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Robin Wigglesworth: The Rise of Index Investing and the 'Renegades' Who Ushered It In

The Financial Times’ correspondent discusses his new book on the history of index funds and the remarkable people who brought indexing into the mainstream.

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Our guest this week is Robin Wigglesworth. Robin is the Financial Times' global finance correspondent based in Oslo, Norway. He covers investing in markets with a focus on technological disruption and quantitative investing. He joined the FT as a Gulf correspondent in June 2008. Before that, he was a Nordic economics and politics correspondent for Bloomberg News. Robin is a graduate of City, University of London and received his master's in history of international relations from the London School of Economics and Political Science. Robin is here to discuss his new book, Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever.

Background

Bio

Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever

History of Indexing

Louis Bachelier: An Underappreciated Revolutionary,” historyofdatascience.com, June 3, 2021.

Paul Samuelson

Efficient Market Hypothesis

Rex Sinquefield

Dean LeBaron

Mac McQuown

Jack Bogle

John Brennan

Dimensional Fund Advisors

Dan Wheeler

Larry Fink

Eugene Fama

Harry Markowitz

Bill Sharpe

Baby Bells

Technology

Cowles Foundation for Research in Economics

Can Stock Market Forecasters Forecast?” by Alfred Cowles, yale.edu, 1933.

The Beginning of ETFs

Passive Attack: The Story of a Wall Street Revolution,” by Robin Wigglesworth, FT.com, Dec. 19, 2018.

All That Drama About Fixed-Income ETFs Was Overplayed,” by Robin Wigglesworth, FT.com, April 21, 2020.

Nate Most

Transcript

Jeff Ptak: Hi, and welcome to The Long View. I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Christine Benz: And I'm Christine Benz, director of personal finance and retirement planning for Morningstar.

Ptak: Our guest this week is Robin Wigglesworth. Robin is the Financial Times' global finance correspondent based in Oslo, Norway. He covers investing in markets with a focus on technological disruption and quantitative investing. He joined the FT as a Gulf correspondent in June 2008. Before that, he was a Nordic economics and politics correspondent for Bloomberg News. Robin is a graduate of City University London and received his master's in history of international relations from the London School of Economics and Political Science. Robin is here to discuss his new book Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever.

Robin, welcome to The Long View.

Robin Wigglesworth: Thanks for having me on.

Ptak: It's our pleasure. So, we're excited to talk about your book, which is called Trillions: How a Band of Wall Street Renegades Invented the Index Fund and Changed Finance Forever. You said you wanted to write something that would help readers appreciate the rise of index funds and understand their context in the broader history of investing. What made now the time to tell that story?

Wigglesworth: Well, I can tell you that writing a book under a pandemic was not optimal at all. But writing the book now found it's even more important because we can just see the size of this thing growing. And Paul Singer, the hedge fund manager, once called it a blob that's devouring capitalism. And I think that's a little bit over the top. But we are talking now, depending on how you slice it, $15 trillion to $17 trillion in index funds globally. And if you include various internally managed index strategies--big pension plans and sovereign wealth funds--then I calculate, we're probably looking at well north of $26 trillion. So, this is just a huge force that's kind of rewiring markets in many ways. We're only starting to understand now. And I just wanted to tell that story and especially, the people that invented this, because it's just a really fascinating story of technological innovation and subsequent disruption.

Benz: You recount indexing's history very much through the story's principal characters, and that makes the story a lot more interesting and relatable. But it also invites the question of whether indexing would have seen the rise it has seen without these particular people having advanced it. Would it have?

Wigglesworth: I think it's a great question. Some things maybe are just down to the people and the time. But I think fundamentally, this is just a fantastic idea. And at some point, somebody would have done it. In many ways, it's almost surprising that somebody didn't start some sort of an index fund or a market portfolio, as it was initially called in academia, a long time before one actually emerged. Bill Faust, who was working at a bank in Pittsburgh, he suggested that in the late ‘60s, but his bosses basically threw him out of the office. There was an academic called Renshaw that wrote a paper suggesting this and saying this would be a pretty good, simple product to offer people, and he got laughed out. So, I think the idea was floating around for quite a while, and maybe you needed somebody who was both steeped in the academic knowledge, but also, worked on the practical sides of finance to do it. But I think, in another twist of history, maybe the characters would have been different, but the idea was still solid enough that it would have won through eventually anyway.

Ptak: In the book, you trace the history of indexing to 19th-century French mathematician Louis Bachelier, if I say that correctly. His theory of speculation held that securities moved in unpredictable ways, but he was largely ignored in his day, and he really wasn't on the map until Nobel Prize-winning economist Paul Samuelson started championing his work in the 1950s. Why do you think it took so long for researchers to coalesce around the idea that seems kind of obvious, with the benefit of hindsight, namely, that markets are efficient?

