The transcript from this week’s, MiB: Charlie Ellis on Vanguard’s Rules of Investing is below.
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ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, what can I say? Charlie Ellis is a legend in the world of finance, whether it was at Greenwich Associates, or as chair of the Yale endowment, or a board member at Vanguard.
He has seen pretty much everything in the world of investing. His career spans the entire modern era dating back to, you know, the Paul Volcker era, and what took place during the boom periods of the ‘80s and ‘90s, and how technology has changed the world of investing.
He’s just one of these people who is so thoughtful and insightful about everything. It’s just always a pleasure to chat with him. I found our discussion to be absolutely fascinating, and I think you will also.
With no further ado, my conversation with Greenwich Associates’ Charlie Ellis.
The last time we spoke, we really were talking about the retirement crisis, and we spent a little bit of time discussing Vanguard. But this new book is so interesting and so filled with details that only an insider can have. Let’s delve into it a little bit. Tell us what first led you to Vanguard. How did you get involved with them?
CHARLIE ELLIS, FOUNDER AND FORMER MANAGING PARTNER, GREENWICH ASSOCIATES: Well, it started a long time ago, 1966, I was working with a securities firm in New York, and Wellington was a client in Philadelphia. And I would go down to Philadelphia and meet with John Neff, Jack Bogle and the others, and I got convinced that these were very bright and interesting people doing interesting things.
But old Wellington was not really a great and interesting place. It was a balanced portfolio. The assets were going down year by year by year. As people said, you know, it’s just out of date, I’m going to get a performance fund. I’m going to beat the market. These guys will never get out of the slow that they’re in. But still, there was something special about Jack and John. So —
RITHOLTZ: The irony of that is in 1966, hey, we were about to start, you know, a long period of equity underperformance. You would have guessed, had you known that a balanced fund, the stock and bond portfolio was going to do a lot better than just the pure stock funds over the next 16 years.
ELLIS: That’s the way the world works. Just when you least expect it, something goes in a different direction. I’ve really liked the guys. When Jack said he was going to be leaving after the merger made in heaven, with the Boston group, Jack, you really are stretching it.
This is a very unlikely proposition. You’ve got less than 30 people working with you. You’re in charge of the back office activities. That’s an activity you never ever personally enjoyed at all. You always assigned that to somebody else. And he would say to me, don’t worry about it. Jim Reid (ph), he’s going to take responsibility for that.
ELLIS: I don’t have to do it. You’re not allowed to do anything in investment management, and then allow it to do anything in sales. The mutual fund business is all about sales and investing. What are you going to do? And the answer was, I’m going to hang in there and find a way to make this thing work.
RITHOLTZ: And the fascinating story is the argument that he concocted around indexing, first, it’s not investment management because, hey, we’re not making any decisions. We’re just buying all the stocks in the index. And second, there’s no sales. People are going to come to us. So therefore, this is outside of the deal he cut with the folks at Wellington.
ELLIS: Right. And it was just barely enough over a period of several months to convince his board of directors it’s okay to do that.
RITHOLTZ: And he just kind of skated through. They barely approved it.
ELLIS: Very close run. But Jack was a very argumentative, persuasive, always had the facts supporting whatever case like a really good litigating lawyer. He was always able to make his own case very, very, very well.
RITHOLTZ: So let’s talk about that initial fund. The plan was to do an IPO to raise $200 million in new client assets for the funds. How much did they end up actually raising?
ELLIS: This is the first index fund.
RITHOLTZ: The first index fund?
ELLIS: It’s a very interesting story. Going to raise a pretty serious amount of money, it was very hard to get Wall Street to agree to do the underwriting. And then it was really hard to get salespeople in the various cities to say, yeah, I’m going to pitch this to my clients for a very good reason. Everybody knew in those days, the purpose of investment management is to beat the market. Everybody understood that was the game.
So you’re looking for a manager who’s going to beat the market. Everybody talked that way. And here’s a guy coming along, saying, hey, I got a really good idea for you. I’m not going to beat the market. Jack would have argued, well, wait a minute. 75% of the active funds are underperforming what they said they were going to do. If I meet the market, match it, I’m going to beat most of them. I’ll be in the top quartile as a consequence. Yeah, yeah, yeah.
But Jack, you’re going to charge a sales load of 8% on this index fund, so people’s first day are 8% behind the market, how are they ever going to catch up with the market? Don’t let that bother you. We’ll find a way to make it work out.
But that was a killer, and people would look at him and say, straight faced, I’m not going to go to my clients and say, go into this investment opportunity, you’re guaranteed to be behind the market for the rest of the time that you hold on to it.
RITHOLTZ: Now, some of the data that Jack had showed that the active managers, all of whom were high fee, not even counting the fees after a period of time, the vast majority, some 95%, lag the market. And then once you work the fees and after 10 or 15 years, they’re way behind the market. Why did it take so long for that concept to be recognized by investors?
ELLIS: We’re all governed by our beliefs, and beliefs are much more powerful than data. And as we’ve seen in politics, as we’ll see in all kinds of other subject areas, what people believed is what drives them to their behavior and decisions.
Don’t bother me with the facts, is a reality of human beings. So if you’re fact-based, you got to be prepared for people to say, you’re crazy, that doesn’t make any sense. I know what’s right.
RITHOLTZ: And when you look back to the 1970s and ‘80s, you know, we’ve taken for granted how much data is available today, how easy it is for us to access historical returns for various indices versus inflation, versus dividends, versus everything. That technology and that information wasn’t all that readily available 40, 50 years ago.
ELLIS: What do you mean it wasn’t readily available? It wasn’t available, period. I mean, we go back a little bit of personal history. I was privileged to have the responsibility for representing Greenwich Associates consulting with Wall Street firms. The smartest people on Wall Street in terms of picking up an understanding, this is really good information, I can really put it to work.
