Calling passive investors. Come in passive investors.
Passive investing has a simple and appealing mantra: Just buy the market. But good luck finding its adherents. Not even Jack Bogle, who introduced the first passive index fund in 1976 and is widely considered the father of passive investing, can be counted among them.
Of course, buying the market has meant different things throughout time. In the 1920s, it would have meant owning roughly 500 U.S. stocks. By the 1970s, that number would have grown to 4,000. Today it means owning 8,600 stocks representing more than 40 countries.
Despite the swell of global stocks over the years, it’s never been easier to invest passively. Investors can own those 8,600 stocks by buying an assortment of low-cost ETFs, or even just one ETF that tracks the MSCI ACWI IMI Index — a collection of companies that represent 99 percent of global stocks by market capitalization.
But rather than buy the market, Bogle is staking his entire stock portfolio on the U.S. In a recent conversation with Bloomberg News, Bogle channeled an active manager proudly describing a carefully chosen investment.
“I believe the U.S. is the best place to invest,” Bogle said. “We probably have the most technology oriented economy in the world. I would bet that the U.S. will do better than the rest of the world. It is a simple bet on which economy is going to be the strongest in the long run.”
Indeed. Replace “U.S.” with a different country — or even industry — and lots of simple bets sound appealing. China and India have the world’s largest populations, a burgeoning middle class and economic growth that dwarfs that of the U.S. A bet on one of them seems sensible. Or technology companies, which are likely to drive future growth. Why mess around with has-been industries like oil or banks?
Apart from the obvious uncertainty of predicting the future, the difficulty with active bets is that they can be clouded by biases.
One such bias is a common belief among active managers that their bets represent a contrarian view of markets. Bogle cautions that “the crowd is always wrong” and that “if you believe in the majority, you can just throw my opinion in the wastebasket.”
But Bogle’s preference for U.S. stocks is squarely with the majority. According to Morningstar, 73 percent of the assets in U.S. equity mutual funds and ETFs are in U.S. stock funds; only 27 percent are in international and emerging market funds. That’s a huge overweight to the U.S., considering that U.S. stocks represent roughly 50 percent of global market cap.
Another bias is the belief that because a bet has paid off in one period it will pay in others. Bogle has apparently been promoting his preference for U.S. stocks since 1993. Reflecting on the period since then, he says “I was right, really right.”
It’s true that U.S. stocks have beaten overseas stocks during that period. The MSCI USA Index has returned 9.5 percent annually from 1993 through May, including dividends, while the MSCI ACWI ex USA Index — a collection of global stocks that excludes the U.S. — has returned just 6.9 percent.
Much of that outperformance, however, can be attributed to U.S. stocks' winning streak in recent years. If Bogle were looking at the score card in late 2007 or in early 2008, overseas stocks would be ahead. In fact, overseas stocks have beaten U.S. stocks 53 percent of the time over rolling 10-year periods since 1993.
Still, Bogle may prove to be right about U.S. stocks. But the real lesson is that investors’ personal — and often subjective — views have a habit of creeping into their portfolios.
To borrow from Warren Buffett, passive investing is simple but not easy. Just ask the father of passive investing.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Nir Kaissar is a Bloomberg Gadfly columnist covering the markets. He is the founder of Unison Advisors, an asset management firm. He has worked as a lawyer at Sullivan & Cromwell and a consultant at Ernst & Young.