For most individual investors in 1975, access to the markets came typically through mutual funds, pooled accounts holding stocks and bonds in which investors own a share proportionate to their investment. The funds were actively managed, meaning the fund companies bought and sold positions as their forecasts for each security’s prospects waxed and waned. Mutual funds tended to be expensive due to the research and trading costs along with manager salaries, company profits and sales commissions to selling brokers.
A new player emerged on the field that year that would ultimately rewrite the rules of the entire game. Vanguard, today a household name in the fund industry, was founded by another future hall of famer named John C. “Jack” Bogle. Now celebrating its 50th year, Vanguard serves 50 million current investors, but its focus on index investing and low costs has benefited practically all fund investors.
It has long been known that most actively managed funds underperform a relevant benchmark that reflects the fund’s objective. Each year, Standard and Poor’s queries its massive fund database and invariably reports that over the most recent 20-year period, around 95% of all active funds underperform the market after fees and expenses. As early as the late 1950s, researchers recognized the inefficiency of active management. However, at the time there was no way to invest directly in an index like the S&P 500. No such investment vehicle existed.
In 1960, two University of Chicago graduate students wrote a groundbreaking paper that appeared in the Financial Analysts Journal titled “The Case for an Unmanaged Investment Company.” Edward F. Renshaw and Paul J. Feldstein made the case for a passive fund that merely replicated a market index that would obviate the need for individual stock picking and could be operated at lower cost. The first salvo has been fired.
This critique of active management was met with a spirited rebuttal a few months later in the same journal, entitled “The Case for Mutual Fund Management,” a fierce defense penned by an active fund manager writing under the name of John B. Armstrong, a nom de plume for none other than John C. Bogle. Bogle at the time was the CEO of Wellington Management, a large investment company with a vested interest in quashing the upstart passive index approach that threatened its own profits.