On Monday, August 8, as the Dow Jones industrial average plummeted toward 635 points, 82-year-old John Bogle, the father of index funds, seized the moment to hurl an insult at the beleaguered market’s current star, exchange-traded funds. The founder of Vanguard Group said that “90 percent of ETF volume is used by speculators.”
In the mayhem of the Standard & Poor’s 500 index’s 6.7 percent drop and the Nasdaq composite index’s 6.9 percent fall, Bogle’s charge went largely unnoticed by most. But not by Gary Gastineau, a Harvard Business School-educated Wall Street veteran with a healthy number of books to his credit, including Dictionary of Financial Risk Management and Somebody Will Make Money on Your Funds — Why Not You?, a book that deal with ETFs.
When Institutional Investor asked him about Bogle’s comment, the normally media-shy Gastineau shot back, “I hadn’t heard, but did speculators lose their rights this summer along with private plane owners?” — alluding to Congress’s hot debate over taxing execs on their heretofore sacrosanct private planes.
Bogle, a Princeton University graduate born in the Great Depression, has himself authored several books, including Common Sense on Mutual Funds and his open attack on ETFs, The Little Book of Common Sense Investing. Bogle keeps the media stocked with homely observations delivered with a signature wit that usually hits a chord with retail investors, such as his expression of dismay over ETFs as a mangling of the index fund concept: “What have they done to my song, Ma?”
Bogle recently spoke with II Contributor Maureen Nevin Duffy about the state of ETFs and the current market chaos.
Institutional Investor: If 90 percent of ETF volume is used by speculators, what’s wrong with that?
Bogle: I have certain messages that are eternal. Look at my article in II’s Journal of Portfolio Management this spring, “The Clash of the Cultures,” in which I talk about the dominance of speculation in markets. Each year we trade about $40 trillion in stocks — with each other. Money keeps going back and forth, and the only winner is Wall Street. It’s just speculation in stocks, no different from going to Las Vegas, where the winners are the croupiers, the middlemen.
The question is, how much does that contribute to capital formation? If that’s the purpose of the capital markets, the financial system isn’t performing its role properly.
Doesn’t all this trading create liquidity in the markets? Don’t speculators’ trades reduce the cost of ETF trading for long-term investors?
Liquidity is the last refuge of the scoundrel. What do we need all this liquidity for? We never used to have it. Liquidity just allows one speculator to trade more cheaply with another. I’m not sure what social utility is created by that. A long-term investor doesn’t need a lot of liquidity. Investors just want to know they can get their money out of the investments.
Don’t ETFs facilitate that?
The whole rationale for ETFs is that you can trade in the middle of the day, any minute, any second, in real time. Well, that’s speculating. I’d say 50 percent of the time, people probably want to get out at the absolute low and jump back in when the market recovers later in the day. What’s the gain in that?
Haven’t ETFs improved since you wrote Common Sense Investing in 2007?
They’ve actually gotten worse. They’ve added complexity: triple-reverse leveraged funds, funds created from narrow sectors and actively managed funds. How would investors know how active the manager is in the middle of the day?
The original ads for Spider ETFs said, “Now you can trade the S&P 500 index all day long in real time.” What kind of lunatic would want to do that? A worthy purpose, but a terrible outcome for most ETF holders. I’ve been in this business for 60 years. In the long run it’s a mathematical truism: Investors win; speculators lose.
What do you think of the current market turmoil?
It’s so insane what’s going on in the market. But it’s really just speculation writ large.
What about S&P downgrading U.S. bonds?
I don’t fault S&P, although I do question the timing. The country’s not in immediate danger. People who say the downgrade precipitated things in the market speak from ignorance, to be honest. But a lot has to change, and it will.
Like what?
There’s no jump-starting the economy. This isn’t like the automobile engine happens to be stalled; it’s out of gas. The economy is on the mend, but I wouldn’t dismiss a double-dip recession. If consumers are going to take $5 trillion a year out of their real estate in the first half of the decade, they’re going to have to pay it back sooner or later at a trillion a year. You can’t borrow forever. We’ve got to get some economic growth, but it will take time.
What can be done right away?
Little things like extending unemployment benefits and eliminating Social Security contributions for a time. Nothing can be solved in the short term. We have to do the reforms, which Congress will have to tackle, like those recommended in the Bowles-Simpson plan. We’ve got to tackle those deficits. Still, it will take time for consumers to liquify their balance sheets.
You say long-term investors needn’t worry. What does concern you?
That the United States of America appears to be losing the ability to govern itself. That’s a bearish factor that wasn’t new two days ago, wasn’t new when the debt ceiling impasse came and went. The first two words that come to mind when I think about Washington are not usually “wisdom” and “courage,” and that’s what we need right now.
Any worries about Europe?
The solutions the European Central Bank has offered are still quite inadequate, to the point where the bank may be endangering itself.
Should American corporations get a tax break to repatriate their assets?
That’s part of an international competition that has grown very complex. Corporations don’t want to pay taxes. No one is paying the federal tax rate of 36 percent. It would be great to bring the money back to the U.S., but I wouldn’t want to be the one to write the rules to make sure that happens. Enormously complicated.
We deal every day in glittering generalities and oversimplifications that are not going to get us anywhere. We need real hard economic data.
