The perfect anti-anxiety investing solution for countering the uncertainty triggered by Donald Trump’s taking office as president? Index investing, Charles “Charley” Ellis, esteemed investment strategy consultant and author of the classic “Winning the Loser’s Game,” tells ThinkAdvisor in an interview.
In his new book, “The Index Revolution: Why Investors Should Join It Now” (Wiley), Ellis, who founded and led institutional investing consultants Greenwich Associates for three decades, continues to vigorously argue that active management is “a loser’s game” – and he explains why.
In the interview, Ellis, 79, discusses the ways that indexing can help financial advisors, why active managers have underperformed for the past several years (they can be their own worst enemy, he says), and how trying to beat the market can hurt far more than help. He talks too about meetings he enjoyed with the legendary economist and investor Benjamin Graham.
Today, Ellis, who invests almost entirely in index funds, is a consultant to large institutions like the California Public Employees' Retirement System, the GIC (Government Investment Corp.) of Singapore, and the Future Funds of New Zealand and Australia. Five years ago he joined Wealthfront’s advisory board.
Ellis’s current mission is to help investors – ranging from modest to high net worth – achieve retirement security through index investing. He has long advocated a strategy of low-cost indexing, ever since he wrote his doctoral dissertation on the subject.
Ellis has served on the faculties of Harvard Business School and Yale School of Management, and for 11 years was a Yale University successor trustee. He graduated from Yale and received his MBA from Harvard Business School and his Ph.D. from New York University. He is one of 12 to be honored by the CFA Institute for lifetime contributions to the investment profession.
ThinkAdvisor recently spoke with Ellis, on the phone from his office in New Haven, Connecticut. He believes that indexing is ideal for today’s market because, as he writes in “The Index Revolution,” it “eliminates or reduces all the ‘little things’ that, like termites, eat away at returns: high fees, taxes, errors in selection of managers and more.” Here are excerpts from our conversation:
THINKADVISOR: How do you see Donald Trump’s presidency affecting Americans, and investors in particular, in the short term?
CHARES ELLIS: There’ll be a period in the Trump presidency where there’s more worry and anxiety on a macro level. Fear of war and the possibility of serious mistakes will be a real part of the calibration of what people are thinking. So, there may be more flutter, or anxiety, expressed in the market or in individuals themselves. Whether or not Trump reduces corporate taxes could have a real impact on investing. Meanwhile, [foreign] investing will give people reason for anxiety too because of everything that’s going on internationally.
Can index investing be of help with any of this?
One of the things that’s important about investing in index funds is that you can kind of relax. The reduction in anxiety that goes with investing in them is an offset to the uncertainty that’s [causing] anxiety with the new administration. With indexing, you avoid being distracted by the tricks of the market.
What are the top four reasons for indexing?
You’re able to get higher returns than any other way. You’ll outperform other investors in large numbers, for sure. You have lower cost, which is kind of comforting, and lower anxiety. And because you know that everything will be done correctly, you don’t have to worry about operation or implementation. Therefore, you can concentrate on what’s really important about investing, like what you’re trying to accomplish, what resources you have, how much time you have and which portfolio structure would be best for you.
Why have active managers consistently underperformed over the last several years?
As a group, active managers are more talented than they’ve ever been. They have more information than they’ve ever had and better computer power. There’s only one problem: There are too damn many people doing this fascinating and deeply enjoyable work and which pays extraordinarily well.
You’re talking about heightened competition?
Yes. People are competing for the same process. About 50 years ago, there might have been as many as 5,000 active managers. Today, there’s got to be at least a million. Further, in 1965 there were half a dozen firms starting to produce research available to anyone who was willing to buy it for commissions. Senior management would take you out to dinner and tell you what was going to happen in their companies. You could get all the information on your side. That was the secret sauce of active investment management.
What happened to upset that applecart?
Today, the [Securities and Exchange Commission] requires that any public company that delivers any useful information for investment purposes must make sure everybody gets the same information at exactly the same time.
How do financial advisors view index funds?
Those that are really working for their clients would say, “This is really great — an enormous positive. We can compose a portfolio in each asset class for our clients that’s beautifully suited to a particular client and help them understand why they ought to stay with it or when they should modify it. And we don’t have to worry that the manager is going to make a mistake that will cause us embarrassment and require us to apologize to our clients.”
What about advisors who don’t have that attitude?
If they think, “My business is to find ways to beat the market rate of return,” then that’s a mistake in definition of purpose. They have a real challenge because they’re not going to be able to beat the market.
If indexing performs better than active management on a long-term basis, why is only 30% of total investment dollars in indexes?
