This article is part of Morningstar's Guide to Passive Investing, helping investors make smart choices to meet their long-term investment goals.
Christine Benz: There has been a vogue for what's called strategic beta or factor investing or whatever you want to call it. What's your take on that general phenomenon that we've seen take hold?
Jack Bogle: Well, our confession being good for the sole, Christine. According to Morningstar, I created the two oldest and largest strategic beta funds in the business. You know that?
Benz: No, I did not.
Bogle: They are called Vanguard Value Fund and Vanguard Growth Fund.
Benz: So the indexes that…
Bogle: I use those S&P indexes and ran funds out of each of them and since the mid-90s, early 90s – I think the year was 1993. I started them, but it had nothing to do with strategic beta. I said in the first annual report and the second annual report, I am reading it further, don't buy one because you think it's going to do better than the other. You will always be wrong. Nobody knows whether value or growth will win over the long run, but they will go back and forth each year and my projection assumes that in the long run they will be identical, okay?
So, the end of 20 or 15 years – 25 years' company – excuse me – and both funds had given a 9% return. Then you see – I mean I don't mean to brag, but that's not too bad. I said they'd be the same and they were the same. And aye, there's the rub. And that is the investors in both funds did about half as well whether you are in the balanced fund or the growth fund because the money comes into the one when it looks good and goes out into the other one when it looks bad.
So they were used on what we'll call a strategic beta basis and therefore, ill-used. My idea was, as I explained in those reports, why we're doing this because it seemed to me that with the growth fund it would be good to accumulate.
We have less taxable income and more of your return in form of capital gains. And then when you get older, you go the value fund and have a much more a higher income and have a much more stable component of your return and the less volatility. I mean, it seemed perfect. It wasn't perfect because people misuse that. And so, what's going on from then forward has been a whole mirage of ill-thought out and well-thought out funds, but the people have tried it and the best-known examples are Rob Arnott's fund and Jeremy Siegel's fund when based on fundamental earnings, dividends and things of that nature, book values, for Rob and for Jeremy, totally weighted by dividends they pay.
Benz: WisdomTree.
Bogle: So Rob has had 10 years to prove that he had this Copernican ID, he was reordering the universe, seemed like kind of a big talk to me and the same idea from Jeremy and he's actually was the one that used and he called himself the new Copernicus. There is no new Copernicus in this business and if there is, it's the simplified view of the heavens, which is the index fund, not the complicated view of the heavens which requires different orbits here and there as those all-time astronomers used to do.
So the result is that after 10 years the returns of all three funds are virtually identical. In Rob's case, it's a little bit better with higher volatility and therefore, a lower Sharpe Ratio and the S&P 500 risk-adjusted return ratio and for Jeremy's just the opposite, a slightly lower return and a slightly lower volatility, and therefore, the same Sharpe Ratio, risk-adjusted return ratio below that of the S&P 500.
So we are looking at 19 years cumulatively and nothing has been proven. So my argument was from the beginning was it may work, but I will tell you what I know works. If you're trying to get your share of the market return, get it by owning the market.
