As a proponent of passive investing, I want to acknowledge a major historic milestone: This summer the 500 Index Fund turned 40. Originally named the First Index Investment Trust, it was created by John C. Bogle in 1976 and introduced the world to passive index investing. Bogle is the founder of The Vanguard Group and served as CEO for over twenty years.
This fund has always had the same objective—to track the performance of the 500 largest US companies. And we now acknowledge the advantages of this approach to investing, but at the time, the fund was deemed “Bogle’s Folly” because the financial industry looked down on utilizing a passive approach. Active fund managers did not think that they could be replaced.
However, as Vanguard’s Michael Buek observes, “The case for indexing is based on the belief that investors in aggregate are unable to beat the market.” Everyone wants to think they’re a rock star investor, and they definitely exist. David Swensen, Chief Investment Officer of Yale’s Endowment, has averaged 13.9% returns for the past twenty years, which is about 4.5% higher than the S&P 500.
But for every David Swensen, there is a multitude of other managers like Lucidus Capital Partners, Fortress Investment Group, or SAB Capital Management, which are just three of the 979 hedge funds that closed in 2015. After a tough year of losses and volatility, they could no longer continue, and as a result, 2015 was the first year since the 2008 financial crisis that more hedge funds closed than opened.
And on top of lackluster performance, active management also bears a cost. Buek continues, “Their active returns are significantly eroded by costs. Therefore, investors who own the entire market at a very low cost through indexing reduce the hurdles that make successful active management so difficult over the long term.” In other words, you win by doing less.
The active versus passive debate lives on. But for those who endorse a passive approach, it is important to see where the industry has been and reflect on where the industry will go.
Josh Norris is an Investment Advisory Representative of LeFleur Financial. Josh can be reached at josh@LeFleurFinancial.com.