The First Retail Index Fund Breakthrough
It was forty years ago last week that Jack Bogle and his new firm The Vanguard Group launched First Index Investment Trust, the world’s first index mutual fund available to retail investors. Looking back on it from the vantage point of today, you’d probably be surprised at just how difficult the effort turned out to be. Not only did it take him two years to get the fund launched, as Bogle writes in an article in the Journal of Index Investing, but its IPO flopped. Yet after several years of poor performance the fund, later renamed Vanguard 500 Index Fund, ultimately grew to hold over $250 billion of assets today, while The Vanguard Group has become the largest mutual fund company in the world, managing well over $3.5 trillion of investors’ money. It’s worth spending a brief amount of time noting some of the industry breakthroughs that this fund and others of its era pioneered.
First there was the challenge of tracking the net asset values (NAV) of the stocks in the S&P 500 (which is the asset class the fund was targeting) on a daily basis. Computer technology in 1976 was not what it is today. Your Android phone or iPhone is more powerful than some of the largest computers available at that time. Although not the first fund company to utilize computers to track NAV, Vanguard’s difficulty was compounded by the sheer number of stocks in the index (500). One way the fund was able to cut corners was to actually hold only a subset (280 stocks) of the full index. Today, of course, there are funds that are able to hold every tradable stock on the planet and track them with just a fraction of their management companies’ available computing power.
Another element of mutual fund structure back in the 1970s that was ripe for change was high fees. In addition to annual expenses, many funds charged an upfront load of as much as 8% to attract salespeople at the brokerage houses to sell them. Vanguard chose to eliminate the front end load and sell the fund directly to the public. You can imagine just how difficult that must have been. Bogle recognized that the only way the index fund could succeed with that kind of sales model was for it to outperform its competitors. Which it did from 1982 through 1989, beating three-quarters of actively managed S&P 500 funds during that period.
The fund’s performance also helped shift the balance in the passive vs. active investing debate. Prior to its introduction virtually all retail mutual funds were actively managed. Despite the voices of well-respected economists such as Paul Samuelson and Burton Malkeil arguing that it was almost impossible for an active mutual fund manager to beat the market in the long term, the prevailing belief was that investing in all the stocks in an asset class such as large cap companies, including the losers, made no sense. This debate continues today, although the evidence that actively managed funds are simply unable to sustain higher returns – if only due to their higher cost structures – continues to mount.
Notwithstanding Vanguard’s validation of passive investing as a potentially superior investment strategy, I think their greatest contribution to the mutual fund industry was to drive investor costs lower. Ben Steverman at Bloomberg.com speculates that over the last 40 years Vanguard may have saved investors as much as one trillion dollars. That number is probably impossible to determine with any accuracy, but even if it was a tenth of that, the value to the investing public would have been tremendous. As I am constantly reminding my readers, we cannot control investment returns, but we can control costs. Congratulations and thank you, Jack!