Wigglesworth: Well, I think it boils down to data. It sounds crazy for us today. But people forget that in the 1950s, people literally didn't know what the long-term returns of stocks were. We didn't know what equities did in the long run in the U.S. and certainly not abroad. So, you had some indexes that had been around like the Dow Jones Industrial Average for close to a century by then. But it had all sorts of technical issues with it. It's a price-weighted rather than market cap-weighted index. It only captured 30 stocks and mostly industrial stocks. So, a lot of this data just didn't exist. Or if it did exist, it existed in old, rumpled newspapers, archives. So, you didn't have the numbers to prove some of this. You could have a theory--people had talked about, even in the 1800s, there were some British stockbrokers that remarked at how markets seemed kind of random but continually priced in new information as it filtered into the coffee houses of the City of London. But nobody turned it into an actual theory for how markets function until you had the data to back it up.

And even today, efficient markets is a pretty controversial theory. It's roundly dunked on because we can see craziness all the time all around us. But for me, the efficient markets theory and why it's still a really great shorthand for how markets function is, it boils down to what a British statistician called George Box once said that, “All models are wrong, but some are useful.” And efficient markets hypothesis might not be perfectly right. It clashes with our understanding of what the word “efficient” means. But it is a good model for how markets function, and that they continually bake in new information constantly--also misinformation--and also why they're so hard to beat in the long run.

Benz: You devote a passage of the book to profiling a group of important early proselytizers for indexing, who you call the quantifiers. Can you talk about who they were and the role they played in as you put it, breaching the financial industry's immune system to spread radical ideas like indexing?

Wigglesworth: Yes, it was very radical at the time. It wasn't just seen as eating up markets as it is today. It was just seen as lazy at best, giving up. So, there were three characters, I think, were the original pioneers. So, it's John McLeod, who worked at Wells Fargo; Rex Sinquefield, who worked at the American National Bank of Chicago; and Dean LeBaron, at Batterymarch in Boston. And I think it's no coincidence that these three people, although very different, were all very determined people, and in many respects, thrived on being outsiders. And not only that, they didn't work at the top-tier Wall Street institutions. Wells Fargo, at the time was a third-tier regional bank of little renown outside San Francisco and California; American National Bank of Chicago wasn’t even the biggest bank in Chicago, didn't have the biggest trust department; Batterymarch was basically a small startup that was trying to do financial engineering at the time when people hadn't really yet coined that expression even.

So, I think they were the ones that were able to transmit the ideas that were permeating through academia, and by the late ‘60s were well known, and were able to implement them. And you needed to be wildly stubborn to do this, because clearly, a lot of people in the finance industry hated a product that was at its core cheap and simple given that this is an industry that quite often thrives on complexity and cost.

Ptak: There are some very familiar names in this story. Markowitz, Fama, Bogle, Fink, to name a few. Then there are others who played pivotal roles but haven't necessarily entered the financial Zeitgeist in the same way. Which key figure do you think will be the biggest revelation to readers of the book?

Wigglesworth: This was one of my favorite things of researching the book, in that, I think most of us know all these names like Jack Bogle, obviously, titanic figure and all that. But I love finding out the people that played pivotal roles behind the shadows. Thomas Carlyle famously said that the history of mankind is the biography of great men, and obviously, at a time when there were just great men that we're talking about. And it's kind of a tempting mental model for us. Even today, Hollywood does this. Batman doesn't have Robin anymore in modern-day Batman incarnations. But the reality is that, even the most titanic people who are great--this isn't to detract from their greatness and what they did--wouldn't have been able to do so without the help of other people.

For every Napoleon, there was a general Jean Lannes or marshals that did the actual war-winning and empire-building. And in the history of indexing, there are lots of people who, I wouldn't say have been scrubbed out of history but might be unfairly forgotten. At Wells Fargo, Mac McQuown was a force of nature. But could he have done it without the help of people like Larry Cuneo, Wayne Wagner, Bill Faust, Jim Vertin? At Vanguard, Jack Bogle was the man. But I think Vanguard would have quite possibly failed or at the very least not been the institution it is today without people like Jim Riepe or Jan Twardowski, who matched the first incarnation of the Vanguard 500 Fund. Later Jack Brennan built Vanguard into what we know today. DFA--there were three cofounders of dimensional fund advisors. But they probably wouldn't have survived the early years without Larry Klotz and his salesmanship. He was the guy that basically started and won one of the first clients before getting ousted by Booth and Sinquefield. And more present day, BlackRock, Larry Fink is the modern-day king of Wall Street. But quite a lot of people that know him say that as much as they respect Larry, he probably wouldn't have been able to build BlackRock into what it is today without the help of Rob Caputo, his aggressive, not always popular, right-hand man. So, I think that's important to remember that we sometimes like to elevate certain people above everybody else, but we need to recognize that quite often there are teams and systems that allow great events to unfold.

