TTU118: TRILLIONS...The Passive Revolution ft. Robin Wigglesworth

Niels
Hey everyone, and welcome to another edition of Top Traders Unplugged, where today I’m joined by Robin Wigglesworth who is the Global Finance Correspondent at the Financial Times and the author of the great new book called Trillions which we will be diving into today.
First off, Robin, thanks so much for joining me. I’ve very much been looking forward to our conversation. How are you doing? How are things where you are, today?

Robin
Things are good. My daughter just got COVID. We’re in Norway. We’ve luckily been fairly shielded from everything going on. But it touches everybody. But, apart from that, everything is fine.

Niels
Now you mention Norway and, of course, we’re both from the Nordic countries. I’m Danish and you are Norwegian, but I have to admit that I did notice that your last name is not very Norwegian sounding. I’ve also heard you pronounce financial terms in perfect Arabic which, I’m sure, we’re not taught in our schools systems. So, tell me a little bit about how that all ties together.

Robin
It’s a good question. Yeah, growing up in Norway it was weird having a name like Wigglesworth when everybody else was called Hanson, Swenson, and Johnson and so on. My father is English. He came from the Lake District, but my mother was in Scotland. They were both studying architecture. The plan was to do five years in Norway and then five years in the UK and they just ended up staying here.
So, I grew up feeling fairly international. I went to an international school and I studied abroad. But it was only now that I had kids I wanted them to grow up in Norway. So, I happened to be based for the FT, now in Oslo but I cover, basically, everything other than the Nordics from here.

Niels
But you picked up a little bit of Middle Eastern skills as well. So, how did that fit into your career?

Robin
Well, it was just the fact that, sadly, qualified journalists don’t actually grow up dreaming of being Financial Correspondents and covering stocks going up and stocks going down. I wanted to be a war correspondent or a foreign correspondent and I studied international relations and history and political Islam.

When I was doing my masters, at the LSE (London School of Economics), I saw job opening for a Financial Journalist in Dubai. Now obviously, as you probably know, Dubai is probably the least Middle Easterny part of the Middle East but it sounded a lot more tempting than going into the Norwegian Army and we still have conscription; and to be a paratrooper.

So, I packed my bags and moved down to the Gulf and my first job was covering, primarily, Islamic finance. My very first interview, the day after I landed, was with a local Sheik about Islamic reinsurance, Arita Kaflo.

I was wildly unqualified to talk to him but the great thing about being a journalist is that you get to talk to lots of really smart, interesting people (and, sometimes, some not very smart, not very interesting people) and just learn all the time. So, for me, discovering finance and economics was like seeing the hidden wiring behind the entire world and it just fascinated me.

So, I later became a Middle East correspondent for the Financial Times. I did get to play a war correspondent briefly, during the Arab Spring, but the first cut was the deepest and I still love unpacking the puzzles of modern finance more than anything else.

Niels
Yeah, very interesting stuff.
I want to stay a little bit longer with your background; your career. I’ve got a few reasons for that. Firstly, I would say that I find journalism extremely interesting and I have come to appreciate, over the years, the power of narrative and storytelling even in the world quant investing, I can assure you.
I also remember, frankly, that when I started out in the hedge fund business that one should stay away from journalists because they prefer to talk about the bad and negatives rather than all the positives. Finally, we have witnessed this massive transformation in the world of media. You’ve seen the rise of ordinary people suddenly showing up as amazing content creators, including writers and bloggers, with no formal training in journalism.

So, this is a long winded way to get to the question. What I’m really curious to know is how you think journalism and the financial media have changed in the last ten to fifteen years? Also, how has that impacted you, personally, in the things that you have done, but also in the things you want to do going forward?

Robin
I think you’re raising great points and it has changed massively. I think the big inflection point was the Financial Crisis. Before that there were a lot of people that ended up in financial journalism, but very few people had dreamed about that when they were ten or twelve. It’s not like being an astronaut or working for the Financial Times.

I think the Financial Crisis really hammered home, to an entire generation, how much you might not care or know much about finance, but finance cares and matters a lot to you and effects us in profound ways. So, I’d say that the quality of people I see that apply for jobs at the Financial Times is astonishingly higher than it was before. (I don’t think that I could have gotten a job at the FT today and that’s a good thing.) These are people that still need to be taught and have a lot to learn but they have a fundamental curiosity. I think that is the most essential skill for a journalist.

The dirty secret is that a lot of journalists aren’t actually very good a writing. Some people are naturally great writers but are still terrible journalists. You have to be curious and want to figure things out, the puzzles I mentioned. You must think that people and situations are fascinating. You want to unpick them, or report them, or explain them.

I think that has definitely gotten better in that there are still areas that I think are badly covered and there are structural issues with journalism in that I think the whole “Oh, we’re domed” mongers, who only care about bad news, is just silly. Frankly we just reflect what humans are like and that humans love bad news. We love titillation and salacious gossip and bad news and people getting embarrassed.

I think it’s more that the structures of how we do journalism and what is considered how you write a newspaper article hasn’t changed massively for generations. I think that is getting blown up a little bit by the Internet for good and bad. It does mean that those sloppy standards that creep in all the time (and I think there’s a value to rigor and a strong model to follow – for quants you follow the model and the system, you override it at your own peril. I also think the industry needs a bit more creativity where the fundamental mission is to inform and help explain what is going on in the world.
Sometimes rules of journalism can be a little bit of a straight jacket around that. I think things are moving in the right direction but I think there is going to be a lot of things happening over the next ten, twenty years. Just think, when I went to journalism school, I had a class where they taught us this new tool called Google. That was considered breaking news. That was really like “hot shit” for journalism at the time.

Now, Twitter erupted whilst I was covering the Arab Spring; there’s Tik Tok now; there are people doing stupid stuff on Tik Tok. But, actually, there is quite clever sophisticated through the meme medium, but still pretty smart stuff on TikTok. That is not a medium I can master.

So, I’m quite excited about the fact that no matter what your generation or your interest in Finance there is going to be a broader and probably better ecosystem of providers there for you in the coming decades.

Niels
I completely agree. I actually think you made a great point. I think curiosity is one of those completely underrated skills and, unfortunately to a large extent, the school systems of today rarely have areas where they encourage curiosity, although, my kids have also attended international school and there it is very much in the forefront of what they are being taught. I also see other school systems and it doesn’t seem the same.

Robin
I think it’s a lot, frankly (this is a diversion, I guess). It’s not just schools. It’s parents. We need to encourage that. I do think that I can teach somebody to write. I had to learn it myself. I was always an OK writer but I had to learn it. It’s like a muscle. The more you exercise it the better you get. You can teach people about complex financial concepts but the curiosity to have the will to do so, that is very hard to teach. That is the one thing that I sometimes see still is an issue when we get younger, or older, journalists; that the curiosity goes. You feel that you’ve seen it all; you have nothing new to learn and what I love about journalism is that you’re almost paid to be a student, a permanent student. I get to learn new things from smart people all day long, every day and that’s just one.

Niels
Yeah, absolutely.
Speaking of curiosity, I am very curious to focus on your new book, Trillions, which I highly recommend that people listening today should definitely get a copy of and read. Now, the book comes across as a very deeply researched book and also it is written in a very engaging way, with some of the characters and important discoveries dating back for more than one hundred years, yet you start off quite close to our hearts (here at Top Traders Unplugged) namely with a bet between the hedge fund performance and Warren Buffet. Tell me why this is such a great way to frame the topic of the book (which, of course, instantly got me hooked on it)?

Robin
It’s like you said earlier, that humans think in narratives. We like narratives. Even the most mathematically oriented around us might be in denial about it, but we’re just narrative driven animals. I wanted to not write another Dummies Guide to ETFs or Index Funds, I wanted to write something that would be gripping; something that my wife could actually read and enjoy even if some parts pass her by. The way to do that is through the people.

I just thought that there were fascinating people behind this huge revolution. I also felt that dumping my readers in 19th Century Paris might be a little bit of an abrupt introduction to the wonderful world of passive investing.

So, I wanted to start with something a little bit more current. This bet between Warren Buffet, on one hand, and Prote҆ge҆ Partners (a fund-of-hedge-funds), on the other, about who would beat the S&P 500 in a ten year period, hedge funds or a cheap index track from Vanguard? I just thought it was a great way of explaining the stakes; why this matters; and introducing some of the characters we’re going to meet later on as well.