John Whitehead at Goldman Sachs, who was unbelievably demanding and rigorous as a client, but I loved working for him because he always took everything very, very seriously. And there’s one other person, Mike Bloomberg at Salomon Brothers, and Mike took the information and convert it into decisions on a regular basis.
That put him in a very strong position competitively, but it also proved to him the value of having good hard information. And you can’t deny, anybody can have good hard information and not use it. He was really good at using it. And that’s characteristic of why he’s been so extraordinary and as successful as years and years and years later.
RITHOLTZ: So all of this is really fascinating. What made you 19 books and decide to say, hey, you know, it’s time to tell the inside story of Vanguard, what led you to saying now’s the time?
ELLIS: I was a director of Vanguard. I had worked with Vanguard as a strategy consultant before being a director. And I was deeply convinced that this was for almost any American investor, the right way to do your investing.
And that it was low cost, yup; high value, yup; reliably delivered in a systematic way. And that looking at it as a director, it seemed to me very, very clear that Vanguard was way underestimated by almost everybody. The clients of Vanguard underestimated how good a deal they were really getting.
People who weren’t clients of Vanguard were crazy not to know what the facts were. They can make their own decision, but they should know at least what the facts are. Here’s a better way of being able to get good investment, guidance and information.
And as a director, I said, you know, I think we really are making a big mistake not to make it clear to our own people how good a deal they’re getting. Yeah, yeah, yeah. But, you know, everything about Vanguard as an organization is modesty, and particularly with Jack Brennan, who was very much, Mr. Modesty, and it just didn’t take off.
And then after I left the board, Jack and I were both advisors to a very, very large investment fund, and so it gave me an opportunity to make the pitch to him one more time. And he said, you know, I think you’re right. I think this would be good for investors. I said, but Jack, it’s going to be good for Vanguard too. He said, yeah, but it’s really good for investors. So let’s go ahead.
RITHOLTZ: So I like the concept of Vanguard’s culture as unique in the world of finance, low cost, high integrity. And tell us a little bit about the Vanguard culture.
ELLIS: Well, it starts with one very simple proposition, nobody is making a profit. Every other investment organization got a problem that somebody is taking money out of the pot every day, every month, every year as a profit. That’s the American way. It’s a good incentive.
Yeah, yeah, yeah. But here’s a group who’s highly motivated, they’re doing all kinds of leadership things, and nobody is taking a profit. Everybody who’s an investor in Vanguard is an owner of Vanguard.
The only owners of Vanguard are the investors in Vanguard. So it’s a nice tight little situation where you eat your own cooking and you’re doing what’s really right because it’s what’s really right for everybody.
RITHOLTZ: Really interesting. So given how the world has changed over the past few decades, have you noticed any changes in the culture at Vanguard over that period?
ELLIS: Honestly, no. It’s astonishing. It’s still Boy Scouts and Girl Scouts gathered together every day to do — as they like to say, to do the right thing. And that’s the only metric by which they make a judgement. What’s the right thing to do for our investor clients? Because it’s their shop and we’re here to do the right thing for them.
RITHOLTZ: So when we look around at the world of low cost indexes, they’re all pretty much the same. They’re cheap. They tend to hold almost identical portfolios. What makes the Vanguard version of this so different? How does Vanguard brand itself in what is essentially a commodity product?
ELLIS: It’s really fascinating, essentially, a commodity product. If you have a client, they will understand and appreciate. They get good service, not fabulous service, but good service at low cost, on a very unreliable basis. And there’s a group of people who are working full time to protect them from anything dumb or getting conned. Not bad.
RITHOLTZ: So let’s talk about the enigma that is Jack Bogle. He spent the first 25 years of his career on the active side of the street. It seems like it’s almost a coincidence that Vanguard was even launched. Tell us about that.
ELLIS: A lot of different ways you’d commit to answer your question. First, Jack engineered what was supposed to be the great merger made in heaven, combining old fashioned Wellington with all of the integrity that it might have had in days gone by, heavy sales load, heavy on sales activities, not so good on investing, combined with a hot ticket group in Boston.
And it looked like that would be a winning proposition for everybody. Only problem, culture, personality, way of thinking, way of doing business. Jack always wanted to have complete control of everything. The guy said the Thorndike, Doran, Paine & Lewis Partnership, which is now the core of modern Wellington, believed deeply in a consensus development as friends talking things out, figuring out together what’s the best thing to do, take a long term point of view.
The two cultures did not mix. And Jack insisted on his culture being dominant because that was key to his personality. And that made it worse, not better. And then he insisted more on having it his way, and that made it even worse. And so, finally, they got to the point of saying you have to go.
RITHOLTZ: And essentially, they deposed him. They tossed out the king, eventually winning a vote at a board level where he was removed from Wellington, the investment firm. But Jack had a clever backdoor way around it.
He was still a participant and part of the board, where there were numerous independent directors. And the way the mutual fund industry is set up, the administration of the funds and the management of the investments are two different creatures. So he was able to stay with the admin side. Tell us a little bit about that.
ELLIS: You’ve said such a nice job of summarizing it, there’s almost nothing to say other than you got it exactly right.
RITHOLTZ: Oh, I got a couple of chapters just on that.
ELLIS: Jack Bogle understood that the directors had certain kinds of power that could not be taken away. And they were because of the SEC and the whole concept of regulation of mutual fund industry, representatives of the investors in the mutual funds.
That was a very strong base. And so, legally, the directors were responsible for figuring out what to do about investing, then the directors were responsible for figuring out what to do about sales. That’s legally. That’s not the way it actually worked.