Benz: Another thing that's striking in the book is the role that serendipity played in some of the most pivotal events to take place in indexing. For instance, David Booth might have ended up teaching economics at Kansas University had one of his professors not introduced him to Gene Fama's theories, which led him to pursue a Ph.D. at the University of Chicago and eventually to launch DFA. So, what's another example of a fortuitous pairing or confluence of events that set indexing on the trail that it eventually blazed?

Wigglesworth: Well, there's so many sliding-door moments in the history of indexing. The one that I always return to is Mac McQuown, who was working at a brokerage as an investment banker on Wall Street. But he loved computers and he'd fallen in love with computers at a time when that was seen--and it was even seen as geeky on Wall Street--it was just seen as preposterous. You didn't have engineers, computer scientists in those days. But he moonlighted for a professor he'd be working on as digging out stock market data to see if stock markets can be predicted. And they used this big, massive IBM mainframe in the Time Life building in New York. And they weren't able to find anything. It was essentially a complete waste of money and time. But the local IBM manager of that facility was so interested in that they were trying to use computers in financial services. And this was a time when IBM was trying to get clients outside of some poor accounting firms and the government.

So, they paid for Mac to fly to San Francisco--or to San Diego to give a speech about what he was doing. They didn't really care what it was. They just liked that he was a dude in finance; he was using a computer. But in that audience, by complete chance was Ransom Cook, the chairman of Wells Fargo, and he got so taken by Mac that he offered him basically a job the next day. And what if that hadn't happened. The entire Wells Fargo walk is fascinating because Wells Fargo later became Barclays Global Investors that is now core, basically part of BlackRock. And Mac was the guy that hired the first academics--the Gene Fama, the Harry Markowitz, the Bill Sharpes--as consultants there and created what I see is the world's biggest economic think tank. And you can see that legacy of that think tank that Mac established out of this serendipitous meeting with Ransom Cook in the success for BlackRock today. So, that's kind of fantastic to think about.

More recently, Jack Bogle met Nick Morse when Nick Morse was an executive at the Amex trying to count this idea of tradable index funds, and Jack Bogle hated the idea and chucked him out. So, by pure chance, that job, by creating tradable index funds, went to State Street, not Vanguard and cost Vanguard hugely in what would eventually become the ETF market. So, I think that's pretty incredible as well.

Ptak: Wanted to shift and talk about technology. And since you mentioned earlier data, which you rightly point out was so important to the eventual acceptance of theories like efficient markets theory. In the book, you tell the story of something called the Cowles Commission, and the breakthrough it made in calculating the return of the stock market from, I believe, it was the 1870s to the late 1930s. In a way, it almost seems quaint. That something that mundane would mark a milestone. But as you point out, it really was important to investors’ understanding of the stock market at the time. Walk us through that and how it subsequently impacted the field of indexing.

Wigglesworth: Well, again, almost a serendipitous event, but almost tragic in how it started at least. So, Alfred Cowles was the sign of great wealth in Chicago. His grandfather had been one of the founders of the Chicago Tribune. He'd been groomed to eventually take over that newspaper. He was a skull and bones man at Yale, studied law there and then became a journalist. And then, just as his career was taking off, he got a very bad case of tuberculosis, and almost perished and had to be sent to Wyoming to recover and recuperate from TB. And whilst he was there, he decided to keep busy. So, he decided, “I'll take over managing some of the family's wealth.” So, he subscribed to all sorts of investment letters and stock-tipping services and The Wall Street Journal and so on and tried to manage the family's money. But when the 1929 great crash came and the Great Depression, it's a kind of shock that none of them had really predicted this. So, given that he had lots of time and money, he decided to try and find out why people were so bad at predicting markets.

So, he was one of the guys that first did the first comprehensive gathering of the raw data in how the stock market did in the long run and how the average investor did. So, he signed up to all these newsletters; he got the annual results for various insurance companies that had public results. And he all published it in a magazine that he self-financed for Econometrica. And with the title that was pretty blunt, "Can Stock Market Forecasters Forecast?" And the abstract, the subtitle, was pretty brutal: “It Is Doubtful.” He just discovered that there was no sign of any skill whatsoever. And although that study wasn't that widely known at the time, it did ripple through academia eventually. Though, it's important to remember that this is long before the Internet days. So, information traveled very slowly. And this was not nearly as comprehensive a study as some of the seminal papers that were done in the ‘60s did, because the computers were just a lot better then.

Benz: You offer it as almost an aside in the book, but it was funny to read about how one of the earliest index fund managers, Wells Fargo Index Advisors, was able to enhance an early version of its S&P 500 index strategy so that it suffered only 1% to 2% of tracking error a year. So, that kind of tracking error would instantly get an indexer fired today. But by the standards of the late 1970s, it was pretty good. So, talk about how advances in trading and portfolio management have played a role in indexing success.

