Weekend reading

Good reads from around the Web.

The behemoth of low-cost investing is having a great year, reports Bloomberg’s Businessweek:

Vanguard is not just having its best year ever. (It shattered that record in September.) The $130.4 billion in deposits in mutual funds and exchange-traded funds that Vanguard has taken in through November is the most ever for the industry, according to data from Strategic Insight.

That beats the $129.6 billion that JPMorgan clocked, mostly for money market funds, in 2008. This year’s not over.

The article is peppered with interesting quotes about the advance of Vanguard’s business, and the rise of passive funds and ETFs in general.

But consider this section:

It’s asymmetric warfare, as Vanguard’s sole ownership and constituency is its fundholders, the savings it wrings from its buying power are passed on to them, not to shareholders or partners.

As Vanguard grows from niche player to one of the biggest beasts in the investing jungle, I think this practice of redeploying money towards its customers might enable an unbeatable feedback loop.

The Robin Hood of the fund world

Consider how much Wall Street and The City has syphoned off returns over the past few decades. Now imagine more of that vast amount of money going to lowering Vanguard’s already tiny fees on its passive products, and you see the power of the model here.

Customers owning the company would be a template for a new kind of capitalism if it worked everywhere, but it doesn’t. Usually self-interest allied to the profit principle works better. The pursuit of self-interest produces innovations and superior results at the expense of lazier competitors. That in turn generates superior profits, driving out weak competitors while making the winning companies even stronger.

But I think financial services might be different – and Vanguard able to exploit that difference – because historically it’s been the case that superior marketing – if you include the very idea that active funds beat the market – is what has generated superior profits, as opposed to superior performance being duly rewarded.

After all, in aggregate, active management can’t outperform passive funds, after fees. That is the whole point of index investing.

Passive index funds are cheaper, so will deliver better profits for most investors over time. Yet while index funds are on the rise, they don’t yet attract the lion’s share of money their performance should theoretically deserve.

The worm that turned

Because of superior marketing – which we might define to include everything from a more compelling story to established and trusted brand names – active fund management still attracts investment ahead of passive funds.

Indeed, hugely expensive hedge funds can potentially net their promoters the best profits of all – despite these funds in aggregate failing to beat a 60/40 balanced tracker portfolio!

Yet this is a zero-sum, largely zero-skill game, after costs1, which is what makes cheap passive investing so attractive.

In the past, the excess profits generated by the myth of active fund management has gone to enriching the employees and shareholders of City companies.

But because it reinvests the profits that most of the rest of the industry hives off, Vanguard is different. In its case it’s the fundholders that are going to be enriched. The more record-breaking fund flows it attracts, the more its customers will benefit through better (i.e. cheaper) performance.

Will there be a tipping point where ‘everyone knows’ that passive investing is the mainstream choice for greater returns over the long-term?

Or will active fund managers always be able to sell short-term outperformance as a more exciting long-term prospect?

Place your bets, and pick your funds!

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: The physical gold provider Bullion Vault has beefed up its silver offerings in recent weeks, so you can now buy and hold both gold and silver in its New York, London, and Zurich vaults.

Mainstream media money

Note: Some links are to Google search results – these enable you to click through to read the piece without you being a paid subscriber of the site

Passive investing

Active investing

Other stuff worth reading

  • How to build ‘money for life’ – CBS
  • Time: Your best bet to beat a ‘rigged market’ – Wall Street Journal
  • Amazon’s zero-profit business strategy – Slate
  • Why do TV scriptwriters hate entrepreneurs? – Slate
  • Could the next BoE governor be moving the goalposts? – FT
  • Is it cheaper to be a man or a woman? – The Guardian
  • Key statistics from the 2011 census – ONS
  • What it’s like to live on $1 a day – Business Insider

Book of the week: Four Pillars author William Bernstein has a new £2 Kindle book out: Skating Where the Puck Was. Aimed at professional investors, it argues that yesterday’s alternative assets (gold, hedge funds) are tomorrow’s correlated ones, as dumb money piles in and loads up.

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  1. It is not that active fund managers are not hard working and clever that is the problem. It is that they are ALL hard working and clever, as well as competing against each other. In aggregate across the fund universe there is no out-performance in returns – there is only seepage to fees and expenses.

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