The way it actually worked is the directors did exactly what they were told by the management company, because otherwise they wouldn’t get the very nice fees that they were getting and they wouldn’t have the privilege of coming to the meetings, and so on and so on.
RITHOLTZ: All the directors were buddies of the folks running the investment.
ELLIS: Why else would you choose one?
ELLIS: Obedient directors, friends of the firm, all this sort of stuff, it’s really not a nice part of the history. It’s very different today. But 25, 30 years ago, it was a different world. So Jack had worked out that the directors would have responsibility for making the final decision on things that were important enough so that they had some real gravitas and some real strength. And he had a very close relationship with several of the directors.
And several of the directors had a high regard for Jack as a man of integrity, and so they were very strong in support for him. Guys like Chuck Root for an example. He was the head of TF&C, the actuarial firm, and a really distinguished talent in the Philadelphia business community.
And basically thought that Jack was good guy with strong intentions, and maybe too strong a personality sometimes, but a good guy for the long run, and was clear going to support him. And Jack had similar relationships with people who give him support, just enough so that he could get the vote on his side for things that had to do with administration.
Interesting phenomenon. One of the guys said he was most focused on getting to be sure that he would get the right support, management consultant named Warden who was doing some terrific work for European companies, trying to understand American business after the Second World War, and built up a very nice franchise. He died and if he hadn’t died, the vote might have —
RITHOLTZ: The night before the vote.
ELLIS: If it hadn’t happened that way, vote might have gone the other way, so that close. Jack won by marginal vote, the right to be able to do the administration. What a win. You think about Pyrrhic victories, what a win. Let me just be sure I understand this. I’m Jack Bogle. The one thing I don’t care about at all, have no interest in whatsoever is fund administration.
ELLIS: That’s my sole business. And I’m going to have less than 30 people working with me. And the crowd of funds that I’m managing are basically going downhill because redemptions are larger than new sales. That’s not much to start with, but —
RITHOLTZ: Not at all.
ELLIS: — you’ve got to understand at the start, there’s a magic missing ingredient. Jack’s ability to be ferociously angry and beautifully articulate for any case he ever wanted to make was a major competitive factor. And then a couple of things were lucky breaks, money market funds came out and you could charge 1% on a money market fund, which is a lot to charge for something.
This is plain vanilla on some money market fund. But a money market fund was sure to be a winner compared to the bank CDs that were limited by regulation to 5% interest. Then Paul Volcker was driving the interest rates up to 8%, 10%, 12%, even 14% on money market instruments.
All you had to do as a money market fund manager is buying the standard stuff, Treasury bills, commercial paper and the like. You could put together a portfolio that’s producing a very high income, and the banks that had all the money were limited to that 5.5%.
So then when they float out of the banks into the mutual funds, and Vanguard made itself obvious choice by having slightly lower fees, and then lower fees, and then lower fees as their assets built up. So they had low fees for an identical product. Then you don’t have to be that smart to figure out, hey, wait a minute, these are identical products —
ELLIS: — and one is low cost, why not?
RITHOLTZ: Why not? So let’s also talk about what was then thought of as a fairly radical concept, neutralizing the mutual funds business. Tell us a little bit about that idea, where instead of being profit-driven, the profits would eventually flow back to the owners, the investors in the funds, through lower fees.
ELLIS: Well, you just said beautifully.
RITHOLTZ: Well, you know, I’ve been —
ELLIS: The proposition.
RITHOLTZ: I’ve been educated with this book, so it’s deep in my thought process.
ELLIS: And you know, once you get 2 and 2 is 4, it’s easy to remember and put to work. But the secret here over and over and over again is ferocious drive to not fail, which was Jack, ferocious drive to be recognized as Mr. Wonderful, which was a very important part of Jack Bogle all through his career, but —
RITHOLTZ: Saint Jack.
ELLIS: — to get more and more and more important as he got deeper into Vanguard. Those two phenomena show up over and over and over again.
RITHOLTZ: So given how successful the mutualization was, why didn’t any other asset managers copy the structure? It seems like —
ELLIS: Oh, wait, wait, wait, wait, wait, what’s the American way? I start a business to make a profit. If I do a good job, people will come to my business. I’ll get bigger, I’ll make more profits. So I do a good job, I keep getting more. And it’s a positive cycle. Okay.
What would attract anybody to get into a business where you do a really good job and you break even? You do a really, really good job for years and you breakeven. You do a really, really, really good job for year after year after year for all kinds of people, and you breakeven. You mean you never ever make a profit? That’s right. You never ever make a profit. Well, what’s in it for me?
RITHOLTZ: Well, you —
ELLIS: And that is a stopper for almost everybody who starts a business. If you can’t make a profit, why in the world would you get going?
RITHOLTZ: Well —
ELLIS: It goes back to Adam Smith and all the way through since then.
RITHOLTZ: You do end up achieving a certain size where there are economies of scale, and you pay yourself a very nice salary. Hey, maybe you don’t go public, maybe you don’t sell the firm. But you sleep at night and you know you’re doing the right thing for your clients. There’s got to be some appeal for that.
ELLIS: Now you’re getting to why is the culture at Vanguard so steadily the same and why do people at Vanguard enjoy being where they are? First, they really like doing a good job and doing the right thing in doing a good job. It’s amazing. People really do like being honest. People really do like delivering good value. People really do like doing a great job for other people as customers.
And particularly if you make clear, when you join Vanguard, you’re never going to get rich. It is not going to happen. So if that’s the main item on your agenda, go somewhere else. And there are plenty of places as Wall Street, where they’ll say you want to get rich? Come here.