It was just an epic bet. Who doesn’t love a million dollar bet, especially when the underdog, the cheap boring index fund that you can buy from Vanguard for four basis points, actually beat these five funds-of-hedge-funds that Prote҆ge҆ selected.

Niels
Yeah, absolutely.
What’s great about the bet was also that they funded it by only paying in about a quarter of the money. This was back then when we had positive interest rates.

Robin
I know. Imagine telling your kids about positive real interest rates. That’s going to be a hoot.

Niels
Yeah, I know.
Now, by the way, a fun fact for you, I actually got your book as the audio book version of Trillions and, just to let you know, the twelve hours and three minutes matches perfectly the time it takes to drive from Denmark to Switzerland. So, I’m very glad that you managed to do just that as well.
Now, the book is, of course, about the rise of passive investing and indexing. But before we dive into the path and evolution perhaps you can share why this is so important, and an important part of history of finance, and what the impact has been (to kind of set the framework for some of these characters we’re going to talk about today).

Robin
Well, the fundamental thing that I wanted to write about was a history of investing over the past century. There has been so many books written about banks, for example, and bankers, and even a few really good ones about hedge fund managers: More Money than God by Sebastian Mallaby, for example. I love the great books telling you a story through the prism of a person or an institution that really tell a broader story.

So, the hero of my book is the index fund. This humble thing that was spat upon when it was first started, that kind of grew to take over the world.
I really want to explore how investing has evolved for the past century. I think the index fund is the biggest shift in the fabric of the financial system over that period, arguably. So, the mutual fund is almost coming up to one hundred years, if you count the first U.S. mutual fund (which is more the structure that we’re acting on today). But in the past 50 years it’s the index fund. It’s just mammoth.

So, the reason why I started covering it so much at the FT was because I felt it was under covered as a phenomenon compared to some of these more titanic hedge fund managers. Financial journalism can, sometimes can be (at its worst) a little bit of celebrity journalism but for people in finance. So, you care about loud mouthed activist more than you care about quants, or certainly index funds, because you don’t have these human fund managers running them.

It was so big, and it was clearly having such a mounting impact on markets and the wider investment industry that I spent, and I still spend, most of my time at the FT covering it. This is now just the world that we know about, is seventeen trillion dollars – seventeen trillion dollars. That’s twice as big as the global hedge fund venture capital and private equity industries combined, and that is just the public funds.

There are lots of investors, sovereign well funds, pension plans, some private banks, that do this in-house. They don’t need to pay BlackRock to do this. They have internal index strategies, or have some separately managed account with a big index house. If you add up all those numbers (and I have done some reverse engineering on this) then we’re probably talking about twenty-six trillion dollars, at least. That’s my most conservative estimate of money that just tracks some sort of benchmark, whether it’s the S&P 500, the Barkley’s AG, the EMBI, the Nikkei, whatever. That’s just mammoth.

It’s really only in the last two decades that things have really exploded. So, that’s why I wanted to write about this book to show both where we come from and how far investing has evolved over the past century, but also, maybe, paint some contours of where we’re heading in the next twenty, thirty years as well. I think indexing is unambiguously going to be a huge part of that future.

Niels
Yeah.
A fun little anecdote from my side, and I don’t know if you’ve come across this in your research, actually, but as you may know, I come from the trend following, the managed futures side of this world and back in the ’90s (when I started out) we had this wonderful monthly publication called The Managed Account Reports which was an industry update about trend followers and managed futures, then (around the year 2000) they started publishing the same magazine but it was called ETF. I thought, “this doesn’t sound very interesting,” and stopped my subscription, but boy was I wrong. That became a much bigger area of finance than managed futures, but there we are.

Robin
Well, you’re not wrong. I think the interesting thing about the first index funds and for pension plans, and the first index mutual funds, and then the ETF, they all were, essentially, damp squibs when they first launched. So, it goes to show that sometimes good ideas need some time before they get traction.

Niels
Absolutely.
Now, early on in your book you show this wonderful list of people who feature in your book and you call it the “cast of characters.” Many of them are really part of the who’s who in financial history. Actually, I was also surprised how many of them I had not heard of before.

So, in my previous episode in this series on the podcast I had a conversation with Professor Steve Foerester, who just recently published a book with Andrew Lo, also a Professor, called In Pursuit of The Perfect Portfolio. In that conversation with Steve we focus on three of the academics, who also feature in your book, who obviously have had an enormous impact on how we invest today, and that was Harry Markovitz, Eugene Fama, and Bill Sharpe.

So, what I’d like to hear and what I’d like to hear from you is a summary of the period that they cover (let’s call it 1950s to 1980s) and who else (and we’re going to leave Jack Bogle aside for just now), but who else would you highlight in terms of laying the foundation for both quant investing and, of course, indexing? And then we can move on to Jack Bogle after that. I just want to hear who else you thought were really interesting characters over that period of time.

Robin
Well, I’d say the history of indexing and quant investing, arguably as well, actually starts with one guy called John McQuown, or Mac he was known. So, he was deeply steeped in the academic backdrop that you are talking about. He was also (this is in the ’60s), he was also uniquely… He studied mechanical engineering; was the first person in his family to do so – to get a degree.

He fell in love, whilst at university, with a computer and learned to program. He then, later on, did an MBA and started working at Smith Barney, but this was at the time when even having an engineering background was unusual on Wall Street and the idea that you wanted somebody to program? That was just laughable. Banks literally didn’t buy computers then, or only very few of them did and didn’t really know what to do with them.
Mac, essentially, ended up at Wells Fargo where an unusually foresightful CEO and Chairman, called Ransom Cook, essentially gave him an unlimited budget to set up an internal Think Tank (a kind of skunk works) called Management Sciences that was, basically, dedicated to finding out how they could use computers to improve finance. It was kind of an FinTech Think Tank before those terms even existed.

It’s amazing what you can do with an unlimited budget, Mac hired this all-star cast of economists and financial experts to consult for Management Sciences. So, just to mention the Nobel Prize winners, there was Gene Fama, Bill Sharpe, Harry Markowitz, Merton Miller and quite a few others, Jack Treynor and the whole works.

They did lots of things. They invented the FICO scores, among other things came out of Management Sciences as well. The greatest was the index fund. Not only did they invent the index fund, the first iteration of it was born in 1971 (so, it’s 50th anniversary is this year), but that became, that was later spun out to become what was called, then, Wells Fargo Investment Advisors – WFIA.

If you look at a lot of the big giants of quantitative trading and portfolio management a lot of them have worked there or have been associated somehow with WFIA. So, Ron Conn, Richard Grinold, Barr Rosenberg consulted for them. A lot of the stuff that we now take for granted [gained traction at WFIA].

It wasn’t just WFIA, some of this happened organically in other parts of the world and in the country of course, but it’s kind of the original quant factory. It’s astonishing to see how many people around the world have some sort of background in WFIA which later became WIFNIA, when they merged with NIKO, and then later Barkley’s Global Investors and, today, is the crown jewel of BlackRock, the world’s biggest investment company.

Niels
Absolutely.
We’re going to come back to some of that, of course. Let’s dive into the story of Jack Bogle and Vanguard. I think a lot of investors, today, are familiar with these names and I was as well before reading your book, but I have to say that after reading the book I’m not sure I really did know the real story about Bogle and Vanguard at all.

So, take us back to where it all started and guide us through this fascinating story.

Robin
Well, he’s just a riveting character. Actually, he became even more interesting to me, at least, when I was researching the book, then the image I have of him before because he’s far more complex and multifaceted than, frankly, even he sometimes pretended. So, he came from a wealthy upper-class family that, essentially, lost all their money, when he was tiny, in the Great Depression. His father became an alcoholic and essentially that, I think, scarred him throughout his life.

He was the only person who (he had two brother’s including a twin), the family had gone with him, as well, from being privileged to being posh but poor. They could only afford to send one of the three to university and that was Jack Bogle because his grades were the greatest. So, I think that really fired up just an incredible drive in the young man.

So, he went to Princeton and worked hard there. He was not always the brightest. He did bad at mathematics originally, and economics but he worked harder than everybody to get himself great grades. He wrote a thesis on this hot new thing that was growing out of Boston, primarily, called The Mutual Fund. This was a time when the mutual fund was a pretty new, radical invention and growing quickly. That thesis came to the attention of Walter Morgan, who was the founder of Wellington Group, one of the oldest and biggest mutual fund groups in America. Jack Bogle went there, was hired, and quickly became the “boy wonder” of the investment industry. He was the prote҆ge҆ of Walter Morgan.

