John Bogle CNBC

Jack Bogle on CNBC: A $1 Trillion Swing in Investors' Preferences

John Bogle CNBC

Transcript from CNBC

Investors pulled close to $120 billion out of actively managed U.S. stock funds in 2012 making it the biggest yearly outflow since 2008. At the same time the inflow for exchange traded funds topped $30 billion. But you can add this: over the last five years, over 65% of large cap active managers lagged behind the performance of the S&P 500. No surprise to our next guest, our friend Jack Bogle of Vanguard. The founder of the index fund and no stranger to this debate. Great to see you. Happy New Year.

Same to you, Bill. hi, Maria. hi.

All these exchange traded funds and everybody's getting into these passive management funds right now. Are we at an extreme point in that regard, do you think?

Yes, I do think we are. There are a whole lot of -- I don't know -- I hate to say it, but a whole bunch of nut case ETFs out there.

It's the hottest marketing idea of the 21st century here and a lot of people jump on the bandwagon. But at its core, the flows in indexing are basically in the broad market funds. S&P 500, total U.S. stock market, told U.S. bond market and even total international developed and emerging markets. That's where the big flows are. There's a lot of game playing out there. They will come and they will go. Believe me. They always have and they always will. But what we're seeing now, that's a marginal fringe element of it.

<strong>We're seeing finally after all these years the real triumph of indexing.</strong>

This is not a one-year phenomenon, in the last six years there's been about a $650 billion inflow in the index funds. 350 billion outflow. <strong>That's a $1 trillion swing in investors' preferences. That's a big swing.</strong>

I recognize it's really the triumph of the indexes, but what do you think the active managers are doing wrong? Just lacking diversity? making the wrong bets? how come they so badly lagged the rest of the market? well, the essential reason for it is they lagged the market because they have to.

These pools of capital and mutual funds are so huge, maybe 50%, 55% of the market, it's they can't outperform each other so they end up being average before cost and below average after cost. That's the mathematics, the rules of humble arithmetic. And those costs are higher than people expect. Not only got the management fees, the operating expenses of a fund, they're explicit. Some funds are highly priced. But there's also the trading cost and the trading cost, the transaction cost, these portfolios turned over 100% a year. <strong>Which is a lot to do with speculation and not very much to do with investing.</strong>

Is there no place then for -- in a person's individual portfolio for actively managed funds in your view?

<strong>Well, in reality, I have to say there is no place.</strong> But there will always be managers that outperform, roughly offset by managers that are underperformed. that's just the math. so if you think you can pick a good manager, go try. but in my book <em>The clash of the cultures</em>, I show what people have forgotten in this business when you look at active managing. I've taken the eight largest of the modern era. there are eight of them, I think, in there and they peak relative to the market and then they fall. Every chart looks pretty much like this if you can see that little kind of mountain i'm drawing there. and when you get up here at the peak, the money pours in. and when you get down, it starts to ooze out. <strong>So investors in many respects are their own worst enemy and it means paradoxically or ironically enough that while active managers don't do very well, their investors do even worse.</strong>

Jack, do fundamentals matter right now with the fed providing such free money all the time? Do fundamentals matter?

Fundamentals matter forever, Maria. But the fundamentals that really matter are really relative to the stock market are the two we know about and can rely on in some way to continue. Dividend yields: it's around 2% today. Earnings growth of corporate America. Not each corporation, but corporate America which should be 4% to 5% over the next decade. If you add two to that, that's a 6% to 7% total return on stocks. The fed can disturb that. They can support the economy as they are now. They're building a pretty risky financial system with all that borrowing. I don't see how it could be other than substantial inflation down the road, but they could stave it off in a slower economy like this one. They could stave that basically inflation, huge inflation off, because the economy's weak. That's not going to happen forever. The economy will come back.

All right, Jack. Always good to see you. Thank you.