So if you don’t want to get rich, but you do want to do something you’re proud of every day, with a group of people who are just like you, proud of what they’re doing. Boy Scouts, Girl Scouts, pretty soon you start to say, you know, there’s something to this, maybe being a Jesuit is not all that bad an idea. Then pretty soon, you start finding, hey, wait a minute, this works.
RITHOLTZ: Let’s talk a little bit about not just Jack Bogle, but the era and the team he assembled that was so crucial to Vanguard’s success. Tell us a little bit about how this, you know, 1927 Yankees came together.
ELLIS: Great question. First, Jack was a man with a mission. And if you spent time with him, you could be infected with that sense of mission and purpose. And if that rang the bell for what you wanted to do with your working career, it was almost magic because there wasn’t very much competition from other people doing things in the investment world.
Secondly, this was a man of tremendous conviction about what was going to be the right thing to do. Sometimes that worked very much at the advantage of Vanguard. There were some times when it worked just the other way and it was a real negative, but decisive. Whichever way, it was characteristic of Jack.
As a personality, he could put on the charm in a way in which almost anybody would melt. And then, of course, there were hard-hitting times when he was absolutely determined that everybody was going to do this or that. You were already onboard and you sort of say, well, you take the good with the bad, we can work this one out, so on and so on.
RITHOLTZ: Really interesting. Tell us a little bit about Jack Brennan, the man who succeeded Bogle as the second CEO of Vanguard. He’s really quite a fascinating character.
ELLIS: Well, he had a terrific impact. And if you look at the impact in terms of assets under management, what Bogle did in his time, Brennan did 10 times as much in his time —
ELLIS: — 10 times as much. And he did it by putting together a team of other people, empowering them to be strong and effective of what they were doing. Then it goes back to a couple of different root factors; Boston, Irish, Catholic, training. His dad was told by his guidance counselor in high school, no kid, you’re not going to become a mechanic.
You’re going to go to school because you’re too good and too smart to stop your life right at this, graduating from high school. You’re going to college. And that was a breakthrough.
And Jack’s father became a consequential banker in the Boston area. But he always stayed clear to his basic roots. Jack Brennan grows up as a son of that kind of straightforward guy, and becomes a very, very straightforward guy himself.
The second characteristic is he was a very good athlete, and he was very good at lacrosse in particular. And one day his kids were asking him, well, Dad, were you the highest scorer? He said, that’s not the right question. What do you mean, Dad? They gave him a copy of the Dartmouth Indian, the student newspaper, Brennan 28 assists —
ELLIS: — 8 goals. He said it’s not whether you score, it’s whether your team scores.
ELLIS: And that’s Jack Brennan all the way through. He’s all about bringing the team forward. As he said himself, being famous is not on my agenda.
RITHOLTZ: Right. Right.
ELLIS: And it’s very clear. Most people have never heard of Jack Brennan. He’s probably the most important person in the development of Vanguard as an organization.
RITHOLTZ: That’s quite a statement. I don’t disagree, but I don’t think most people are aware how he professionalized Vanguard, how he brought in a huge team of people. But he also found all sorts of both cost savings and growth that as good as Bogle was, it was just outside of his expertise.
ELLIS: Yeah. And what Jack Bogle always said, I’m a small company guy. And Jack Brennan understood to be the really right Vanguard in the future, you’re going to have to be a big organization. Second, you’re going to have to have a lot of computing power because technology is the secret to keeping costs low, low, low in the long run.
Jack Bogle would say over and over again, computers are too damn expensive. And he was right on the day that you buy them, but if you can only think of them as that moment —
ELLIS: — you’re not going to be able to get a payoff. If you think of them as going on for 5 years or 10 years and going to use them as tools to bring the cost of the operation down, it’s a completely different answer. And so Jack Brennan was absolutely key to the whole idea of using technology, particularly computers, and moving in advancement to that direction.
Second thing is he’s very good at distributing responsibility and hiring in outstanding individuals to do in a quiet way, the things that needed to get done. So shift from one person to a team, and the team has got maybe a dozen key players on it. Then you get something that’s got tremendous capacity to manage a larger and larger organization which Vanguard had to become in order to get the economic power that it has today.
RITHOLTZ: Right, to keep driving costs lower. So Brennan and Bogle were very close. Eventually to Brennan’s dismay, the relationship fell apart. Tell us a little bit about that episode.
ELLIS: Well, easy analogy would be father and son, older guy, younger guy, Mr. Outside Jack Bogle, Mr. Inside Jack Brennan. So long as that was the working relationship, things were great. But Jack Bogle always thought of Vanguard as my company.
And when you have a possessive view like that, you can talk yourself into making serious mistakes. He had agreed with Jim Rabe (ph) way back when that the longest that anybody ought to work at Vanguard would be maybe till 70. So let’s have 70 be our retirement age.
They get closer and closer and closer to it, and Jack Bogle said, well, yeah, but it doesn’t apply to the chairman. It doesn’t apply to me. It can’t be really the right thing in the board of director. He said, no, it really is the right thing. In fact, the company has already gone past your skill set.
ELLIS: And Jack Brennan has got the skill set, and he’s proving it over and over and over again. We want to make that change in a very clear way. I don’t want to make that change. Then Jack Bogle really, really resisted it. Finally, it turned out he was deeply upset about not having made a fortune the way Ned Johnson had made a fortune at Fidelity.
So they gave him a substantial settlement to leave with good behavior and a great opportunity for him to start Bogle Research, which turned out to be a marvelous success for Jack Bogle and for people who are paying attention in that direction, but take him out of the controls position on Vanguard, so it could basically grow in its natural way as a major phenomenon.
RITHOLTZ: So let’s talk a little bit about John Neff, another name that made a huge difference early on, doesn’t really get talked about all that much. Tell us what he did and why he was so pivotal to Vanguard’s success.