He was one of the youngest senior Vice Presidents, and he eventually took over Wellington, in the ’60s with a brief reinvigoration. It was a very conservative organization and the ’60s was the Go-Go Era; it was the first dot-com boom. Of course, there wasn’t Amazon and Apple, but there was Xerox and Kodak and IBM were the hot tech stocks of the day.

Jack Bogle made the fateful decision to pivot Wellington towards the future by merging with a Boston rival that managed a very hot tech oriented growth fund. That decision proved fateful. Essentially, he got fired by his partners that he merged with. So, when the Go-Go Era ended, in the early ’70s with a horrible bear market, they started fighting between themselves and, in the end, even though their performance had been doing badly, Bogle was just too much of a forceful character for them to tolerate and they actually had a bigger ownership stake than he had by then, so they managed to fire him.

He managed, in a Hail Mary to convince the independent boards of the funds themselves (this is how it works in the U.S.) to give him, essentially, a bit of a consolation prize which was they would set up an administrative company to do all the paperwork for the Wellington Funds and he called that Vanguard. The rest is history.

Niels
It is.
I want to just ask you… and this is from my memory of the stuff that I read in preparation for our conversation today, Walter Morgan was an interesting character, as far as I can tell. I think he was someone who really wanted to do good, not just necessarily focused on the numbers, if I can put it that way. How do you think Jack Bogle was influenced by that experience or mentorship? How important was that?

We’re going to come to it, of course, but some of the driving forces about low cost and doing well, making sure… (coming from the hedge fund industry we don’t always see people who want to do well for the investor), so, how would you describe that influence?
He (Walter Morgan) doesn’t get a lot air time.

Robin
No, and I think he was a titanic figure in the start of the mutual fund industry in the U.S. Like most people, he was the product of his experiences and he lost a lot of his family’s money in a stupid mania in the early 1900s and that meant, when he did set up a mutual fund company, he was very conservative and he actually ran the first (I’m pretty sure) and, certainly, the biggest balance fund that both invested in stocks and bonds. That was his thing. His innate conservatism, and inclusion of fixed income, also meant that they were one of the few big investment company winners from the Great Crash and the Great Depression that came. So, I think that just burnishes your belief that being conservative, and careful, and prudent, is an essential thing.

I think it’s hard to have not grown up in certain eras and not be shaped by them and that shaped Walter Morgan and definitely shaped Bogle because he also had his own family’s brush with having money and having lost it. So, I think they merged well.

Wellington wasn’t necessarily then known for low fees per se, but they certainly weren’t super high. Bogle was unambiguously a cheapskate his entire life. This was his family having had money and then lost it. His friend Berton Malkiel once told me that Jack Bogle’s favorite drink was an eight dollar bottle of Cabernet Sauvignon. Anything more than eight dollars was just wildly extravagant to spend on red wine. So, I think that shown through.

In his thesis he talked about the importance of low fees, as well, and in his subsequent work and how he structured Vanguard. So, the structure of Vanguard being owned by its own funds is, frankly, happenstance. There was not grand plan. It was how it ended up, but the low cost is something that was very much a part of his being, as it were. I think the importance of the mentorship of Walter Morgan was reflected in how Bogle later on mimicked his system of always having one young, promising man or woman to mentor. So, he always had an assistant that he would coach himself and then sort of spread out through the organization to spread the word of Jack Bogle.

Niels
Yeah, interesting.
Another interesting thing that, actually, you write about (which is again something that I don’t think of today) is the role that pension funds played back then. Usually, you don’t think of them of first movers or being very creative, so to speak, but actually AT&T, their pension fund did play a role in particularly the breakup of AT&T. Can you tell me a little bit about that?

Robin
No, the underappreciated hero of the story is actually the “Baby Bells” (as they were called). Obviously AT&T was set up by Alexander Graham Bell and when the government decided to break up the AT&T monopoly they essentially splintered it into small regional AT&Ts and each of them had their own pension plan (Baby Bell as they were called). It was known as the Bell Systems (in combined).

Now, they still shared a bit of information. Essentially the Bell System could see that they were all invested in hundreds of mutual funds and they were essentially (as one person said or put it to me) swapping bananas. So, mutual fund A, that was owned by Bell Midwest, was selling IBM to mutual fund B, and vice versa. So, they were all just swapping these securities.

First of all, obviously, they were charging quite a lot of money for doing so, but also this was an era of just outrageously high transaction costs (at least compared to present standards). So, basically AT&T in some of the Bell System (not all of the Bell System but in large parts of it), could see that they were essentially getting the entire U.S. stock market. They were the single biggest holder of U.S. stocks at the time, but minus all these trading costs and the fees of management.

So they were, if you look at almost every single one of the pioneering index funds (and sometimes this was done because they wanted to nurture the industry) they thought this was valuable. In some part of the AT&T, one of the Baby Bells was almost, in every single case, a backer of the first generation of index funds.

Niels
Interesting.
Speaking of the pioneers of index funds, what did the first index fund look like and how was that received back then?

Robin
Well, so, this is the naughty thing, and why people still argue about which one was the first. So, what I think is the first is an account, a separately managed account that Wells Fargo set up for Samsonite’s pension plan, that managed six million dollars for Samsonite. Samsonite was the pioneer most because the heir of the family fortune, Keith Shwayder, had studied under Gene Fama at Chicago. [He] thought it was horrific that a pension plan of Samsonite was invested in all these awful mutual funds. So, that’s how all that happened. Gene Fama introduced him to Mac McQuown at Wells Fargo.

It was a separately managed account, so not a fund per se, and the index they chose was all the stocks of the New York Stock Exchange and weighted just basically dollar equal dollar amount. So, not an S&P 500 Market Index. As quite a lot of listeners will realize, that was a logistical nightmare. Even today that’s a bit annoying, but at the time, when there was no electronic trading, there was no portfolio trading, you had to rebalance all the time.
So, although that was the first one, it was an ill fated one and eventually, a couple of years afterwards Wells Fargo was to set up an S&P 500 Index vehicle for its own pension plan and the Samsonite money got folded into that. So, at the same time the American National Bank of Chicago, under a guy called Rex Sinquefield, who plays a huge role later on as well, he basically converted (in mid 1973) one of their existing funds into an S&P 500 Index tracker. So, that’s the first live money in a fund structure, but it was a conversion.

In Boston there was a start-up driven by a very eclectic financial savant called Dean LeBaron and he thought this was just a fun new… He liked doing new things. He was a genuine pioneer. He liked pioneering for the sake of it. He set up (in early 1973) a program (basically you can buy separately managed accounts from them – an index tracker), but he got zero clients for an entire year which tells you how much of a hard sell this was. Rex Sinquefield told me that they felt like John the Baptist trying to convert all the heathens in the early days of Jesus Christ. It was a hard battle.
I think the most vivid quote that I got was from Mac (this was also internally, they were generally hated by all their active colleagues), Mac said it was like shovelling shit upstream, which I thought was quite an evocative description that harkened back to his background on a farm in Illinois.

Niels
It’s easy to imagine what that’s like.
Now, I want to insert a question here and that’s to how you see what has happened in this space. When we look at Bogle’s inspiration for all of this I guess you could say that the thesis of Markovitz and Sharpe, which is about most people not being able to beat the market and therefore you should be a long-term passive investor (and Bogle’s own belief, that we talked about, about the low cost playing a key role) and that kind of makes sense but, as we know, humans, we have a long successful track record of making a mess of good things. I’m wondering if you see some issues with those virtues and the evolution of ETFs, that we talked about earlier, where essentially, we’re now allowing the same investors to become active investors without the experience and knowledge, to some extent.

Robin
No, it’s a very good point. One of the things that sometimes gets highlighted, even in my own writing for the FT sometimes, is that the idea of some key distinction between active and passive is a complete fantasy. Even if you are investing in the S&P 500, or even a broader Index like the MSEI or USA Index sort of thing, you are still choosing an index. That is a choice which index you use, and then you construct the portfolio systematically and cheaply but there’s still an active choice somewhere.

So, I think sometimes people will say there’s active and passive, in reality, for me, it’s systematic and discretionary are the two sides of the axis. An index fund is just a systematic fund that is really cheap and broad based that tries to harness the diversification.