Wigglesworth: Yes. I'd say one of the reasons why I did want to write a book about this is because I think indexing is leaving such a huge footprint on markets throughout history, but increasingly so. The mental model I always used for markets is that they're an adaptive complex system in the way that physicists use the concept complex system. So, it constantly adapts and changes. Think about a jungle ecosystem. New animals come and go, and they affect the environment themselves. So, I think, to a large extent, indexing not only benefited from these changes, but also helped bring them about. So, for example, portfolio trading, was largely invented for index funds to trade more efficiently. And many of the electronic trading techniques we see today were halfway inspired for indexing. So, portfolio management, better portfolio management analytics, many aspects of that kind grew out of the quantitative work done around index funds as well. Because once people have this idea that, well, actually, there is something known as beta, the market return, you shouldn't pay an active manager for that. So, let's analyze what is true beta and what is actually alpha. So, people are far better at judging whether their active manager is adding genuine alpha or not these days, thanks to some of the analytics that grew up around the whole indexing world, I think.

And I think this is probably in the earlier stages. Because over the next 10, 20 years, indexing is just going to grow even bigger. And that is going to ripple through how all of Wall Street is set up to operate--just how they provide research, how their trading desks are set up--is going to change in the era where ETFs are kind of the dominant trading blocks of risk. So, I think that's going to be really exciting. And hopefully, I'll be able to dig into that even more--if I'm allowed to do an updated edition in 10 years' time of my book.

Ptak: Wanted to shift and talk about the early days of indexing, and maybe you can help us to settle a debate that still sometimes rages at certain quarters that debate being about who should get credit for launching the first index strategy. Your book does seem to settle that debate. So, maybe tell us who did it first, whether you're talking about an institutional separate account, index strategy, or a registered fund that did the same?

Wigglesworth: Yes. It’s a classic case of failure being an orphan and success having many parents. And I think, to a certain extent, you can make a plausible argument for Wells Fargo, American National Bank of Chicago, and Batterymarch, for all of them, for different reasons. So, I think Batterymarch was probably one of the first to offer an index strategy to clients in early 1973 sometime, though, the exact date when he was formally offered is hard to nail down, but it seems to be the first one. And that was a separately managed account, which Batterymarch said, “Look, clients, park your money here, get the market return, and we'll charge you a flat fee for it.” But they got zero clients. Basically, Dean LeBaron at Batterymarch marketed this for over a year without getting a single client, earning an award from Pensions & Investments magazine for the Dubious Achievement Award of the Year for having tried to sell something for an entire year without success. To his credit, he did go to collect the award and framed it and hung it up in his own office. And he did get the first client for these SMEs in early 1974.

Then there's Rex Sinquefield at the American National Bank of Chicago. He managed to get buy-in from his bosses at the trust department pretty quickly in the summer of 1973. And he was able to essentially convert a small existing fund into an S&P 500 fund. So, that I think is the first S&P 500 Index fund. But it was just a conversion. It wasn't launched; it wasn't sold. On the other hand, and who I think has a stronger claim to being the first if you accept some flexibility around the term “fund” is Wells Fargo. So, already in 1971, they set up a separately managed account to manage money for Samsonite pension plan--$6 million from Samsonite, because the son of the founder, or the grandson of the founder, had gone to Chicago and had drunk very heavily from the well of efficient markets theory from people like Gene Fama. So, they were willing to back this. But that 1971 project was, first of all, it was not a fund formally. It also tracked the entire New York Stock Exchange, 1,500 stocks of the entire NYSE index. And it was supposed to be equal weighted. So, it was just a massive nightmare to manage in those days. So, you could say that that first index fund was a bit of a failure, and it was later folded in into a more recognizable S&P 500 Index Fund in '73, I think first and then it became '76, it was formally labeled as such. So, you can slice and dice it anyway. I have this enormous respect for all three of them. My money is if I had the gun to my head, I'd say Mac McQuown and Wells Fargo got there first, but I think the other people have got very strong claims as well.

Benz: Indexing has its roots in academic research and theory, but it gained an early foothold among institutions and institutional investors. I think you've said the Baby Bells were early adopters. Can you talk about what those institutions saw in indexing at the time? And what brought about the change in their thinking?

Wigglesworth: Yes, this was an institutional revolution to begin with. We can see now how popular it is among retail crowd. But that didn't really take off until the ‘90s. So, the U.S. had really big pension plans that started growing quite a lot in the ‘50s and ‘60s. And none were really bigger as a whole as the Baby Bells. So, this is the old AT&T that was split up into different regional parts and each had their own little pension plan. These were known as the Baby Bells. And they did exchange some information, and they could kind of see that, look, we are the biggest investor in equities in the U.S.--institutional investor in equities in the U.S.--and we have invested between all the Baby Bells in hundreds of fund managers and active fund managers who all try and beat the market. But we can see that actually what they're all doing is that they're swapping one stock for the other. So, your fund manager is selling IBM to my fund manager, my fund manager is selling General Electric to your fund manager. And in the process, we're paying them pretty hefty salaries and at the time really massive trading costs. It was expensive to trade those days.

