Image credit: William Blake, “Time, in Advance, behind Him Hides His Wings,” from Young’s Night Thoughts, 1797, Yale Center for British Art, Google Art Project
2:43 pm ET
Aug 22, 2014
In my “Intelligent Investor” column this weekend, I interview Charles Ellis, often called “the dean of the investment-management industry,” on his views that “active” stock-picking fund managers are an endangered species. He even suggests that many of them will be thrown out of work—and might want to pursue second careers as financial planners.
The trend that Mr. Ellis describes has been in the making for four decades.
In 1974, the Nobel prize-winning economist Paul Samuelson wrote in the inaugural issue of the Journal of Portfolio Management that “a respect for evidence compels me to incline toward the hypothesis that most portfolio managers should go out of business—take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives.” He added, “Even if this advice to drop dead is good advice, it obviously is not counsel that will be eagerly followed.”
In 1975, Mr. Ellis himself wrote a famous essay in the Financial Analysts Journal called “The Loser’s Game,” in which he predicted that “institutional investors will, over the long term, underperform the market.” With so many smart people competing so intensely to outperform, bargains would disappear almost instantly. Instead of trying to win by beating the market, he argued, investors should seek to avoid losing—by buying an index fund. These autopilot funds buy and hold all the securities in a market, rather than trying to outsmart the market.
In 1976, John Bogle, founder of Vanguard Group, launched the first index fund for individual investors, enabling just about anyone to own a broad swath of the market.
But only in more recent years has the rise of indexing come to resemble a juggernaut, as this chart courtesy of Morningstar shows:
Since 2000 alone, the share of total fund assets in index funds has tripled, to 28.5% from 8.9%. If anything, the trend is accelerating. And there’s no logical reason to expect it to reverse anytime soon.
At least Mr. Ellis’s advice that fund managers should consider becoming financial planners is more palatable than Prof. Samuelson’s suggestion that they should become plumbers.