and GameStop, when that stock went down, they blame Citadel or Robinhood or anybody but themselves, right? Not the fact that these companies are probably still going to zero. They're kind of sitting on a melting ice cube. So my worry is that if crypto just becomes basically another gambling, then like if you're going to on a bet on Dogecoin and Shiba Inu or Bitcoin or bet on football matches, fine. That's okay. That's completely fine. People find value in the entertainment in many different areas. Maybe there will be something positive out of it. My concern is that if things do crack, then the political consequences of this could be quite severe.

Yeah. That's interesting. All right. I've got one more potentially inflated asset class to ask you about. So, private equity, lots of assets going in there as well. On the premise, I think for at least from what I've seen that expected stock returns are really low, expected. Bond returns are really low, but here's private equity to save the day. What are your thoughts on that?

No, I think it's a great question. Well, I think a lot about these days just because it is by far one of the biggest trends in the financial world. It's not just private equity, it's private debt, private real estate, infrastructure, anything that doesn't trade on an exchange or is a bond basically is wildly boomy at the moment. So, to take a step back and to draw the link also with crypto in that I feel crypto is at least 90% bullshit but the 10% that remains could still be so valuable that it is genuinely game changing innovation, but it could be maybe 20% real or 2% not real. Similarly with private equity, private debt, these are all viable, important asset classes that actually I do feel at least in theory and quite often in practice have a valuable role to play in a market-based capitalist system. Like there are many dumb things that people or people in private equity have done stuff that I might find reprehensible, but there are many things that people have done on a football pitch as well that I find reprehensible.

So I try not to kind of get too moralistic about these things. And I think these are valuable asset classes and have a bright future, private equity, private debt, all these things are going to be way bigger in 10 years time, but are people at the moment going wildly over their skis in these asset classes? I think clearly yes and it's desperation, right? For a long time, a big institutional investor, a pension plan or sovereign wealth fund, essentially let's say broadly speaking had 6% in equities, 40% of bonds. And the bonds was there as insurance like it was supposed to do well if everything went down the crapper, but in practice you got paid for that insurance. It's like you got paid money, a lot of money from insurance. And actually because interest rates have been falling for 40 years, you got paid a lot. Like a lot of investors have made as much if more money from their fixed income portfolios than they have from stocks depending on their geographic split. That's just unprecedented.

And it's almost impossible to envisage a future that doesn't have... I don't think we're going to go into a big bond bear market, but clearly a big foundation zone of every institutional investor portfolio now looks like it's going to not deliver you the same returns or hardly any returns and probably only a little bit of insulation if market sell off. Private equity and venture capital and private, the whole private side is seen as the savior. And I think everybody knows that with so much money gushing in, returns are inevitably going to get crimped, but they all hope they'll get crimped for the next guy. Not me. And that I think is the central fallacy here that yes, there are going to be some venture capital funds and some private equity funds that are still going to deliver great returns.

And let's face it. We're not talking that institutional investors don't need 30%, 40%. Even 20% is luxurious. If you can get double digits, they are happy as Larry. That's all they care about. If you can beat like say 7%, 8% bogey, that's great. So maybe the counter point to my fear about bubbles in private equity and other private capital markets is that actually yes, there are some bubbles, but broadly speaking is just going to bring returns down to a completely okay-ish 10% and that's fine for most institutional investors, but I do worry that the dispersion in those returns, there's going to be some funds that still 20%, 30%, 40% and some are going to deliver a significantly less than that. And I don't really always trust every institutional investor to be able, it's not even if they're good enough, it's whether they can even get an allocation to what is likely to be a top performing fund. So I do worry that this is something that's going to come back to haunt us in 10 or 20 years time.

And the dispersion in private equity is massive compared to like a public mutual fund.

Yeah. And in VCs it's even greater. The interesting thing about both private equity and VC is also the persistence is fantastic. So the persistence in mutual funds like the whole point of active management, it would be a lot easier if you found somebody who had done really well for three years and knowing that odds are that continue to do well for the next 10 years. But in fact, the greater you've done over one or two or five or even 10 years, the chances are actually, you're actually going to be an underperforming the next period. Venture capital and private equity, the persistence is far greater, but the capacity issues are harder. So that means that if I rock up to Ken Griffin on the hedge fund side, or Izzy Englander, Millennium or Benchmark or Sequoia and say, "Hey, I want a prime slice of your next fund." I'm not going to get it. You can be a big pension plan and not get that.