So, they could see that they were kind of getting the market return just with a lot of cost stripped out. So, they were the first pioneers of the first three index funds. I think all eventually got money from some part of the Bells system. And it was just because, even if they didn't always have all the data, they had some of the data, at least their internal data, and they could see this. And they also did have a view, which started coming in the ‘70s, after the big bear market then, that they didn't want to pay active fees for passive management, because they could also see that a lot of their managers that they were paying a lot of money were in practice just hugging the index--closet benchmark huggers. They were index funds in active drag, essentially, and were charging a lot of money for doing so. So, there were even some congressional hearings around this when they started becoming a bit of a mini scandal. But still, hope springs eternal. A lot of pension plans still invested the vast majority of their money in active management for decades, even after the index funds were invented and the data became one that you know.

Ptak: No story about indexing would be complete without Jack Bogle and Vanguard. And so, that's the next place we'll go. And I wanted to start with a story that you tell in the book of an unknown financier, name is John B. Armstrong, who in 1960 wrote a paper ridiculing academic research that showed fund managers did a poor job and should instead strive to just mimic the market rather than try to beat it. Essentially, it was a passionate defense of active management. Who was John B. Armstrong?

Wigglesworth: Well, drumroll, boom, boom, boom: It was Jack Bogle. At the time he was a senior vice president at Wellington Group, one of the biggest mutual fund companies in America. And although he wrote under the pseudonym, his views on passive were well known. And this paper that he was ridiculing was the Edward Renshaw paper I mentioned recently. And he just thought this was absolutely preposterous. But it just goes to show that, I think even Bogle once described himself as a hedgehog, somebody who always has one really big idea in his head. But he did change what that idea was. And I think one of the more remarkable transformations we've seen in the history of the investment industry was Jack Bogle's conversion from being an active fan to a passive one.

Benz: Do you think it's fair to say that if Bogle hadn't allowed hubris and pride to have gotten the better of him at Wellington, he might never have pursued Vanguard and indexing or is that oversimplified?

Wigglesworth: No, I think that's a very fair question. I think there were some parts of his later career that were very much always there. He always cared about low costs. And this was something that he did talk about in his master's thesis, or bachelor's thesis, at Princeton that first got him his guard at Wellington, when he talked about the importance of keeping costs low. And that was something that he did talk about even in his career at Wellington as an active manager and as an up-and-coming wonder boy in the investment industry. He also did flirt with the idea of neutralization before Vanguard was set up. I found several press clippings where he talked about this. Though, admittedly, mostly, in the context, or obliquely, in the backdrop was his fight with his partners at Wellington at the time. So, I'm not sure if he would have neutralized Wellington if he’d had the chance. But it at least was something that he was thinking about long before Vanguard ever sprung into his head.

On the indexing--I think that's an open question whether he’d do this. I think it might have appealed to the innate cheapskate in him. He was a very proud self-admitted Scottish-American cheapskate. One of his old friends once told me his favorite drink was an $8 bottle of Cabernet Sauvignon. I thought that really summed up Jack quite well. So, indexing might have appealed to him anyway. But pretty much everybody who knew him back in those days was very clear that Jack Bogle did not believe necessarily in indexing at all when they launched the first index fund at Vanguard. It was purely a corporate ploy to basically stick two fingers up to his nemesis at Wellington who had sacked him so brutally. And it wasn't really until the 1990s that he kind of became that messianical fan of indexing that we know now. So, I think, possibly, he wouldn't have gotten into indexing if he just stayed at Wellington. But it's entirely possible that that would have been a very different arc of history. And Vanguard would not exist, and Wellington would just be a really big well-respected active mutual fund manager today ala Capital Group or T. Rowe.

Ptak: I wanted to build on that. In the book, you talk about the context in which Bogle pursued Vanguard's first index fund. In the way you describe it, it almost sounded more like a practical business necessity than something where he was aspiring to loftier ideals. He was obviously a very principled person, and that was such a big part of how Vanguard presented itself to the market. But in that particular case, it seemed like it was more a question of pragmatism, is that right?

Wigglesworth: Exactly. He was a very principled person. I don't want to talk down on what he did and what he achieved. And I always feel that we have a tendency when there are great men and women that we want to ignore any faults, and I actually think the greatness of great people is enhanced by recognizing, seeing that they were multifaceted, flawed human beings like everybody else. And Jack Bogle is Saint Jack, and he has done enormous amounts of work for the advance of passive investing. But he was not a firm believer in the beginning. Indexing was purely work for Vanguard, and he later turned this into a motto of his: strategy follow structure. Vanguard was set up as a clerical outfit to do the boring paperwork for the Wellington Groups. It was kind of a “gimme” from a sympathetic fund board to the former CEO who had been sacked by his partners. And he just realized that they wanted to get back these partners, didn't know how, and read about these index funds that have started to gain ground in passive on the institutional pension fund side and read Paul Samuelson, whose textbook he had once struggled with at Princeton, talking about how somebody should do this for ordinary investors. And that was perfect, because the sleight of hand that he did with the board was he went to them and said, “Look, I know we're not allowed to do investment management, but come on, this is an index fund; it's passive, it's unmanaged.” And unbelievably, the board said, “Yeah, that sounds like a completely legitimate argument, go ahead.” But he couldn't have done anything other than an index fund at that time. But that was the first step in essentially extricating Vanguard from under the thumb of Wellington as he saw it. So, it was a power gambit, basically, and convenient, and not necessarily a point of principle for Jack Bogle, I think.