Now, you can be a fan of indexing and not believe in efficient markets. So, for example, a Rex Sinquefield was deeply schooled in Chicago. He was an efficient market zealot. He calls himself the Ayatollah of Efficient Markets. Gene Fama then (I guess) is the Gaul in his Anthian and Jack Bogle who was friends with lots of active managers. He just thought, generally speaking, that they charged way too much money and essentially many of them aren’t that good. So, that was his issue, but he just felt that rather than the Efficient Markets Hypothesis, he called it the Cost Matters hypothesis.
My view is that, yes, what was still just a phenomenal invention – a genuine boon to human kind – has now evolved into areas I think are, at best, pointless; at worst dangerous to individual investors and potentially even to the integrity of the financial system. I don’t see any meaningful distinction between individual investors punting on some stupid gold stock or some gold ETF. Yes, you get more diversification with ETFs, but it’s still fundamentally that you are just taking an active punt.

Then, some of the leverage in inverse ETFs (I don’t want to sound too much like a Statist Scandinavian), I do think there is a case for governance. So, you could say, “Well, heroin is bad for you. You should not do heroin. That has societal costs and cost to you as an individual and we’re just going to say that’s illegal.” Now, maybe that is the nanny staked on a mop, but I don’t think so.

I also think that some of these leveraged ETFs are giving owner investors access to financial products they wouldn’t be allowed to touch on a standalone basis. So, for example, my favorite example is the long VIX ETNs (some of them are ETFs, some of them are ETNs). These are VIX futures that ordinary retail investors would not be allowed to touch if they were just a standalone product. But you wrap them up in an ETF then hey, presto, through some sort of magic their regulatorially blessed and that just seems crazy to me. Not least because you would have made more money investing with Bernie Madoff than you would have through these long VIX products.

The long VIX products have just burnt a staggering amount of investor money over the decade that they have been around for no discernable purpose what so ever except to generate fees for basically the market makers and the product sellers. At worst these products are not just dangerous to the individual investors but they’re actually dangerous to the financial system because we can see times when they cause chaos because of some of the structures around them. For example, oil prices going negative in March 2020, or April, May 2020, and (infamously) the inverse VIX products of Volmageddon in February 2018.

Niels
Yeah, we may come back to that towards the end. I wanted to continue a little bit.
Now, for me at least also, I’ve always thought of Vanguard as being kind of led to success by Jack Bogle and, of course, it has. When I read your book, it’s not quite what happened because he ran into some health issues and that opened the door for another Jack (so to speak), so tell us a little bit about what happened there and they ended up having a pretty interesting relationship I guess you could say.

Robin
Yes, I mean, Jack Bogle was just a really interesting character. Unambiguously, no Jack Bogle, no Vanguard, no question. But I think we talk about the importance of narratives and we, as humans, always like narrative with a keen, clear hero. We might like them complicated but we like a single hero. So, back in the day, Thomas Carlyle said, “The history of mankind is the biography of great men.” This was at the time when there were just men, of course, and certainly in finance.

We know that reality is a lot more complicated than that. Even in the founding of Vanguard, Vanguard wouldn’t probably have existed without the help of some of his aids, like (most notably) Yar Trendowski, who managed the first index fund for Vanguard – the Vanguard 500 fund – and his assistant Jim Rebee who went on to have a glittering career in the investment industry per T Rowe Price, afterwards as well.

But Jack Bogle was a great talent spotter. It’s incredible how many of his people have gone on to leadership positions including, ironically, at Wellington where they had this horrific divorce. I think the most consequential one for the growth of Vanguard, that really we would not know Vanguard as the giant, the titanic company it is today without him, is Jack Brennan. He was the Yin to Bogle’s Yang.

They complimented each other quite nicely in that Bogle was a charismatic visionary and the strategic mind, and Brennan was just (I don’t want to denigrate and say just an operations man) he was the guy that kept every train running on time. He was an incredible manager and a man manager and could do all the detail stuff and was always on top of everything and professionalized Vanguard in many respects. They also complimented themselves in that they were both incredibly hard workers. So, they started competing in who could get to the office earliest. So, they were incredibly close until they suffered, sadly towards the end, a terrible falling out over who would (and when) take over the reins of Vanguard.

Niels
Yeah, absolutely.
Now, we’ve spoken about the rise of Vanguard, which of course today is a mega player in the world of passive investing and so on, but I want to pivot a bit and I also want to talk of the rise of another maker player namely (what we know today as) BlackRock, under the leadership of Larry Fink. Now, this journey was also not something that happened in a straight line, I would say is fair to say. So, take us back to the beginning of the journey which, for me at least, kind of dates back to what you mentioned earlier. There was Wells Fargo, certainly as part of it, and certainly two characters that I remember from the book, Patricia Dunn, and later, Fred Growa (I think he was called).

Robin
Yeah, so, Wells Fargo, we kind of left them when they went to the index fund, but then they kept building up and basically became this quant factory (is how I think of them). The thing is that hiring all these academics and brilliant people was really expensive and, ironically, even though Wells Fargo became the leader in indexing, as that was growing institutionally in the 80s, it never made any money.

Mac left because he’d gone to budget battles, and basically, Rasom Cook had left and he wanted to do something else – a very entrepreneurial guy. Bill Foust, one of his main Lieutenants, took over the ship but he had lots of battles with Wells Fargo the Bank. Wells Fargo the Bank kind of hated the fact that holdings, on the investment management side, were getting paid more money than they were but they weren’t actually producing any P&L. More importantly they were producing lots of L but not a lot of P. So, there were all these battles. So (Foust took a lot his main people and started a rival called Mellon Capital.) It was kind of imploding.

Patty Dunn, who had started as a secretary there, a part-time secretary, but actually had become this brilliant young prote҆ge҆ of many of the people that worked there, she suggested that they hire back somebody who Bill Foust had sacked a few years earlier called Fred Growa. So, former academic, great academic career, but then entered the practical world of finance. He was a top salesman from Merrill, at the time on the West Coast. I think if Wells Fargo hadn’t been a complete disaster zone he would have never gotten the job.

This was a desperate rescue operation, essentially. Fred Growa managed to stabilize it and put the shit on the right course just as all the tide started pushing in the favor of passive. In the mid 80s, essentially, interest rates were falling, and falling, and falling, and we started these twin bull runs for stocks and bonds that had, obviously, a few interruptions here and there but has basically continued to this day. And passive… People became more and more cost conscious, as well, so passive was growing and Wells Fargo managed its growth.

Eventually, and we see this many times through history, Growa fell out with Barkley’s, which had bought WFIA and turned it into Barkley’s Global Investors, and he was replaced by his own prote҆ge҆, Patty Dunn, who was, by then, sort of co-CEO with him and he was her mentor. They had a falling out over that (and we can see a pattern emerging here) but she was brilliant.

So, she was not an academic like a lot of the other BGR people were former academics, but she was great at understanding that and translating that to investors. She was a god level people manager. Everybody tells me, everybody had a story about what a wonderful person she was. She saw that something started when Growa was there called Webbs which was basically a copy of the ETF of State Street start-up called SPDR on the ETF SPY. They thought the potential for that was for that to be a lot bigger. At this time when that magazine you mentioned would maybe change its name to TF, but it wasn’t a hot thing at the time.

So, SPDR kind of languished and had grown some assets but it wasn’t a huge thing. QQQ had launched, the NASDAQ ETF with a bang, but then basically that had imploded when the dot-com bubble burst. She saw, and some other people at EGI, most notably Lee Kranefuss, saw the potential for the ETF to be sort of Indexing 2.0, maybe 3.0 depending on how you define it.

We can use the more flexible structure of an ETF to essentially create blocks of risk, of different types: credit, investment grade, high yield, U.S. equities, sectors, and so on, and build, in time, a menu of investment products that a financial advisor, a hedge fund, an institutional investor can assemble whatever way they want and throughout the day as well. Then you can even build products on top of that – the options.

So, they essentially managed to get Barkley’s blessing and this was the prescience of Bob Diamond who was the head of Barkley’s Capital at the time, to go on a massive build-up that now Silicon Valley would call a Blitz Scaling, but basically they just chucked money on advertising and rolling out products at a dizzying rate across every major part of the investment real estate map, essentially. This was long before people thought there was any potential here.

They managed, essentially, to build up the first mover advantage because in ETFs nobody cares about the difference between Russell 2000 ETF 1, 2, or 3, you just go to the cheapest one. The cheapest one is usually the biggest one. So, if you get there first then you have a huge advantage. She and Lee Kranefuss built Webbs into what is now called iShares which is the crown jewel of BlackRock and why BlackRock bought BGI at the depths of the financial crisis in 2009.

Niels
Yeah, absolutely.
I’m sure they didn’t realize, at the time, how great the name iShares came since Apple started to use the “I” in everything they did but yeah, that was around 2000, I think, they rebranded to iShares.

