Frank Thoughts: The Passive Mythology
Frank Boland
April 16, 2021

According to Webster, “a myth is a popular belief that has grown up around something or someone.” That would make John Bogle and Vanguard’s “passivity” a perfect example of a mythology. There is a belief that John Bogle originated the concept of passive investing with his 1975 launch of the then eleven million dollar Vanguard Index Fund. No, not so. Wells Fargo and American National Bank both had launched index funds two years earlier in 1973. Secondly, there is a belief – central to index funds – that Bogle started Vanguard because he believed active managers could not beat the S&P 500.

Nothing could be further from the truth. It was because he had strongly believed in active management that he lost his job as C.E.O. of Wellington Management. At the time, Wellington was a prestigious Boston money management firm. One that adhered to the concept that a fiduciary account should be managed as a balanced portfolio; 60% of a portfolio in equities and 40% in fixed income. But in 1955 there started to be a seminal shift; stocks, which had yielded more than bonds since the crash of 1929, became growth stocks. Technology – then called Electronics – was evolving.

Bogle made the decision to increase the percentage going into stocks. More importantly, he also recognized the shift occurring in the stock market. Stocks started to be bought for capital gains … not income. While few realized it at the time, a group of young Boston Brahmins did. They had started a mutual fund called Ivest in 1959. It was the early precursor of today’s Cathie Woods’s Ark Innovation (ARKK) Fund. The four principals - Thorndike, Doran, Paine & Lewis - epitomized the “Go-Go” era. Bogle bought the firm. When the period ended in 1974, Bogle was fired and then had a problem.

The problem was a non-compete contract with Wellington Management. He could not join or start another “active” firm until his time period expired … or he could start a passive fund.  It’s doubtful he thought the 1% fee active managers charged would prevent them from doing well. Otherwise, why would he have bought Ivest? It was the premier active growth stock fund at the time. Yet that trope has been part of the mythology passive “managers” have constantly repeated. Never mentioned is the S&P 500 routinely moves plus or minus 1% or more intraday 260 times (excluding holidays) a year. Falling interest rates and correlation above 26% have been the unrealized “killers” of active success.

The key to active management success is rising interest rates. However, we have had declining rates for decades which has “fed” the passive movement. Interest rates peaked in 1982 and began a secular decline that has now lasted 38 years! This bull market in fixed income gave rise to the homogenization – (high correlation) - of the stock market, which created a positive feedback loop for passive fund expansion.  As a consequence, it further destroyed price discovery among individual stocks. At the moment, some maturities are now effectively – after inflation - yielding 0%.

Long forgotten, or even experienced, is the “golden” era of active portfolio management. It lasted for twenty-seven years from 1955 to 1982; a period of ever increasing interest rates. Interest rates have always been a major force on the economy and stock market. John Bogle’s Vanguard grew in the period – 1982-2021 - from eleven million to six point five trillion. There has never been a thirty-eight year bull market in stocks. In the words of singer, song writer (and stock market philosopher) Bob Dylan decades ago, “The Times They Are A-Changin.” For everything there is a season …             

-Francis Patrick Boland                                

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