Burton Malkiel, Ph.D., wrote the first edition of the ever-popular book A Random Walk Down Wall Street in 1973. The Princeton University economics professor and Vanguard consultant is now working on the book’s ninth edition, which should be published in January 2007.
Widely considered to be a “father of indexing,” Malkiel also has made the case that investors should take a core-satellite approach to portfolio investing, with index funds constituting the core. He spoke recently with Research about the state of indexing, the ETF marketplace and the next version of his best-seller.
Research: How did you first get involved in ETFs and Vanguard?
Malkiel: I recommended that index funds should exist in my book, but they didn’t. Vanguard was the first to sell them in 1976, when I was working for the Ford Administration. When I got set to leave in early 1977, John Bogle asked me to join Vanguard as a fellow in the company’s index institute and then I joined the board in 1979.
Vanguard deserves a lot of credit for getting index products from the academic world out into the real markets.
Are you surprised at the success of ETFs, which today have $343 billion in assets?
No, because they are really good products for people, which is true for indexing in general and index funds.
Individuals now hold about 10 percent to 15 percent of their portfolios in index products and for institutions this amount is up to 30 percent.
Are these figures too low, in your view?
The initial idea for indexing came from the university environment. And it’s amazing that it’s had so much impact.
When the Vanguard Index Trust started, John Bogle and I were the first investors, and there were years that it traded without much interest. But today, I am delighted to see the interest in index funds and ETFs. ETFs have a tax advantage, making them particularly effective, since changes in the portfolio aren’t taxed for individuals. This is great.
How else have you influenced the world of ETFs?
I was governor of the American Stock Exchange and after this post stayed on as chairman of new products. I was involved in the Dow Diamonds and Spiders, which did a lot to make the AMEX a market innovator; now the New York Stock Exchange is working to get into ETFs too.
How do you view ETFs as products for financial advisors?
I think they work best in fee-only arrangements, which is the model I prefer. Advisors should be supporting investors and these products.
The investment business is rife with conflicts of interest. I prefer passive investments to 100 percent actively managed funds, which are tax inefficient, have costs associated with the bid/ask spread and other costs. ETFs are extremely useful vehicles for any investor and institution.
How much attention do ETFs get in Random Walk?
In the edition that came out four years ago, they got a little. But in the upcoming ninth edition, they will be getting more.
At Princeton, what is the general view of indexing and ETFs on the part of students?
People still don’t believe you can’t beat the market, especially with all the information and technology geared toward investing today. So, I have students research and test this.
In the book’s ninth edition, I discuss behavioral finance and the idea that because of biases in the market and mistakes affecting it, it can appear easy to beat the market. But that is simply not true, as I tell students.
Some of the great minds in behavioral finance still buy index funds. Even if they don’t see these funds as entirely efficient, they do see the advantages they offer.
What markets have you focused on lately?
I just returned from my third trip to China. There’s more growth there than
anywhere. I’m bullish. And the extent to which individual investors can access
this market through ETFs is great.
Portfolio theory tells us that uncorrelated assets decrease risk and increase diversification. Emerging markets generally have a low correlation with U.S. markets, making them good diversifiers.
Each time I’ve been to China, the change has been dramatic, and the growth is overwhelming. Think of what national growth depends on: energy and the entrepreneurial spirit of a people. Shanghai makes New York and San Francisco look like sleepy little towns.
As you reflect on your career, what stands out?
In the ’70s, there were no index funds, not many international funds, no Roth products. Opportunities and investments were limited, and we hadn’t yet heard of ETFs.
Also, we now have a paradox: It’s easier than ever to invest. But the proliferation of products has led to confusion.
The media focuses on the “best funds” in terms of quarterly and yearly performance. But this performance cannot persist. It’s index funds that are useful. Investors should buy them, and then not switch.
Janet Levaux is managing editor of Research.