Benz: Speaking of mutual ownership models, why do you think we haven't seen other mutual fund firms try to replicate Vanguard's mutual ownership model?

Wigglesworth: Jack Bogle talked a lot about this, and he thought this was the future. And his fundamental point about why this might be necessary is completely true and still holds true--that you serve two masters. That there is at some point, not always, but there is quite often a conflict between the interests of the investors in your funds and the interests of your own shareholders. And you actually have a legal fiduciary duty both to your shareholders as investors to maximize their returns, but also to your investors as a fiduciary. And that's hard to reconcile. I think the reason why mutualization hasn't happened is because most people don't want to do that. A company owner wants to own the company. Shareholders don't want to do this. Vanguard was a very unique situation, where he was able to set it up as a mutual--he did like the idea of mutualization even before Vanguard was set up. But the reason why he really pursued it aggressively was because that was a way to, again, stick it to his former partners, the Boston Partners they've merged with in the ‘60s. So, I think it's also entirely possible that if Jack Bogle had stayed at Wellington, Wellington would not have been utilized in the same way that Vanguard is today. I think for most owners of any company, the idea of essentially de facto giving up some of the upside is just a really hard thing to do. It'd be great if it happened more, but how many really big cooperative mutually owned businesses are there in the world? There aren't that many left. They're kind of slowly dying out. So, I don't think we're ever going to see something like Vanguard ever again, sadly.

Ptak: I think that really was a brilliant, brilliant career as you point out, that might have been his master stroke. And I also wanted to talk about the competitive conditions or climate that helped make Vanguard's ascent possible earlier in the firm's life. As you explained it in the book, the big banks couldn't offer indexing to retail clients because regulations forbade it. And the big mutual fund complexes were loath to offer it for fear they'd cannibalize demand for the pricier active funds they offered. So, in a sense, Vanguard was able to exploit that to the hilts, right?

Wigglesworth: No, exactly. No, it's a great point. Frankly, I hadn't quite appreciated enough as well before researching the book. I've heard many people in the finance industry joke that fundamentally it's all about financial regulation and arbitraging that regulation. But at the time, the regulation forbade a Wells Fargo from offering this to retail investors. So, they couldn't do it. And the people that could do that didn't want to or weren't--not just because they hated the idea of indexing, but it was far from an obvious commercial opportunity at the time. Wells Fargo, that unit of Wells Fargo that started indexing didn't make a profit for 20 years, almost. It was staggering. It was not considered the huge profit machine that, let's say, a BlackRock or iShares is today. And Vanguard did it not because they thought this was a huge commercial opportunity but because it was pretty much the only opportunity they could take. They had to do something that was plausibly unmanaged. And they could sell to retail, but they didn’t have distribution themselves. So, they had to get banks to help it, and they just kind of managed to stick at it until essentially indexing started taking off in the ‘90s. Because there were other people--I think Dreyfus also started retail as the index mutual funds not long after Vanguard. But essentially, it just grew tired of subsidizing it for so many years and shut it all down just as indexing started taking off. But it was also the time of the bull run that started in the 80s. Just without that would Vanguard have done as well as it has? It's unquestionable. They were suddenly the low, cheap provider in the biggest bull run that Wall Street has ever seen and at a time where the 401(k)s were propping up and people were becoming a bit more cost-conscious. So, there was quite a lot of serendipity involved in the rise of Vanguard. But arguably, there probably is a lot of serendipity involved in the rise of any big phenomenon or company.

Benz: Rex Sinquefield features prominently in the book. You mentioned him before. He's one of DFA's founders and a distinguished researcher in his own right. But his wife Jeanne was an unsung hero in building out DFA's trading and portfolio management operations. Can you talk about the impact that Jeanne Sinquefield had, which was all the more notable given that she was one of the few women in leadership during that era?

Wigglesworth: No, one of the first ones actually. Luckily, later on, especially indexing has been slightly less skewed in gender issues than maybe some other areas of finance. But Jeanne, I think, was one of the first ones, an incredibly impressive person with her own Ph.D. in Sociology, then an MBA. I think she worked on the pioneering Treasury futures in Chicago, and then came over to this, almost--let's face it--almost crappy startup that her husband was working at as a favor to them initially. She worked program for them and did their trading system for free, as a favor. And it took a couple of years of them essentially nagging her to join full time before she finally did. And it's crazy how many people have worked at DFA, especially overlap with her, talk about how she was the one that kept everything running, and everybody who worked there had to pay or pass what they call the Jeanne test. Rex Sinquefield admitted to me that he luckily didn't have to take it, and he wasn't quite sure if he'd be able to pass it. But essentially, it's a crash course in markets efficiency and financial concepts that everybody takes at DFA to make sure that they were of a sufficient caliber to work there. So, again, would DFA have been around without her? Probably in some form or fashion. But would it have been as successful and as big as it is today without her? That I think is far more questionable. She was undoubtedly a big part of the DFA success story.