Now Dunn, Patricia Dunn, she didn’t stay at BGI. I think at some point she tried to do a buy out with a private equity fund which didn’t succeed. But I want to move on because you just mentioned the financial crisis, so I want to move on to that period. So,2008, 2009, because that becomes another pivotal time for index and ETFs. So, tell us what happened at this meeting at a baseball game that led to the deal of the century, so to speak, and the rise of Larry Fink, even if he didn’t participate in the meeting, I think.

Robin
No, so, if we cast our minds back to 2009, this was April, the depths we were in (in the financial crisis) but we certainly didn’t know it at the time. I remember things being still scary as hell. Barkley’s had avoided taking government bailout after the financial crisis but had a acquired the U.S. parts of Lehman and that and many other things were dragging it down and it was desperate to avoid a government bailout that would restrict bonuses. Let’s face it, it was that silly. So, instead of taking government money they decided to sell the family silver including BGI. So, CVC, a big private equity firm, put in a bid that was accepted for iShares, specifically. Now, Barkley’s would have to sell the rest of BGI off piece meal.

Now, BlackRock, lead my Fink, realized this was the wrong move. Fink has become a little bit controversial but I still think has one of the finest strategic minds in the investment industry. He realized that you can’t really disentangle iShares from BGI. So, iShares was a brand, it’s own marketing arm, a sales team, it’s own culture but the fundamental financial engineering was done at BGI.

BGI was kind of the best financial factory in the world and it had gone not just beyond index funds and quant funds but pretty much anything they could construct there and just churn out in scale. So, he wanted to buy the whole thing. So, he sent Rob Kapito to a baseball game that Bob Diamond was attending in New York in April 2009 where they thrashed out, essentially, the contours, the very first contours of a deal for Barkley’s to sell all of BGI to BlackRock and thereby transforming BlackRock from a really big, well respected investment house in New York to being, essentially, a global empire.

It took quite a few years of hard work and quite a lot of sackings and bruised egos but I think nobody can look back at that deal and not think that it is certainly the most successful acquisition in the history of investment management, but arguable in finance and almost globally. It’s staggering that probably just BGI now is worth more, and BlackRock is worth more than all of Barkley’s today. It has been just a phenomenal success.

Niels
Yeah, absolutely.
Now of course, we’ve already touched upon it. Larry Fink, he’s an interesting character and I want you to talk a little bit about the back story of Larry Fink. Again, it is not necessarily as straightforward as you might think of someone with that success today. So, how would you sort of describe his getting to that point of being able to pull off a deal like that?

Robin
Well, this takes me to one of my favorite issues in journalism, and maybe really in human nature, I’m sure we all know this intuitively, going through the back-story of a lot of sort of the heroes characters and sometimes villains in my book, you realize how many of them have suffered some sort of horrific setback in their lives early on, and it didn’t break them but it made them. Jack Bogle’s family background was really tough and that made him who he was. Then being sacked by Wellington, by the partners that he brought in, just basically kind of just ratcheted that drive up to just firmer nuclear levels.

I think the same thing with Fink in that he definitely didn’t come from sort of a hard scrabble background, but his father was a cobbler and his mother was a university teacher. He was not the brightest person in his family. So, once his brother could focus on school he started to help out with work at the shoe shop. He studied a bit of political science because he didn’t know what else to study and then drifted into real estate because he thought that sounded interesting. There was a professor there that sort of mentored him. Then he drifted from that to Wall Street, but screwed up his interview at Goldman Sachs, notably, and ended up at First Boston. There, I think there was this perfect sort of alignment of circumstances.

He had studied real estate, knew the mortgage market just at a time when people were starting to… The securitization engine was really starting to rev up and Larry Fink just proved brilliant at managing that market and trading and running a team of bond traders. So, together with Solomon Brothers, Larry Fink was one of the ultimate big swinging dicks of bond trading in the 1980s. He was phenomenally successful, he was the youngest managing director in First Boston history, he was the youngest person on the management committee in First Boston history. Then (and we see this occasionally) things just collapsed. His team, essentially put on a wrong way bet on interest rates. Their hedges were badly structured and blew up and they lost the bank one hundred million dollars.

Now, he made the bank many times that over the years, but he still went from CO in Waiting to Outcast. Eventually he did leave First Boston to found BlackRock with a friend of his from Lehman Brothers. I think that setback, like many setbacks for many people, actually can really provide the fuel that you need to prove doubters wrong. I suspect that if we go through the back lot of wildly successful women and men in history, some sort of personal tragedy or professional setback is quite often there I suspect.

Niels
Yeah.
Now, obviously we know it as BlackRock today, but it didn’t start out as BlackRock so to speak. There was another Black in there. There was a Blackstone. How did that fit in and how important was that? It was pretty important, I guess to the beginnings of BlackRock?

Robin
Yes, so, he left First Boston to set up. Essentially, he was talking to a friend of his at Lehman Brothers (Shearson Lehman at the time) called Ralph Schlosstein, another mortgage banker. He was on the investment banking side and worked in the Carter Administration. They decided (this was also after Black Monday), so, they thought that the financial system was getting way more complicated than most people understood and could appreciate. So, they wanted to start, essentially, a technology driven, risk management sophisticated, asset management firm that would basically build a better risk management model to underpin everything that they did and build products on top of that, essentially. That product is Aladdin, today, which is used by trillions of dollars of assets under management not just at BlackRock but elsewhere as well.

They had no name recognition. Fink had this come flaming out at First Boston so they got in touch with a fellow friend of theirs, Steve Schwarzman at Blackstone. Blackstone was then an up and coming private equity firm. It is not the Blackstone we know today but Blackstone wanted to build a bigger empire so they said look, we’ll house you, we’ll give you a credit line that you can draw down in return for a 50% stake (I think it was, or 40% stake, or something like that).

They called it (because Blackstone had an emerging brand), they called in Blackstone Financial Management. That was the name until (and I think this is interesting with Fink compared to many other types of finances and certainly Schwarzman, – most people care about money), but Fink wanted to build something great; not necessarily have the biggest ownership stake in it. So he and Schlosstein, together with some other partners and friends that they got from Shearson Lehman and First Boston, like Rob Kapito and Sue Wagner, and Barbara Novick, they started using equity to attract high quality people.

They didn’t care about necessarily having or maintaining the biggest ownership stake. They just wanted to build something great. Schwarzman was fine with building something great but he didn’t want it to be diluted. Eventually that lead to rupture and a pretty nasty divorce where essentially Schlosstein and Fink forced an exit and a new name and they chose the name BlackRock. The first thought about Bedrock but they thought that was too reminiscent of the Fintstones. I have to admit, I agree with them.

Niels
Yeah, absolutely.
Let’s fast forward a little bit here. We have BlackRock now and before we go to a few other topics I wanted to discuss with you, I just want to ask about their meteoric rise from that time to now. So, since the Financial Crisis to today, what do you think is the secret to their success because it has been absolutely phenomenal?

Robin
Oh, BlackRock…
So, I’d say there are many aspects. Some of it is just smart M&A at the right time and they’ve moved pretty ruthlessly when they’ve dealt something. So, the first one was State Street Research (not associated with the bigger State Street); most famously the Merrill Lynch Investment Managers was the first big deal that really turned BlackRock from a bond house into a broader asset manager and then the acquisition of BGI, which really transformed it into what we know today. The fundamental glue is Fink.

Like I said, he has a strategic mind about the investment management that I think is probably more tuned to trends than most people. I talk to a lot of people in that industry and there are some absolutely astonishingly brilliant people. Brilliant people make stupid mistakes all the time. I’m sure Fink does as well, but he’s been very good at seeing where the puck is heading and then, when he needs to be decisive, he is utterly decisive and ruthless.
So, the pain in BGI, when they got acquired by BlackRock, was immense. A lot of people left anyway because it’s natural their stock options paid out and they were wealthy men and women, but a lot of people got sacked. Fink realized, actually, there are some brilliant people and we’ll keep some of them but this is a factory. We don’t care who mans the buttons, essentially, as long as we have some people they don’t really care. Investors don’t really care whether it’s BGI on the tin, or BlackRock on the tin, or State Street, they just want a good, well engineered product – investment product, essentially.