ELLIS: People don’t talk about John Neff today. But in the ‘60s and the ‘70s and the ‘80s, people talked about John Neff because he had the best record of any mutual fund manager in the country.
ELLIS: And you could argue that one of the great managers at Capital Group had an even better record, but Capital broke up the funds into multiple different portfolio managers, so it was not public. But among the public recorded, John Neff had the best performance over the long term. Wow.
Does that make a difference when you’re looking at year after year after year after year? With some exceptions sometimes for two or three years, but over any long-term investment, he had the best record of anybody in the investment business.
RITHOLTZ: What about Gus Sauter? He was the first chief investment officer at Vanguard Group, highly regarded. Tell us a little bit about his contributions.
ELLIS: A terrific quant with a great deal of modesty and a wonderful ability to think things through. And Gus Sauter was critical to development of the ETF business, and critical to the development of the indexing business and the capacity to manage with the quantitative group, substantial fractions of the actively managed portfolios because he could replicate what an active manager might do.
And one of his quiet, soft spoken, it’s not about me, it’s about the interesting work that my team is doing; the team builder and just terrific technology understander, who was able to put things together in a way that was really wonderful.
RITHOLTZ: You mentioned how important Jack Brennan was. Let’s talk a little bit about Bill McNabb. He was running Vanguard right in the heart of the financial crisis. He’s the one who basically told all the crew members, hey, nobody is getting fired, just get on the phone, speak to the clients, and don’t worry about your jobs.
We’re all safe. Tell us a bit about his decision-making and how important he was not just during the financial crisis, but, you know, I think Vanguard was about $800 billion pre crisis. And now, it’s 10x. It’s $8 trillion. Tell us a little bit about what Bill McNabb brought to the table.
ELLIS: The secret to Bill McNabb is modesty, competence and discipline. And if you look at how would you understand that, think of him as he was for many, many years, a rower. In crew, there are no fabulous individual performers. It’s all about how the whole group of eight people rose simultaneously to a level of perfection. And if they get it really, really right, perform in a way that you can’t match.
And that’s what Bill McNabb was all about, is disciplined, steady, reliable performance. And aw-shucks personality on the outside, but Mr. Trustworthy on the inside, and everybody knew he was the kind of solid citizen that you would like to have your sister marry, or you’d like to have your mother marry, or you’d like to have your daughter marry, one of those things. He’s just Mr. Good guy.
And while every other firm in the investment business was cutting costs because the market was down and looked like it was going to go down a lot, he said, no, we’re not going to cut costs at all. Nobody is losing their job. We’re all going to stay here together because the number of customers is not going down.
It’s just that the profitability of the business is going down, and we are not a profit-minded organization. We’re a service-minded organization. We’re all about the customers because they are owners, that we’re going to stay right steady on through. And that made a terrific impact internally. But of course, it also meant that they had a wonderfully strong organization coming out of the financial crisis and that was a big help too.
RITHOLTZ: Yeah, perfectly positioned. Tell us about Charlie Root, what was his role as an advisor and a board member.
ELLIS: He was the head of the major actuarial consulting firm in Philadelphia, very disciplined thinker, and an organizationally-minded person, and one of those people that you’d love to have as a director of your corporation. Unfortunately, shortly after some of the most important decisions, he was cleaning out the gutters in his home and the ladder he had climbed up to the gutters on, started to slip a little bit to the side.
ELLIS: And I’m afraid that has caused his death. And it was a real loss to Vanguard and a real loss to the Philadelphia community.
RITHOLTZ: There’s one person I really have to ask about and that’s you. You were a director of Vanguard for over a decade. You were a strategy consultant. Tell us about how you felt your role was and what your contributions were during that era.
ELLIS: In all fairness, I have to feel —
RITHOLTZ: Look at you, you’re blushing. I can’t believe this.
ELLIS: I really enjoyed being a director. We didn’t get paid very much. I have to admit the food that we were served at meals was really pretty crummy. But it was all part of the keep the cost down, keep the cost down attitude.
Management was so candid and so open with us as directors. It was a privilege to be working with them. And it didn’t hurt that I was sitting side by side with Burt Malkiel, who is one of those outstanding people in the investments world. And Burt has just turned 90.
ELLIS: And his great book, A Random Walk Down Wall Street, has just come out with a new, very considerably updated version. And to sit with him and to realize, on item after item after item, Burton and I agreed, Burton and I agreed, Burton and I agreed.
So it was a wonderful privilege and opportunity to be able to be candid, direct, blunt spoken, and to have a really capable guy sitting right beside you, I think you’re on the right track, keep going, keep going. And to have a management team that was so glad to hear what we had to say, even when it might be really in disagreement with them or might be slightly in disagreement with them, they’d love to having the candor coming from the outside.
RITHOLTZ: Let’s talk a little bit about the current state of Vanguard. But I have to preface it with Jack Bogle’s CMH, not EMH, not the efficient market hypothesis, but the costs matter hypothesis, which really dates back to his Princeton thesis. It wasn’t so much about active versus passive, it was about expensive versus inexpensive. Tell us a little bit about how that impacted the development at Vanguard.
ELLIS: First, you got to understand that Jack Bogle was a master of the personality franchise development business. When nobody else gave a damn about becoming clearly identified in a very specific way, Jack cared greatly about that. And it goes back to when he likes to tell the story on himself, at least did tell the story on himself whether he likes it or not.
When he was in school, he came in second in his academic performance. And he went around to each one of his teachers, pleading with them to really examine and modify his grade so he could come in first. He wanted to be the valedictorian, not the salutatorian.
Now, why would he care so much about that? It is not the be all and end all of the world. It’s because of his personality. Something deep inside him drove him to always enhance things, make things look better, make things look better, make things look better. And so all the way through the story of Vanguard, you’ll find Jack Bogle doing things or saying things to make the record look much more positive about what he contributed than the reality.