Ptak: In the book, you argue that DFA hastened the growth of index investing by bringing the concepts, underpinning indexing to the advisor world. Maybe talk about how the firm came to be such a key gateway to financial advisors.

Wigglesworth: It's almost again serendipity. And we've talked a lot about how institutions cottoned on to this in the ‘70s and then they just kept growing, but retail was slower. So, DFA was set up as essentially a small-caps index manager--before there was even any indexes for small caps aimed at institutions. But they just happened to grow quite quickly, they found a good niche of the market, and they were doing really well. And then, there just happened to be this one financial advisor called Dan Wheeler, this just really colorful guy, former Marine, started a Ph.D. in economics but hated academia; also worked as an accountant for Jamal Khashoggi, an infamous arms dealer, then set himself up as a stockbroker and hated that. And then, as a sort of present to himself, quit to become a financial advisor, a fee-only financial advisor. And he was mostly putting people's money into Vanguard funds until he came across a newspaper article that mentioned this small-caps fund invested in some heart of corporate America. And that appealed to him. So, he got in touch and said, “Can’t I get my clients into your funds?” And Rex Sinquefield and David Booth, the two founders, they were still there, said, “No, we don't take retail money. It's a regulatory nightmare, logistical nightmare as well and we worry about retail money going in and out essentially.” And they open up the idea that if he could basically gather enough financial advisors that would do it through a pooled omnibus account at one of the big platforms and would train all the financial advisors up in some of the tenets of efficient markets. And Rex and David are very much efficient markets people. They both studied under Gene Fama at Chicago. They said, “Yes, if you can do that.” So, Dan Wheeler did that. It was such a success that he eventually joined DFA and headed up their personal financial advisor arm and started these kind of boot camps, or some people call them efficient markets madrasas, to teach financial advisors about all the principles that underpin indexing. And they weren't allowed to invest in Dimensional Funds if they hadn't gone through one of these madrasas. And that's how I think, to a large extent, many of these ideas managed to go from academia to Wall Street to essentially Main Street via the main interface with Main Street, which is financial advisors.

Benz: Exchange-traded funds have an unlikely origins story. They were developed partly in response to Black Monday in 1987. Can you walk through that story?

Wigglesworth: Well, so Black Monday, obviously, was just a cataclysmic event, and something that bad needs some sort of autopsy. And the SEC report talked about obliquely, almost buried in it, the idea that maybe if there was some sort of financial product that would act as almost a buffer between essentially the cash market, the cash equity market, and the futures market, then that might help to slow down or dampen these kind of feedback loops that turn Black Monday from a big crash into something really quite scary. And at the time, the Amex was really struggling. It'd been obviously in the shadow of the New York Stock Exchange for years and years. And it was also now under pressure from Nasdaq, the hot new exchange on the block. So, they needed something new. And the Amex thought, well, the SEC is kind of asking us to create a tradable index product. And they and many other people rushed to do this. And their efforts were stymied by all sorts of regulatory issues in the U.S. with the SEC and the CFTC not always seeing eye to eye and different products being regulated by different entities and trading on different exchanges. But, eventually, what they came out of it was the exchange-traded fund, but it took years and years. And I have so much respect for the people that worked on this project for all those years, and what must have felt like a Kafkaesque process with the SEC to finally get it approved. And especially given that essentially some plucky Canadians almost copied and pasted their prospectus and their filing and did something very similar in Canada before they were able to launch the first U.S. ETF. So, it must have been immensely frustrating, but it's pretty remarkable what it's ended up being.

Ptak: Nate Most who you mentioned earlier in the podcast--it's a name few have heard of outside the indexing world and all likelihood--but he played a significant role in developing what would eventually come to be known as the ETF. So, tell us about Nate and in what in your opinion made him so notable.

Wigglesworth: I have a special soft spot in my heart for either people that die in obscurity or managed to almost have ambled through life being a little bit unlucky until they finally, late in life, hit it big. So, Louis Bachelier is a classic case of somebody who essentially died in obscurity, nobody knew who he was. And it's only later in life that, not even later in his life, but eventually he is now known as the father of financial economics. And Nate Most was kind of a--to put it a little bit meanly--but he was a kind of a nobody for a long time. He was a brilliant guy. He studied acoustical engineering of physics and worked on a submarine during World War II testing out sonars. But then, after that, bounced between jobs. It was never him; he wasn't the problem--he ended up in lots of places that essentially went bust. He worked with export-importing; he worked with commodities business; ended up through the quantities business to work in the Pacific Exchange and their commodities exchange. And he ended up at the Amex late in life working to develop derivatives products--that was kind of the lifeline for the Amex at the time. So, he was really quite old at that stage. But he was brilliant, and he was creative. And in fact, all those false starts he suffered throughout his life, his career, I think was what actually helped him come up with such an ingenious way to solve some of the challenges around tradable index products.