So, he sees where the investment industry is heading and he saw it with ETFs way before everybody else. He saw that ETFs were not just essentially an index fund 2.0. It was something far more powerful potentially; that you could do this bundling of risk into these ETFs and create building blocks for everything from sophisticated sovereign wealth funds and hedge funds to ordinary retail investors. If you can provide that service, those products, cheaply and more efficiently than everybody else then you’re going to be a winner in an industry that’s, let’s face it, still has really, really fat margins. So, it’s a bit like Bezos famously said, “Your margin is my opportunity.”

I kind of think that’s what both BlackRock and, to an extent, Vanguard sees on both asset management and financial advice. I think it’s interesting that he (Fink) has this strategic mind but quite a lot of people I’ve talked to as well said (even people who, frankly, don’t like him as a person) his grasp on the minute details of every aspect of BlackRock was astonishing. That it wasn’t just that he was a Bogle like strategic visionary, but he also knew every single part of the business really, really well.

I think he has also surrounded himself with people that they seem kind of monolithically in agreement externally but probably people that see themselves as friends and colleagues and equals that will argue things. You need input from alternative viewpoints all the time otherwise there is a danger of having this sort of imperial CEO tendency when you think you can do no wrong. That is something that I think BlackRock has, so far, to an extent avoided.

Niels
Yeah, very interesting insight. Thanks for sharing that.
I want to shift gears and leave your book and pick another part of your brain, so to speak, that has to do with quant investing in general. Although before we leave the passive investment world completely I do want to ask. We talked a little bit about it, but I do want to ask about where you stand in this debate between passive and active: the benefits and the dangers. There are a couple of points, in particular, that interest me a little bit and one of them, actually, has to do with Larry Fink. We’ll come to that in a second.

The first one (and this has been, obviously I’m sure in the media a lot) is the common share of ownership is one danger that has been talked about. The reason that I see it as an issue is (and I don’t know if Jack Bogle was referring to this when he voiced his concern) it’s just the level of influence that these people have in terms of voting rights. You kind of just wait for them to sort of start flexing their muscles. So, I’m not thinking about price fixing or anything like that, I’m just thinking about if they want something like a new direction and they sit with a big part of the voting shares, what’s to stop them?

Robin
Well, there are lots of things to stop them but, I agree, this is the one concern I have that is the least tangible but the biggest concern I have with the growth of passive. With all the caveats that we talked about: active and passive are the blurry concepts, we talk about product proliferation – I think there are way too many silly investment products that are under the header of investment index fund. I think the power that accrues to index providers, themselves, as a result this, is something that we need to watch. I’m unconvinced by the distortive affect that it’s having on markets (or I see the distortive effects where they can be glimpsed as not any more malevolent or bad than the impact of any new investment product, whether it’s a mutual fund, investment trust, hedge fund, or so on).

I think this concentration of corporate power is the one that gives me the biggest pause for concern, and certainly Jack Bogle as well before he passed away.

Now, I think people want them to flex their muscles. This is why I actually have some sympathy with the BlackRocks and Vanguards and State Streets of the world, and on the active side a Fidelity or Capital Group, that they are under enormous pressure to take more aggressive stances on a range of issues. I happen to agree on many of those issues but I don’t, necessarily, think that asset managers are the ones that should stake out positions on them.

Maybe I’m old fashioned but I think major public policy issues are better left to democratically elected politicians, even if we might not like the kind of situation. By trying to enlist, even for the greatest causes in the world, to enlist the clout of an asset manager, I think stinks a little bit of privatizing public policy to an extent. So, I’m not crazy about that.

I think, frankly, most of these index fund providers are aware of this and are very careful of overstepping their mark. You can see that the push and pull between people that want them to take a passive role and people who say, “You can’t be passive.” That includes people on the left and right. Paul Singer famously ( a very big GOP Republican doner who runs Elliott Management) is incredibly thoughtful and smart on this as well.
His fear is that passive investors are passive owners as well and they encourage corporate sloth. They’re not engaged enough. They need to get more engaged. I don’t think he want them to be greener necessarily, but you can see that they kind of get attacked by either side.

Barbara Novick, Larry Fink’s former public policy supremo and one of the cofounders of the company, called this “the Goldilocks problem,” is their porridge too hot, or too cold, or just right? Because they seem to be getting attacks by every political side. So, I have sympathy for them but, frankly, this is just the responsibility that comes with great power and influence. It is something that they cannot duck in the coming decade because even the absence of a decision on these issues is a decision with consequences. You can’t just stick your head in the sand here. That is also something, given their size and given the growth trajectory, has consequences of a huge magnitude.

Niels
Yeah, you mentioned, well two things actually spring to mind, you mentioned that Singer didn’t want them to become greener. Well, in that sense you could say that Larry Fink has certainly flexed his muscles because he has been out saying, “Well, we’re going to double down on ESG friendly funds.” So, this might just be the beginning of some of that.

I take your point that it’s difficult to be in the middle and do the right thing. You kind of, at some point, have to take a side. He seems to be doing it a little bit I guess.

Robin
He definitely is. Larry Fink is a conservationist and is pretty green as a person but I don’t think, for a second, he would be pushing this at BlackRock if it wasn’t good for business. So, this is the strategic mind that I mentioned. You can see ETFs and where it was going and knew that BlackRock, if they wanted to be a global player or THE global player they need to get in there. It’s kind of buy or build and you really you have to buy because the benefits of scale are enormous in the first mover advantage.

ESG started long before BlackRock really threw its weight behind it. You really see that he realized that this was something… You know, they were (I heard) losing mandates because they weren’t seen as green enough. So, it’s a commercial imperative. It happens to align with how he also thinks as a person, but I think there are commercial realities behind this as well and why, also, I think we should be careful about just blaming asset managers because they make convenient targets, especially when they stick their head above the parapets, as Larry Fink does, that they are fundamentally asset managers. They are not asset owners.

The ownness has to be on the asset owners. If the asset owner, let’s say a pension fund ABC, in Sweden, or Denmark, or Norway, or wherever, wants BlackRock to be greener with its money and wants to divest of coal and energy and so on, that is fine but then they are responsible for their plan members and have to answer if that comes at a cost of performance in the long run.

So, I feel that, fundamentally, there is a lot of blame shifting going on. I don’t think that asset managers can duck this issue entirely because, frankly, they are embracing it with alacrity and their clearly fanning it. I get, probably, five or ten press releases a day about some sort of EST plan or announcement of varying degrees of interesting to outright marketing bullshit, frankly. But, it is not just the asset manager’s job to do this. Frankly, and this being hopelessly out of sync with the EFT trends these days, again elected politicians. We all just need to pay more for energy and consumption and that’s not politically popular but that’s fundamentally what we have to do if we’re serious about this.

So, activists, rather than trying to bully Vanguard and BlackRock to divest of X or Y which does zero to cut emissions, they should be lobbying politicians to say that we need a carbon tax, we need more nuclear power, or something else that actually has a meaningful impact on these issues. If we don’t want CEOs to sit on boards, pass a law. This is not rocket science. In this day and age when there is so much political polarization we seem to almost be forced to look towards the investment industry for solutions and I think that’s a bit of a red herring.

Niels
Yeah, absolutely, it’s a little bit scary.
The other thing that I have noticed about it that I think is an interesting issue, at least (I’m not sure there is a solution for that), is how some of these big index rebalances can really influence. I guess we saw it last year with Tesla. That had a huge influence in the markets and, if I’m not mistaking, I think I saw you actually on television a couple of days ago talking about Tesla options and the volume that’s going on in that. It’s certainly creating some interesting dynamics in the markets. I’m not sure it’s for the good.

Robin
No, I think Tesla is an example that I have used in my book because it’s a big, sexy, interesting company and the effects seem to be huge from the index inclusion. In reality, several studies have actually shown that there is the index inclusion effect which is the uplift that you get from being included in a major index like the S&P 500, has been fading quite dramatically for some time and, basically, is non-existent.

The problem is that markets, as Soros has mentioned many times, have these imbedded feedback loops. There is reflexivity imbedded in everything. So, it might not be true that index funds pushed Tesla stock up. But if enough investors believe (and let’s face it, Tesla has a lot of retail investors that will grasp onto any reason to buy the stock) then it becomes true. So, it’s unambiguously true that when Tesla made it into the S&P 500, that was one of the biggest rebalancing trading periods in the S&P 500’s history because they never had an index inclusion of a company that big in market cap.
Broadly speaking the dirty secret (not even dirty, really) is that it was fine; it worked fine. In BlackRock, Vanguard, State Street, everybody else managed to do this without any particular hitch. There was more trading and there was some shuffling around of money but it was kind of in the price by the time it happened. I kind of think that the massive ramp up that we saw in Tesla was because people were overestimating the index inclusion affect and were front running it to a wildly exaggerated degree. If you look at many other companies, there is (certainly in some of the smaller companies), if you make it into the Russell 2000, or you drop out of it, that has an impact.