And one of the awkwardness is the franchise building was done so beautifully, so consistently, so skillfully by a master of that craft, that it’s still 20 years later, 30 years later, carries on. And most people if you ask them, when you think of Vanguard, who do you think of?
Bang, they’ve got it. Well, Jack Bogle was terribly important to the starting. Nobody could have started the organization without being Jack Bogle, partly angry, partly talent, partly skills of various particular characteristics, one of which was building the personal franchise.
Nobody could have started Vanguard. But if Jack Bogle had stayed in control, it would never have become the organization it is today. It would be substantially smaller. It would be deeply outclassed by people who use automation to make their offering a better and more effective proposition. And we wouldn’t see the Vanguard that’s been developed since then.
RITHOLTZ: So let’s talk a little bit about that Vanguard, very huge in ETFs, big overseas investing, lots of other things that Vanguard and Bogle didn’t see eye to eye about. How often did the company disagree with its founder?
ELLIS: Interesting question, and I’m not sure I could do it in terms of numerical quantitative. But if you look back the concepts that Jack Bogle really believed in, computers, he thought were terribly expensive. That would have been a stopper today.
RITHOLTZ: Real, for sure.
ELLIS: He couldn’t do it.
RITHOLTZ: Right. He really believed in he’s making the decisions. It’s too complicated of a business. There are too many things going on. There are too many different responsibilities for one person to do all of the decision-making.
If you look at Vanguard today, you’re looking at a substantial organization that’s going through a substantial transformation towards becoming more of an effective organization, at serving clients’ interests, and doing a better and better job for the people who are already the investor-owners of Vanguard.
So they are not making a major commitment internationally. They are not spending a lot of money to build a future business. In other countries, they’re looking for places where the resistance by the banking establishment or the financial establishment in those different countries is more open to non-local competition. But it’s hard to find, very hard to find. They’ve made some changes that we’re keeping up with the times.
They’ve got a substantial institutional business. If you’re in the investment business as an institution, you really want to know something about private equity. If Vanguard doesn’t have private equity, that’s going to take them out of the running.
So they’ve developed a really interesting joint venture, where they’re able to get access to a very competent private equity investment organization at a very controlled cost. They’re not aiming to be the very best, but second quartile of performance on a reliable basis, with broadly diversified capability. Okay, that will work very nicely.
They’re doing the same sort of a change in going towards more and more advice. And anybody who has been in the investment management business, as you have been, looking back on things, you can tell almost everybody would be well-advised to have been more a long-term investor, make fewer choices and decisions, figure out what’s really right for you. And at the same time, you’d recognize that every individual is unique. Nobody is exactly the same.
Now, if you look at personality, for example, your eyeglasses, I wear eyeglasses; your shoe size, my shoe size; your shirt sizes, color, size, sleeve length. Pretty soon you realize Barry’s clothes are different from mine because Barry is different from me. And he ought to wear the clothes that are right for him, and I want to wear the clothes that are more right for me. I might get advice from my wife or something on what to wear, but we’re two different guys.
RITHOLTZ: We’re actually dressed shockingly similarly with our collared shirts and a blue sweater on top. But doesn’t that kind of raise the point of, well, everybody is different. But everybody needs to save for retirement to pay for their kids’ college, to leave something to the next generation. It shouldn’t vary radically. The broad strokes should all be fairly similar, shouldn’t they?
ELLIS: In terms of the macro proposition, you’re exactly right. But everybody is different from everybody else in age, income, wealth, attitude towards life, how many years you want to keep working, things like risk tolerance.
ELLIS: Everybody differs. So it turns out that almost everybody is specifically individually themselves different from somebody else, specifically individually themselves. And as a result, advice to individuals is increasingly obviously a useful part of the total investment proposition. And Vanguard is moving in that direction, and capable probably of more power in a direction that anybody would ever understand or estimate.
RITHOLTZ: I read a crazy statistic somewhere, I don’t recall if it was in the book or elsewhere, in the state of Pennsylvania, the certified financial planners, something like 96% of them in the state work for Vanguard. That’s just a crazy number as they’ve pushed into the advisory business and hiring all of these CFPs.
ELLIS: They’ve made a major commitment to serving the investor with what they really need. And most people really ought to have a good investment plan, but they don’t. Most people ought to have a clear definition of their long-term purpose as investors, other than I want to do better than the market, or I want to do at least as well as the market, or I want to do well or something vague and general like that. Very hard to get people to be very specific about what do they really, really want to do and why.
And if you’ve got a good advisor, you can do a lot to improve on your results by figuring out together, what makes sense to you that’s available in the marketplace, and making the right decisions of what’s available and realistic as opposed to dreams that may or may not come true.
RITHOLTZ: So let’s talk about two areas that are a little controversial. One is the thought that as indexing became more and more appealing and attracted more and more assets, Jack Bogle was a little concerned about oligopoly, about potential any trust issues. At what size is passive or indexing too large?
ELLIS: I think it’s a wonderful question. But if you don’t mind, I’m going to say it’s the wrong question.
ELLIS: The right question is when will active investors say to themselves, as the professionals, the people who are making their living as active investors, say to themselves, I think I’m going to get a different career? I think I’m going to leave this business and go in a different direction.
At what age will they say to their children, look, it was okay for me in my time, but it’s not a good place for you. Don’t do it, don’t do it. At what point are you going to see fewer people taking courses on investment management at business schools? We’re nowhere near that.
ELLIS: We’re putting more people through the learning process of how to be pretty damn good as an analyst through business school courses, and then out into the industry that are coming out of the industry through retirement. And that’s where the market is really controlled for market efficiency, or correct pricing. There’s really smart people.