So, he had worked in the commodities business in Asia. And you could see how people, rather than literally carrying ingots of metal or barrels of palm oil around, they basically just have it all in the same warehouse and just trade shares in that warehouse, pieces of paper that say, “I owe this and that.” And he thought, “Well, why can't we do that for a financial product?” And that is essentially the kernel of the ETF. And could somebody else have invented the ETF eventually if Nate Most hadn't? Possibly. But I think there was like a unique combination of his expertise and his background and his geniality and his brilliance and his creativity that came all together with an Amex that was desperately needed some sort of Hail Mary to survive. So, that was an alignment of stars that might not actually have happened if somebody else hadn't been there at the right time.

Benz: Indexing was kind of a fringe idea for a long time with its proponents tending to be a kind of class or kooks who didn't conform to the orthodoxy of the time. So, when you look around, are there any other burgeoning movements in finance or technology that remind you of indexing before it went mainstream?

Wigglesworth: It's not just a very good Apple ad from the ‘80s that this is for the disruptors and the rebels. Broadly speaking, disruption requires somebody who's willing to be a bit kooky as well. I cover a lot of quantitative finance more broadly, systematic traders. And I definitely see parallels there to the indexing. These are people that were maybe sometimes considered a little bit too odd to work in the mainstream finance industry. And now, they have become the mainstream, of course.

Some of the parts of the ETF industry, the more innovative parts of it definitely still has a bit of zany kookiness to it. But I think the entire finance industry has belatedly internalized the idea that innovation is good and even if it might imperil your margins in the short run, it's a hell of a lot better to get involved now than see some of that margin go to a rival that does want to do with this essentially. So, I think the finance industry has become far more accepting of iconic class and unorthodox character types today than it ever was 20, 30, or let alone 50, 60 years ago. But I'm sure I'm going to be proven wrong within days, weeks, months. There's always something new. Everyone's getting very excited about crypto. I'm personally unimpressed by that way, but maybe eventually there will be something genuine and tangible that comes out of all that ferment as well.

Ptak: Speaking of innovation, what do you make of thematic indexing? And does direct or custom indexing seem like a natural next evolution for indexing? Or does it seem like innovation gone awry?

Wigglesworth: No, it's a fascinating topic, and I definitely do think it has an extremely bright future. Because it's stuff that frankly institutions could always have done, given some custom mandates to big institutional asset managers. It is something that now ordinary people can do. Or maybe not ordinary people, you still need a bit of money to be allowed to do this. But I think the bar is going to fall and fall and fall. And I think it's natural to see this as the sort of indexing 3.0, 4.0. I'm not sure what you'd call it.

The one issue I have with it is that I think some of the current hype around this somehow, stealing market share or significant market share from some plain-vanilla, boring, old-school indexing, I think are over the top. I think the vast majority of people still fundamentally actually want a pretty simple life and do not want to sit there fiddling around with a custom index. So, there might be some people that do this. And I definitely think for financial advisors this makes a lot of sense that this gives them more opportunities to maybe try and get cute as well around the edges. So, I can easily see this become a trillion dollar, multitrillion-dollar idea. But I think I cannot foresee a scenario where it genuinely starts rivaling the sort of the older, boring, big brother in size and scale. And right now, it's early days, so we'll see. But you can also see how this is a good innovation, but it's also good innovation that people can do dumb things with, that the line between active and passive investing has always been essentially blurry, arguably nonexistent. But with direct indexing, you're kind of wiping out that line even further. So, at what point do you just become an active investor and actually do the same mistakes that we know humans have been making for a century, when it comes to financial investments that they try to get too cute. And direct indexing might just give them another tool to do so. So, I tend to be short term very positive on this trend; long term, it's a legitimate big industry in the making, but not going to be index funds 1.0-big anytime soon or even in my children's lifetime, I suspect.

Ptak: Well, Robin, congratulations again on the book. We've really enjoyed this conversation. Thanks for sharing your insights with us.

Wigglesworth: Thanks, Jeff. Thanks, Christine. It's been an absolute pleasure. Thanks so much for wanting to hear my rambling thoughts on it.

Benz: Thank you so much. You've been great.

Ptak: Thanks for joining us on The Long View. If you could, please take a minute to subscribe to and rate the podcast on Apple, Spotify, or wherever you get your podcasts.

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Benz: And @Christine_Benz.

Ptak: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at TheLongView@Morningstar.com. Until next time, thanks for joining us.

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