This is why I always say that look, index funds and passive investing are clearly having an impact on markets. I struggle with proponents of indexing, like me, who deny that. It’s just so big, how can it not affect its own environment? But is that affect any worse than anything else going on? Are hedge funds doing basis trades in Treasuries, that’s affecting the Treasury market, is that evil? Is that terrible? Is that something that we need to outlaw? No, it’s just the markets, and the markets adapt all the time.

I’m fascinated by how many people, that seem to have such a high opinion about markets, seem to think that they cannot adapt to the presence of passive money. Unless we forget, passive money still is more of a minority. There is still vastly more active money out there charging egregious fees. This is an industry that has profit margins greater than Big Tech. So, the idea that we should cry a river for the fate of the investment industry, I struggle with that argument, put it that way.

Niels
Yeah, I think that’s perfectly fair. I want to do, maybe, one more of these issues before moving on to the final segment and you touched on it, yourself, really. In terms of flows, because we now have… It’s still growing but it’s a pretty big force in terms of a type of investor that doesn’t look at value but just looks at what is the flow telling me what to do?

I’ve heard you talk about this, in terms of “the stress test” from last year with the COVID crisis. The challenge for me about it is that I’m not so sure that we’ve really had a stress test yet because as long as the Federal Reserve and other central banks are willing to throw in what they did last year, they prevent the flows and the crisis from being long in time. I think it’s the time element because, certainly, as a market participant for more than 30 years (and we see it in our industry as well with trend following), the challenge becomes when the “crisis” or the move against you becomes long, like we saw in the ten year bear market in equities from 2000 and so on and so forth.

These blips that we’ve had the last few years, 2018, 2020, I’m not sure that people invested in index funds even have enough time to consider, “Oh, should we sell, or should we not?” So, I don’t think that we’ve necessarily had “the stress test” and that’s what concerns me a little bit. I think it could put some real pressure on the markets if we get a prolonged bear market of some sort.

Robin
So, I’m sympathetic to the idea that the central bank put has been a little bit more hyperactive in recent years. It has imbedded a kind of buy the dip mentality in markets. But, I think the idea that the system hasn’t been stress tested is just plain wrong. These aren’t blips. We had a once a century pandemic that created the biggest economic crash in the history of the world – long before we had data. This is Black Death level. We’d have to go back to the Black Death to see something comparable. Then we have a financial crisis that was the biggest and most global financial crisis in history. I’d argue it was bigger and more global than the Great Depression but we just handled it better.

The idea that there’s some sort of counter-factual history where central banks don’t exist, well yeah, all hell would have broken loose. I think that what happens to index funds would have been roughly five thousandth on the list of shit that we worry about. Take March 2020, for example, as a more present day sort of example. If the Fed hadn’t acted and acted quicker and more aggressively than it did in ’07 and ’08, for example, I think they learned that lesson.

Maybe there is a danger that they over learn these lessons and you do need a bit of a cleansing occasionally. But I think that, at that time, we were so worried about having a global health crisis, a global economic crisis, and a global financial crisis all on top of each other at the same time, I’m very glad that central banks decided, “Screw this, we’re doing everything. We’re just chucking money at absolutely anything that moves.”

But, let’s say if central banks hadn’t acted as aggressively as specifically as the Fed in March 2020. Could more issues have arisen in the index fund universe (specifically credit ETFs)?

Definitely.

But the more I’ve passed and done post mortems into the guts and entrails of what happened there, I feel increasingly confident that the massive, gargantuan systemic shit show waiting to happen sooner, before credit ETFs, were bond mutual funds. Traditional bond mutual funds have been around for a century that were perilously close. In countries like Sweden there were swaths of them being frozen. We were very close to essentially large parts in the entire fixed income universe stopping to function. Now, that would have also hurt fixed income ETFs. That would have frozen them even more but you could still have transacted them. You might not like the price you could transact, but that’s in market. The ETFs, the credit ETFs, were the only true free market when it came to credit in March 2020. We could price risk throughout the day.

So, they traded massive gaps down to their net asset value that were stale because there was hardly any trading going on, but the fact that they had that secondary trading valve. It was like a pressure valve that released pressure from them. In bond funds (and this is one of my favorite themes), we’ve seen this occasionally as well with classic 40 mutual funds in the U.S., or USITs, there is an incentive towards bank-like runs. If you manage a bond fund, and you have a redemption, especially in a time of crisis, you can’t sell the high yield stuff, or certainly at a price that you think is attractive. So, you sell what you can, not what you want. That’s usually the higher grade stuff to realize and get some cash in the door and pay X to investors.

That means that the remaining investors are stuck in a vehicle with crapper quality, to put it bluntly. In extreme, and this happened (famously) with one mutual fund in the U.S., they sold all the good stuff. This was a high yield fund that essentially, by the end of it, was a non-rated distress fund in drag with daily liquidity and they had to gate, and it caused problems. Not problems that were systemic but there were people that were worried that it might have caused something like that.

So, the cost of liquidity is born by the remaining investors. So, you have every incentive, if you think a fund is going down or having trouble, to get out the door before the next guy just like with a bank run. You want to get your money out before it collapses.
With ETFs the cost of liquidity is born by the seller. That just strikes me as fundamentally fairer that, yes, some of these ETFs were trading at a 10% discount to net asset value, well, that’s the price of instant liquidity. If you wanted your money in, then you do that. That’s fine. That’s OK. The remaining investors don’t bear that cost. There is, hopefully at some point, some opportunistic money that will think, actually, we think this is being mispriced, that the true price is actually higher, and we’ll take advantage of that. That’s the magic of markets. They’re pretty adaptive.

So, did the Fed bail out credit ETFs? Yes, but they bailed out everything. I think there were many other things that were going to crack under pressure before credit ETFs.

Niels
And, actually, I should have been more precise in my question because I wasn’t actually talking about necessarily ETFs. I think your points are absolutely valid and very solid. I was actually thinking about the whole space and it’s really the mutual funds that I’m concerned about because they have that. But I think you make a great point.

I want to, if I may, I want to transition that passion into the whole thing about quant and the quantitative investment world.

Robin
I love quants.

Niels
Yeah, exactly, that you love.
So, my first question is really pretty broad. The benefits to you, when you think about investing, the benefits that you see of quantitative investment structures or strategies, just very briefly, what are they?

Then I want to ask you what strategies, in the quantitative space, do you like and do you most believe in?

Robin
So, the reason why I like quants is that, (maybe before I wanted to be a war correspondent, I wanted to be a physicist or an aeronautical engineer and I realized I was too dumb to be anything other than a mediocre high school physics teacher, in the end, so I though journalism was a better choice), some of it is just professional in that I think lots of financial journalists cover the big personalities. Quants don’t always have that. For a lot of journalists they get scared of complexity, and certainly even numbers, and that’s sometimes a little bit depressing. I like numbers and I think complexity is kind of fun to unpack. Quite often you realize that the more time you spend with it, it’s actually not that complicated.

So for me, the reason why I think quantitative investing is going to essentially take over the world. This idea of, we’re talking about old school, active, passive buckets, is just going to become increasingly redundant, is that I think we’re moving all toward a rules based investing essentially. A lot of what quants do is stuff that active managers have for decades, generations, centuries even, done is done systematically in a cheaper way. So, it’s more transparent and cheaper.

That’s kind of what an index fund is. An index fund is just a really simple quant fund that has a rule that is buy all the stocks in the S&P 500, essentially, for example. I think it’s the future. I struggle to see any other industry that is not going to be ruled more by technology and rules based approaches in the future. We can see it in every walk of life. So, I think there are corners of finance that are going to be more immune from this but quants are invading private markets as well. They’re invading lots of areas that we thought were completely inaccessible to rules based investing. It’s going to be way harder. For example, I’d be leery of quant strategies in private debt, for example, than a quant strategy in large cap U.S. equities. But that doesn’t mean that might not change in ten, twenty years time. Fundamentally, if you throw a lot of really smart people at a problem they tend to try and manage to find some way of making it better, I think. And that’s kind of what I see in quant.

What strategies I like best? It’s like choosing your favorite child. I love them all equally. So, obviously, I think trend following is interesting. I don’t have to tell you that, Niels, given your background.