If you go back 50 years ago, there were a small number of people who made their living as analysts, and a small number of people made their living as portfolio managers, maybe as many as 500 people in the world. And today, it’s somewhere between one and a half and 2 million people.
ELLIS: That’s a big change, and there have been lots of other changes. The one that I think is the most powerful, here we are at Bloomberg Radio, think about how many people own a terminal, a Bloomberg terminal that will give you any answer to any question you ever want to ask for the rest of your life within seconds.
RITHOLTZ: It’s all data and technology.
ELLIS: It’s all over the place. Everybody has computing power in their pocket that is much as a 360, which was IBM’s magical power force 50 years ago. And everybody has access to the Internet and it’s instantaneous communication worldwide.
And thank goodness, we speak the English language because that’s the language of investing worldwide. But it means that there’s a huge transformation that’s taking place, and it has made the markets more and more skillful at finding the right price.
But makes it harder for active managers. And as you and I’ve talked about before, active managers underperform the chosen segment of the market they went after. And now, we’re somewhere between 85% and 90% of active managers fall short of their intention. And when they fall short, they often get desperate and fall very short by Hail Mary passes and other kinds of dramatic efforts.
RITHOLTZ: The paradox of skill is the better the professionals get; it becomes increasingly harder to even beat the market. So that’s quite fascinating. One other question that’s a little controversial, we’ve seen some pushback to ESG, environmental, social, governance investing and the voting of proxies. How does an entity like Vanguard manage these issues on behalf of their huge 30 million clients and their $8 trillion in assets?
ELLIS: Very simple. They do what you would like to. If you were a corporate executive, what would you like to have your shareholders do? Pay attention to the votes, be quite consistent about always voting. And as you know, most people don’t vote at all. And then many institutional investors say, it’s not our decision to make because we’re on behalf of others.
So your very best client, if you’re a corporate executive, best shareholder is to be somebody who is in it for the long run. And if you’re a Vanguard and indexing, you’re in it permanently for the long, long, long run, cares about certain basic principles and they do, and they advertise what those principles are.
For example, they believe that a board of directors should have an incentive in the company stock. They’re very strong to have diversification of personality and background. Okay, fine. Those are pretty much straightforward things. Nobody would have any trouble with that. Yeah.
And they’re very much in favor of certain kinds of incentives, but not others. And most people look at and say, yeah, those are the right things to be in favor of. So it’s one after another after another items where Vanguard and State Street, and BlackRock are all three in agreement, basically, that good governance is an important characteristic of a board of directors, and they really want to see that going.
What is it that you wouldn’t like about the way in which the voting is done? It’s a terrifically powerful answer. What wouldn’t you like? And there is nothing that you wouldn’t like. Now, is it possible that a group could quietly somehow skillfully get together and agree, let’s do something that’s really not going to be right for our investors?
Yeah, you could say mechanically, it’s possible. But there’s Canada for an example, it’s a country right next to one of the most powerful military organization, nations in the world. Are the Canadians afraid the Americans are going to attack again? Of course not. In fact, we cooperate in our activities.
ELLIS: Yeah. Okay. What would happen if somebody at any one of the indexing leaders were to do something that was not quite Boy Scout/Girl Scout right down the line? They get called out. I think they’d called out. Would it be the newspapers?
Yes. Would it be on Bloomberg Radio? Yes. Would you have an interview with somebody who had called them out? Yes. One of those perfectly marvelous situations where you’re forced to do what you damn well want to do.
RITHOLTZ: State Street, Vanguard, BlackRock, they all have pretty good businesses. Why would you want to mess with that? Really, really fascinating stuff, Charlie. Let’s jump to some of our favorite questions that we ask all of our guests. And I want to start with the last time I saw you was before the pandemic, what have you been doing during the pandemic? And tell us what what’s been keeping you entertained.
ELLIS: Well, part of the entertainment value is that our children, our daughter and her husband and their two kids under 5 have moved into our house. So we’ve had the privilege of watching little kids again, and I have to tell you that is a dream come true. It’s a lot of fun.
Second thing is we have an agreement in our family that we’re worried about the children and COVID. So we don’t do very much at all in the way of travel. And I used to be five days a week get on a train into Manhattan —
ELLIS: — as a way of doing business. I’ve been in New York City three times in three years.
ELLIS: It’s really something else. And so I’m delighted to be here today. But in our family, I have to drive in, and then turn around and drive back. Then as you know, the traffic is not all that convenient, and so on and so on. But things like that have been distractions.
I’ve enjoyed the privilege — Zoom has made a wonderful difference to my life and I’m sure to most other people, the freedom to be able to do repeat messages and communication in a serious way through Zoom. It’s really been terrific.
The third thing is I’ve got a real bee in my bonnet that I want to be able to try to be helpful to people. And so doing investment advice is just as easy for me, located where I am. Once you make the communication contact, it works out fine. And I’ve really enjoyed being able to provide some useful investment advice to individuals as we’re going along.
And then the third thing is I’ve been quite active in writing. I’ve written for the Financial Times several different pieces and I’ve written a couple of different books. I’ve got three books in the process of coming out. So have I been busy? Yeah, I’ve been busy.
RITHOLTZ: So one of the things I always like to ask people is about their mentors who helped shape your career.
ELLIS: Well, the most important person probably is Nellie Walsh, my sixth grade school teacher, who called me on the carpet one day and I was terribly surprised because I thought I was doing just the right thing. And she said, you were wrestling with Peter Neely, weren’t you? Well, I was.
But that’s because of I couldn’t get him to stop throwing the snowballs with cinders in with the little kids, and he was picking on the little kids and I didn’t think that was fair. And she said, Charles, she never called me Charlie, always Charles, I think more of you, I expect more of you that you would lower yourself to the likes of Peter Neely. You may go.
