John Bogle worries that he has unleashed a monster by successfully promoting indexing as an investment approach. I think he can relax.
Bogle arguably did more for the average investor than any other financial adviser of the 20th century, and he remains prominent now that we are well into the 21st. Despite enormous initial criticism and backbiting from self-interested active mutual fund managers, Bogle pushed the indexing concept that has brought lower costs and better returns (on average) to millions of long-term investors, of modest as well as immodest means.
Bogle founded The Vanguard Group in 1974, and one year later he established the First Index Investment Trust, today known as the Vanguard 500 Index Fund. Its innovative strategy of tracking a broad market index was known at the time as “Bogle’s folly;” today, stock index fund assets total $4.6 trillion, about 17 percent of the overall market. Index funds typically offer lower fees than actively managed mutual funds, coupled with comparable – and sometimes superior – returns. Few people are calling index funds a “folly” in 2018.
However, Bogle recently wrote an opinion column for The Wall Street Journal that sounded a note of warning regarding his wildly successful innovation. As he observed in the column’s opening paragraph, “The question we need to ask ourselves now is: What happens if it becomes too successful for its own good?”
As you might expect, Bogle’s column does not embrace the existing viewpoint of some critics that the growth of index funds could distort financial markets. A few economists have advanced this theory in recent years but, as my colleague Paul Jacobs explained, ordinary investors should not lose any sleep over this possibility.
Bogle’s fear, instead, centers on the potential effects large index funds may have on corporate governance. He posits that, if historical trends continue unchecked, eventually a few large institutional investors will hold voting control of every large public company in the United States. Today, Vanguard, BlackRock and State Street Global collectively control 81 percent of index fund assets; Vanguard alone controls 51 percent. If index funds continue to gain control of a larger segment of the overall stock market, the biggest fund managers could indeed gain effective voting control of a considerable number of publicly traded companies, apart from those where founders or others hold shares with extra voting rights.
In essence, Bogle suggests that the biggest index fund managers so dominate the field that they wield outsize influence on corporate governance, and that such influence is inherently a bad thing. In this, I believe he is confusing the investment merits of diversification – which lowers risk without reducing expected returns – with what he presumes to be the merits of proxy voting diversification, which offers no such benefit.
The Securities and Exchange Commission requires all fund managers to execute proxies in the best interests of their clients. Those investment managers are far better equipped to vote proxies knowledgeably than individual investors would be if they held their shares directly. No individual would ever have time to read the hundreds of annual proxy reports from all of the companies in a typical index fund. Very few would vote in more than a handful of proxy ballots, if any at all, left to their own devices. Instead, nearly all investors would abdicate their ownership rights and responsibilities to the hired help, namely corporate executives, who already have disproportionate power over the public companies they run on shareholders’ behalf.
There is no reason to believe a single index fund manager would vote proxies appreciably differently than 10, or 100, active fund managers would. In fact, the concentration of proxy voting power would be a powerful incentive for managers to consider and execute shareholder votes reliably and thoughtfully. There will be no place to hide if a manager of a big index fund neglects his or her duty, or behaves in a way that is contrary to investors’ interests. No manager would have any incentive to behave irresponsibly, but in the unlikely event that someone did so, well, there are lots of index funds out there. Investors can vote the way they always have: with their feet.
Even for those who sympathize with Bogle’s concern, the worries about corporate governance do not and should not offset the overall good the growth of index funds represents. In his column, Bogle does not suggest that we take up torches and pitchforks against his creation, regardless of whether any action is needed where corporate government is concerned. He rightly points out that index funds have enormous value to investors, and that any proposed check on them should not go so far as to potentially jeopardize their existence.
I have invested a fairly large share of my comparatively modest portfolio in index funds. I am not worried that they won’t look out for my interests at least as well as I would do myself. Jack Bogle shouldn’t worry, either. It may be possible to have too much of a good thing, but we are nowhere near having too much indexing.