For me, look, index funds. They’re the simplest and cheapest. I like that it’s transparent. It’s not as black box as people think in quant finance, and an ETF or an index fund is fundamentally a really simple, cheap quant fund that, if I don’t get an allocation to Medallion or Two Sigma’s top funds, then I’m pretty confident that a broad based, global equity index fund is going to beat the vast majority of discretionary and systematic investors over the next twenty years.

So, yeah, I think my favorite quant strategy is cap weighted market indices.

Niels
Well, that’s a good answer but, of course, as you said I’m highly biased having spent 30 plus years in trend following and managed futures. What I loved about what you said is this thing about rules based. I think what people often misunderstand about the trend following space is that they see it as a very complex strategy and then we try and tell them, actually, it’s not as complex as you think. Then it swings over to the point where people say, “No, it’s so simple that you shouldn’t even pay for it.” It’s kind of, what the hell is going on here?

I want to stay with trend following for my last couple of questions here. What was interesting about my conversation with Steve Foerster, who wrote the book with Andrew Lo about The Perfect Portfolio. He actually at the end, when I asked him, he said, “You know, trend following is pretty close to the Perfect Portfolio because of the massive level of diversification that it offers in terms of markets, in terms of time frames, in terms of being long and short and all of those things. Of course, I work for a firm where we now have a 47 year continuous track record. Not many firms can say that.
What I’ve heard throughout all of my career is that people (and when I say people, obviously, I don’t mean you, but I mean people in the financial press) love to talk about the death of trend following in particular. It really comes up every two or three years like clockwork. Why do you think that is? Do you have any insights from where you sit and look at the quantitative world? Why do people like to say or think that it’s, “Oh because it happened to have not made a lot of money for a couple of years now, it’s never going to work.”

Robin
Well, it’s not a couple of years. So, there are exceptions.

Niels
It depends on who you look at, exactly.

Robin
But the thing is that you can always find an exception to prove the rule whether that trend fund trending is amazing or awful. Broadly speaking, as an industry, trend followers have had a tough decade after having taken a lot of AUM after ’08. So, I think that’s fundamentally it; why the media cares or why people write about it; also investors, investors aren’t dumb, they’ve been kind of ditching this as well because it hasn’t been working.

Niels
They have sure.

Robin
A lot of high profile trend followers, like Wintons, had a very tough decade.

Niels
Because they left trend following.

Robin
Yeah, exactly, well, at the wrong time.

Niels
At the wrong time, exactly.

Robin
I like trend following because I think the idea that essentially the holy grail, certainly for a big institutional investor, is uncorrelated returns. The diversification that you have historically managed to get from trend following has been hugely invaluable. My fear (and I do thing that trend following is going to be around), I think there are two fears: first, that I don’t think that all strategies work forever. I think that markets are pretty smart at adapting and I think there was a lot of money that went into trend following after ’08 and that might, in the short run, might actually make some trends work pretty well, but I think if more people are aware of this it becomes harder to do. Certainly you can’t do a static way that you did 30 years ago. You have to iterate all the time. Secondly, I rather suspect that the reason why trend following became so hot after ’08 is because ’07, ’08 was kind of the picture perfect example for how trend can work but not all crisis are built that way and play out in that way where there were big long trends that trend followers could ride, not lots of short, sharp ones. I think that a lot of the trend followers portfolio ballast or crisis risk offset is, essentially, data mining on the back of one really big example which is the Financial Crisis.

I think we are moving in, or have been for awhile, in a new market regime that I always call sudden shocks. The market booms, the rallies are longer and stronger and more tranquil. They have lower realized vol than ever before. We’ve seen that, certainly, since 2017 or so.

When those booms are interrupted, for whatever reason, they are far more violent for all sorts of reasons like trend following might be adding to it, options, gamma, market liquidity atrophying and so on. I think that kind of environment is going to be really tough on say medium and long term trend followers. There will be different environments that work for different styles.

What I know, if I was running a big pension plan, I’d say I don’t really know (to a high degree of confidence) what kind of environment we’re going to be in for the next 10 years. So, I don’t feel comfortable choosing a particular tenor of trend following that will do well and won’t look terribly and certainly at a cost where I can generally just buy Beta for free, almost. So, I think that’s going to be tough. I definitely don’t think trend following is dead.

We wrote one of the “trend following is dead” articles. Well, I think we had a question mark. It was deliberately provocative because we thought, well if we write this and we ended on a cautious note, partially because we thought a headline like that would be such a classic counter intuitive ring at the bottom. Trend following did do better since then as well. But I don’t think it is ever going to go back to the halcyon days of the ’80s, ’90s and 2000s when this was like a license to print money almost and minted a lot of billionaires.

Niels
Sure, so, I don’t want to make this conversation about that but I will certainly hope that one day I can invite you back and we can thrash out the thing about trend following because I do think you make some very important points. I also think that there is some different aspects to those points, so that would be quite interesting.

It leads into a perfect end to our conversation because I’m going to give you a very difficult task. It seems, after hearing what you just said, because you are an amazing story teller as demonstrated with your book as I’ve heard you speak a few times. So, my final question is what can we do, as trend followers, to tell a better story and narrative about trend following?

Robin
This is comically facile which is better returns. Fundamentally investors, they’ll come out with fantasy stuff like Sharpe ratios and Sortino ratios and all this jazz. All they want is better risk adjusted returns. They can’t eat relative returns. They don’t want to explain and underperforming allocation year, after year, after year to their members or investment committee. So, fundamentally, we can put all sorts of window dressing on it but they just want great returns. Even the risk adjusted, let’s face it, really doesn’t really matter. There are some trend followers that have a few years making 50% a year, that strategy is going to attract massive money regardless.

I think there is one issue and this a broader secular trend that like the risk adjusted, that the attractions of private markets is enormous and also the fact that you can leverage that. So, if somebody could find a conservatively leveraged, but you can plausibly promise an investor an above Beta return, in the long run. Even if it’s just an accounting sleight of hand, like basically the model is in private markets, then I think you’re on to a winner as well. In public markets that’s hard to pull off.

I know a lot of investors are allocating everything private because it looks great, makes their Sharpe ratios look great and also because it can at least promise the hope that they’ll do better than whatever global stocks will do and fixed income over the next 10, 20 years. Some of that is the leverage. A pension plan can’t actually leverage themselves, though some, I think, are probably thinking of doing so. But if they invest in a private equity firm or private debt firm there is embedded leverage there. How you do that in trend following and not get your face ripped off eventually, I don’t know. But that might be a way.

Niels
Well, I think that’s a perfect foundation layer for our next conversation, Robin. I will say, to that (and this we’ll have to think about when we do that at some point) that is, of course, the potential return of inflation and how that impacts trend following. I think that is where the secret might lie and, of course also, central banks ability (let’s say) to steer the markets to some extent. But let’s leave it at that. I think, actually, this was an excellent note and really a fascinating conversation today, Robin. I’m so grateful for you to share your thoughts on the podcast today, and your insights.

It’s been, for me, really interesting to learn the story about passive investing and your book Trillions is a must read, first of all. As you may not know, once a year I update a guide of the best investment books that I could find. There are 200 listed right now and in the new addition your book will definitely be there and I hope to publish that soon.

I want to give you a chance so to share some final thoughts with the audience before we leave the conversation today where they might follow your work which is very interesting.

Robin
Yes, well, thanks for those very kind words. I’m very flattered by that. Maybe on that note I should stress that if there is one thing that I have learned in financial journalism is that people, a million times smarter than I am, do terribly dumb things all the time. The more I learn about finance, the more I realize how little I actually know. So, take everything that I say with a massive fistful of salt. I am just a journalist uttering my vague opinions based on some reporting and all that jazz. Yeah, if you’re actually keen to hear more of my murmurs around the markets then yeah, I work at the Financial Times and I am way too active on Twitter at RobinWig. There aren’t that many Wigglesworths on Twitter, or in Norway, certainly.
It was a pleasure to talk to a fellow Scandinavian though, Niels.

Niels
Yeah, absolutely, it was a fun twist to our conversation for sure.

To all of you listening today, I hope that you were able to take something from today’s conversation onto your own investment journey and if you did, please share these episodes with your friends and colleagues and send us a comment to let us know what topics you want us to bring up in the upcoming conversations with industry leaders in the world of finance and investing. From me, Niels Kaastrup-Larsen, thanks for listening and I look forward to being back with you on the next episode of Top Traders Unplugged. In the meantime, go check out the show notes for this episode and all the other resources that you can find on our website.

Until next time, take care of yourself and take care of each other.