And ever since then, I’ve been held to a higher account, higher standard, higher expectation in every way to be responsive to Nellie Walsh. And more serious, people in the investment world, Joe Lasser, who was the director of Research at Wertheim, a traditional Wall Street firm. He believed deeply in security analysis, and was a very strong advocate of the CFA program. And so he got me in a training group to take the CFA exam as soon as we could. That was an important breakaway time.
Another would be Coyler Crum who was a terrific professor of Investment Management at Harvard Business School. I enjoyed very much working with him. You could argue also, Ben Graham and David Dodd because of their wonderful book, Security Analysis, which was the first affirmation of professionalism in the financial analysis and securities pricing industry. And it really made a big difference to me.
One of the great privileges of my life was to work, when I was working in Wall Street, and then working for Greenwich Associates for 30 years, working all day, every day with some of the smartest, most capable people in the world. And they were all involved in investment management.
And if any one of them competed, all the others competed, and they all wanted to try to find ways to be better. And they’re all willing to tell you any insights that they had. And they’re all willing to provide a chorus of teachers and guidance in terms of what’s going on in investment management.
And for me, that’s really the most important single place for learning that I had, and what a privilege all day, every day, is to be with the smartest people in the room, who are trying to figure out investment management.
Then when you add it all together, you realize they’re competing with themselves. And they’re not going to be able to beat each other on a systematic and regular basis, voice that make a big difference to your way of thinking.
RITHOLTZ: So you mentioned Graham and Dodd, and their books on Security Analysis. Tell us some of your other favorites and what else you’ve been reading more recently.
ELLIS: Well, more recently, I have to tell you, I haven’t found a book on investment management that I thought was really compelling. You could argue, no, come on, there is a very recent book. That’s the new edition of an established book, Burton Malkiel’s A Random Walk Down Wall Street.
It’s got to be one of the best books that’s ever been written about investment management, and about the markets and how to think about them. A wonderful guy and a wonderful book, and has done so much for so many people.
Then if you look at other books that I would like to read, then you tend towards history, biography. and I’m always looking for suggestions of more books to read in that general field because I think you’ll learn so much about the way human beings do things, if you study about them, study about them, and study about them. And so I’m a nut for trying to learn from others.
RITHOLTZ: I like the suggestions. What sort of advice would you give to a recent college graduate who is thinking about a career in investment management?
ELLIS: Here I have a very strong opinion that you should think very candidly about why you’re interested. We all know for an example, that it’s a very well paid line of work. Most people don’t really appreciate how well paid it is, but it is wonderfully well paid.
Secondly, you don’t have to retire at 65. In fact, many people work into their 70s. Many people even work into their 80s. At 85, I’m still working. I have just very wonderful privilege of not having to stop work at some arbitrary date like 65 or 60.
Now, that’s a characteristic. When you look at the lifetime compensation of being in the markets all the time and free to pick anytime you want to, to pick a stock individually, that can be for some people, a very attractive characteristic.
So if you like to make some substantial financial success, that’s one reason. If that’s your motivation, I think you’re in trouble. Because, yes, of course, you will make a substantial amount of income. But it’s not the most important part of your life.
When you get to the end of life and you’re off standing in front of St. Peter at the pearly gates, and he said, well, you had your life, you were very lucky to be born at all. But there you were, and you chose the investment management world. What did you really do during that that you’re proud of? I made a lot of money. That’s not a good answer to a really great question.
So be sure that if you’re going into the investment management field, that you know, is it because you want to make a lot of money, or is it because you like the idea of competing all the time with some of the smartest, most hardworking people in the world, which could be a terrific motivator and you could understand, or is it because you want to serve people and help them with what they’re trying to figure out about what they want to accomplish?
If you’re the latter group, then you’re going to be in a profession and you will also get paid well, but your compensation will come primarily from being good as a profession. That lasts a lifetime. But you have to be clear about what is your motivation.
RITHOLTZ: Really, really very interesting. And our final question, what do you know about the world of finance and investing in Wall Street today that you wish you knew 50 or so years ago?
ELLIS: Well, you know, it’s pretty obvious in a way, I wish I’ve understood how much change was going to take place in the investment management activity and field. Computers for an example, when I first got started, there were no computers being used —
ELLIS: — or maybe in the back office, but they were clunky kinds of operations. And the idea that there would be the transformation of information worldwide is available to you instantaneously through Mike Bloomberg’s wonderful invention, the terminal, that the Bloomberg Terminal has transformed the world of information gathering.
The Internet has transformed the world of information gathering. And as a consequence, the world of investing is now worldwide. And everybody in the world is competing with everybody else in the world in the investment management fields.
So I wish I’ve understood how dramatic a change there would be, because it would make a big difference. If you understood that, you’d have the forces of change working for you and you could have made a completely different transformation of life.
RITHOLTZ: Quite fascinating. Charlie, thank you for being so generous with your time. We have been speaking with Charlie Ellis, author of the new book Inside Vanguard: Leadership Secrets From the Company That Continues to Rewrite the Rules of the Investing Business.
If you enjoy this conversation, be sure and check out any of the previous 475 podcasts we’ve done over the past eight years. You can find those at iTunes, Spotify, YouTube, wherever you get your favorite podcasts from. Be sure and sign up for my daily reading list at ritholtz.com. Follow me on Twitter @ritholtz. You can follow all of the Bloomberg podcasts at podcasts on Twitter.
I would be remiss if I did not thank the crack team that helps put these conversations together each week. Justin Milner is my audio engineer. Atika Valbrun is my project manager. Paris Wald is my producer. Sean Russo is my head of Research.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.