Forty years ago, a new investment firm started offering a type of stock mutual fund that most people thought was crazy: an index fund. Today, that firm, Vanguard Group, is the largest fund company in the world, with $3.6 trillion in assets.
The idea of an index fund seemed a bit of a joke at first. Indiscriminately buying hundreds of stocks, then accepting whatever return the market provided?
Aside from being impractical to build in the infancy of computers, an index fund was an insult to investors who prided themselves on picking the best stocks out of thousands. It sounded pretty cool to economics professors and a few of their financial geek students. Almost everyone else “thought we were crazy,” Oldrich Vasicek, a mathematician who worked on one of the first index products, once recalled in an interview.
“They said, ‘You want to buy all the dogs. … You just want to buy whatever garbage happens to be traded?’”
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In 1960, two University of Chicago graduate students published an article in Financial Analysts Journal calling for an “unmanaged investment company.” “Investment companies as a whole have not outperformed representative stock averages,” Edward Renshaw and Paul Feldstein wrote, so why not offer a portfolio that automatically buys every stock in the Dow Jones industrial average or some other index?
Easier said than done. It wasn’t until the early 1970s that Vasicek and others at Wells Fargo tried using computers to build index portfolios for pensions. And it wasn’t until Aug. 31, 1976 — 40 years ago last week — that a new firm started offering an index mutual fund, one that anyone could invest in.
Today, that firm, Vanguard Group, is the largest fund company in the world, with $3.6 trillion in assets. Buying an index fund is now the conventional wisdom.
But back in 1976, an investment firm executive wrote that all but “a very small minority” believe “index funds are a ‘cop-out’ and a fad that will soon disappear.” Indexing’s biggest fans in the 1970s were mostly on campus.
The problem was that no mutual fund existed that offered the general public index-fund investing. And Wall Street firms had no incentive to create a product that would bleed away their profits.
Luckily for the future of indexing, at the beginning of 1974, Wellington Management fired its chairman and chief executive officer, John Bogle. Bogle went on to found Vanguard Group and, a year later, convinced Vanguard’s board to launch the First Index Investment Trust, a mutual fund designed to match the performance of the Standard & Poor’s 500-stock index. Fortune called index funds “an idea whose time is coming,” bolstering Bogle’s optimism that Vanguard could raise as much as $150 million in an offering for the new fund.
The early years were underwhelming. Then it started living up to the theory, beating three-quarters of competing mutual funds during the rest of the 1980s. Vanguard kept lowering its fees and putting out new index funds to capture the returns for small stocks, the total U.S. stock market, international stocks and the bond market.
By 1995, Vanguard could declare “the triumph of indexing.”
Four decades ago, a financial research firm, Leuthold Group, distributed a poster to clients on Wall Street. “Help Stamp Out Index Funds,” it declared, over an image of Uncle Sam. “INDEX FUNDS ARE UNAMERICAN!” Employees of the firm later said it was a joke. Last week, Sanford C. Bernstein & Co. argued that index funds interfere with the most productive allocation of capital. The firm warned that passive investing is “worse than Marxism.”
It’s still easy to criticize index funds. It’s just harder to laugh at them.