Twenty years ago, it was zero. More and more people are indexing now. The curve of acceleration is astonishing. In the last couple of years, there have been major flows from active investing to indexing. And I don’t see any reason for that to slow down.
What’s behind the increase?
Until the last two-and-a-half or three years, the data on all mutual funds wasn’t available. Now that data is being produced, and it’s stunning. [It shows that] it’s [very difficult] to do better than the benchmark 10 years in a row. That’s important because most people buying a mutual fund don’t expect to get out of it in less than 10 years. But they get terrible results and drop out, or the fund disappears. Nobody should invest in stocks unless they’ve got at least a five-year horizon — 10 years would be better.
Any other reason indexing didn’t catch on in a major way earlier?
The word “passive” is a dreadful negative in our society. If index funds had been called “index funds” — and not passive investing — I know that people would have had a very different attitude much, much sooner.
You write that active managers have created three problems for themselves. Please explain.
One problem is that they’ve defined their mission as beating the market. Second is allowing the value of their profession to be increasingly dominated by the economics of the business. That is, the metric of their success is: Are profits going up? That’s a profound mistake made by investment managers, particularly active managers.
What’s the third problem? Not realizing that most investors can use help in designing investment programs that match their objectives.
How can financial advisors help in that regard?
Advisors can do so much to help people understand themselves by asking 10 or 15 questions, like: “What’s your age? What’s your savings? Do you save money each year? When do you plan to retire? In your family, how long do people typically live? How many children do you have? How strong a view do you have about their going to college? How much of that will you pay?” Once you get those answers, it’s not hard to figure out a really good pathway for a particular investor.
In the 1970s you twice met with Benjamin Graham, “The Father of Value Investing,” near his home in California, for three-day discussions about investment practices. What was your impression of him?
He was a brilliant man with a marvelous sense of humor. We were in seminars that I organized for first-rate successful active managers from all over the country. It was so much fun to watch a guy [Graham] past 80 being smarter than a bunch of guys who were in their 30s and 40s. I wrote to him inviting him to come. He said he’d love to – and wanted to know if there was a charge. The answer was no! Everyone in the group would have agreed that the smartest guy in the room was Ben Graham.
How were the seminars structured?
We’d meet in the morning and then again in the evening. In between, Ben would take a nap. He was in a wheelchair [pushed] by a French woman, Malou, whom he called his mistress.
Were you a big proponent of indexing at that point?
I was going in that direction, but I wasn’t as clear-minded as Ben Graham. At one meeting, he said, “You know, it seems to me that everyone in this room would do better for their clients if they were indexing.”
At the dawning of indexing, you and Vanguard’s Jack Bogle became friends and colleagues. He was among those taking the lead in indexing.
In those days, he was at Wellington Management. Then he [started] Vanguard and began to tinker around with what he could do that wouldn’t violate the rules of his disengagement with Wellington. He put up the argument that indexing was just an administrative, not an investing, decision: You just do it mechanically – boring, dull; same-old, same-old. His directors said, “OK, go ahead and do that.”
What do you think of actively managed ETFs?
I’m uncomfortable with those for the same reasons [as actively managed mutual funds]. ETFs are more complicated than most people think because a lot of ETF activity, or volume, is [generated] by experts hedging a specific, unique component of their portfolio for a very specific period for a very specific reason. So pros are doing a lot of ETF investing, and I’m not interested in competing against the pros.
What about index ETFs?
That makes good sense, [but] I would personally do index without the ETF wrapper, though it doesn’t make any real difference. I just don’t think active management can be useful on a sustained basis in today’s market. For a 10-year-in-a-row period, it just isn’t going to happen because the fee charged for active management is higher than can be overcome by being smarter.
In today’s market, the best estimate for a rate of return is 6% or 7%. So let’s assume it’s 7% and that you charge a 1% of assets fee. To earn that 1%, you have to increase returns by 15% every year. It isn’t going to happen because the manager has to buy from experts and sell to experts. And they all have equal access to the same cauldron of fabulous information.
Why did you retire from Greenwich Associates 30 years after founding the firm?
One reason was that I thought the only thing that hadn’t changed in the company was me and that that was a change we ought to make. I didn’t want to be a roadblock to someone who wanted the opportunity to lead. Also, I didn’t want people to say, “Charley just isn’t what he used to be.” I didn’t want to be a has-been.
You have an unusual facet to your consulting business. Please discuss.
Anybody who’s connected with Yale has an invitation from me to stop by on any Saturday or Sunday, and I’ll give them investment counseling help. No fee. It’s part of being a good citizen of the Yale community. Some very distinguished academics and some straightforward blue-collar workers have come by. I believe that all of us who have a good understanding of investment management should be trying to help people avoid mistakes and get on the right path.
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