I know serious, huge endowments that basically spend most of the time begging some of the top VCs and private equity firms to take their money. That's how difficult it is. And it's also the fact is that these guys know that and they charge accordingly. So you just hope that those above market persistent returns you get at least beat the bogey of the fees that they pay as well. And that's a tricky thing. Like would I invest with like a Citadel or Millennium or Point72 if I could? Possibly. But I also know that like after fees, returns aren't always quite as good. So I think it's better to be a hedge fund manager than a hedge fund investor. And same thing probably goes for private equity. There's a reason why Steve Schwartzman is one of the richest people in the world and most pension fund trustees are not.

Yeah, there's the paper that came out, I think last year or two years ago from, I think Oxford maybe showing that the private equity fund investors had earned about the same as an appropriate public benchmark, but 12 multimillionaires or billionaires were created from the fund managers.

Yeah. It's sort of there Fred Schwed wrote about this in the forties, after going on a walk with JPMorgan's a fictional account, where he said, "Where are the Customers' Yachts," famous book title as well. But now these days, I think we're the customers massive SI castles, or we're their private jets. No. So I think private equity, the returns from the top people are good. I understand why pension plans do this, but I do worry that I think if they think those kind of historical returns are going to be replicated in the next decade, they're deluded.

And I do worry that maybe the whole thing is a bit of a regulatory game and taking advantage of the tax deductibility of debt and really what they're delivering and there are all the people that show this is like leverage small, SMID caps in the long run, but without market to market. Because I think for a lot of the dirty secret as well as I think a lot of big institutional investors just love that the markets are a little bit more creative. So from a pure portfolio perspective, if you have a sharp ratio on your pension plan, the more private equity you have in there, the better it looks from a sharp perspective just because the vault will artificially fall. So I always joke that if somebody could create like an index fund that you could only look at once a year, like a non-market to market index fund, then people would throw money at you.

Yeah. That was the argument that AQR made in that paper and I don't know when that paper came out, but they said that institutions are actually willing to pay more for illiquid assets because of the smoothing effect.

The illiquidity premium is something that people still hold up as sort of religious dogma in private markets. And I'm very much on team Cliff Asness on this that I think it exists in theory, but is not a law of natural science. It only exist if people insist on it. And right now people I think are not actually accepting illiquidity premium, they're paying for that iliquidity, they're ponying up for it.

Right.

And that'd be fine if they accepted that and maybe made it transparent, but I'm a little bit concerned about that side.

Robin. This has been an incredible conversation and we have one question for you. How do you define success in your life?

Well, that's a good... If I set aside latitudes around family and kids, like I just set it, I was in self-quarantine away from the kids for a few days because of if concerns I had COVID and it was weird how much I missed them and how much they matter to me even from a day. For me, it's I like feeling that I've done a good job, that one thing that drives me the craziest is whatever you do in life, just doing it sort of haphazard and half-arsed just drives me a little bit crazy. And maybe it's especially my job that there are many people excellent journalists who are now unemployed these days and through no fault of their own as to say not a growth industry to put that way. So I just feel incredibly grateful I get to do such an awesome job.

So, I feel it's extra important that you put your back into it and make it matter. And for me, success at the end of the day is that yes, that'd be a good father and good husband and all that, fun fortune cookie jazz. But that I actually kind of done a good job that I haven't half-arsed something too much. Sometimes you almost have to, that's part of the job as well, knowing when you have to do that, but that you put pride in what you do, I find a little bit meaning in. The problem is I tend to be always unhappy about everything I do as soon as I've finished it. So, I wouldn't say I found a lot of life's satisfaction, but I always say that a little bit of paranoia also keeps you a little bit maybe sharp as well. I think Andy ball said at IBM, "Only the paranoid survive." So maybe paranoia is also something that people can win and I find a little bit of meaning in.

That's a great answer. And you did do an awesome job with your book, Trillion. So congratulations on that. Listeners know I'm a huge fan of the book and we've talked about it many times here. I absolutely love the book. I think you did a great job and this conversation was so interesting. So, Robin thanks so much for joining us.

No thanks guys for me. It's been a lot of fun. Sorry, I didn't have any better answers on the meaning of life, certainly my life, but my life is finding cool stories and telling people about them. So, it's a little bit humdrum, but there it is.

You do write good stories. I read a bunch of your stuff to prepare for this conversation and it's great. You do a good job.

Well, I do try to get a little bit of some pop cultural reference points. I think my favorite point ever at the Financial Times was getting a Ghostbusters to reference into a column. That was peak of my career. Absolute peak. I'll probably never better that.

Oh, all right. Thanks, Robin.

Thanks having me.