Bogleheads® Conference 2023 - A talk with Gerard O'Reilly, Mgr, Vanguard Ttl Stock Market Index Fund

00:00:00.000 | [ Applause ]

00:00:06.080 | All right, before we get started with the first event,

00:00:08.640 | I'd like to introduce somebody in the audience,

00:00:10.320 | and that is Mike Nolan.

00:00:12.040 | Mike was Jack's assistant.

00:00:14.200 | A lot of you know Mike.

00:00:16.000 | [ Applause ]

00:00:18.760 | Mike was Jack's assistant, helped write how many books?

00:00:22.920 | At least four books, four or five books,

00:00:25.080 | and is still at Vanguard and is my number one go-to guy

00:00:29.160 | for anything I need from Vanguard,

00:00:30.760 | including people to interview,

00:00:33.480 | which brings us to our guest today.

00:00:37.280 | I have a question, though, in the room.

00:00:39.160 | How many people here own a Vanguard index fund?

00:00:46.480 | Okay. The fellow today who I'm going

00:00:49.240 | to speak with is your fund manager.

00:00:51.840 | So if you have any complaints --

00:00:54.160 | [ Laughter ]

00:00:56.800 | Anyway, I am pleased, we are so pleased

00:00:59.400 | to have Jerry O'Reilly as our speaker today.

00:01:03.920 | He is a principal and portfolio manager at Vanguard,

00:01:08.560 | and he oversees the $1.4 trillion Vanguard total stock

00:01:16.480 | market index fund, which is the largest mutual fund

00:01:18.840 | in the world, and he also oversees 16 other funds

00:01:23.200 | of which I believe you said five of them have your name on it.

00:01:26.920 | So in total, I believe, about $4 trillion.

00:01:34.880 | Is that a rough estimate?

00:01:36.280 | Yeah. Which is 10% of the value of the entire stock market.

00:01:41.040 | Guy's important, right?

00:01:46.000 | So with no further ado, let me introduce Jerry O'Reilly.

00:01:48.960 | Please come up to the stage.

00:01:50.800 | [ Applause ]

00:02:09.800 | >> That's yours.

00:02:11.080 | This is mine.

00:02:12.400 | >> Okay, good.

00:02:13.680 | Good to go.

00:02:15.000 | Well, again, thank you for being here.

00:02:16.280 | And my numbers were pretty correct, right?

00:02:17.600 | $4 trillion?

00:02:18.880 | >> Your numbers are good, yeah.

00:02:20.200 | [ Laughter ]

00:02:21.720 | >> I do, yeah.

00:02:23.000 | I do. You know, a lot of it is

00:02:25.120 | because I'm exhausted when I get home,

00:02:26.400 | so there's no problem there.

00:02:28.080 | But, yeah, I mean, listen, I am the name person on there,

00:02:33.040 | and I am surrounded with a phenomenal team that I work with.

00:02:37.320 | And so, you know, we have 25 people, Rick,

00:02:40.320 | that manage that $4 trillion and change with, you know,

00:02:44.840 | average tenure I'd say about 12, 13 years, which is unusual

00:02:48.840 | in terms of, you know, the tenure.

00:02:50.280 | But, like, when we hire people, it's all about, you know,

00:02:53.640 | how are they going to work in that team environment?

00:02:55.720 | How are they going to work in terms of collaboration?

00:02:58.160 | I know that if I'm jammed on something, there's like three,

00:03:00.560 | four people I can go to to have them pick up the lead.

00:03:02.560 | So we pride ourselves kind of in the team concept.

00:03:05.760 | But it is great.

00:03:06.880 | I mean, you know, I started off entry level

00:03:10.080 | on the phones at Vanguard.

00:03:11.480 | And, you know, my first paycheck, I remember,

00:03:18.360 | coming home, and I said to my wife, "Yep."

00:03:21.160 | I said, "We're starting."

00:03:22.280 | And she was working in a shoe store.

00:03:24.920 | And I think, you know, I remember thinking, "Well,

00:03:27.360 | it's a start."

00:03:28.200 | I got my foot in the door.

00:03:29.440 | And within three years, I was on the desk.

00:03:31.480 | And I felt like this is what my passion --

00:03:33.600 | this is where my passion lies.

00:03:34.880 | >> Now, you have an interesting background.

00:03:36.640 | So I'm going to go back even before then.

00:03:39.360 | And you were born and raised in Ireland.

00:03:43.200 | >> Partly correct.

00:03:44.080 | I was -- I grew up in Ireland.

00:03:45.960 | But my mom and dad -- so my dad was one of 17 kids.

00:03:50.200 | >> Seventeen?

00:03:50.840 | >> Seventeen.

00:03:51.360 | One-seven.

00:03:52.080 | No twins. Grew up -- I have an aunt who's five years older

00:03:58.000 | than me, my Aunt Mary.

00:04:00.360 | And if you asked me to list all 17, I'd be stretched.

00:04:03.080 | I'd be here for a while.

00:04:05.160 | But dad was -- grew up on a farm in Cowles County Mead,

00:04:07.680 | outside Cowles County Mead.

00:04:09.400 | Probably some of you have heard of the Book of Cowles.

00:04:10.920 | So that's where, you know, Cowles is.

00:04:14.240 | And dad, when he was in his early 20s,

00:04:16.520 | someone locally had gone to Canada to work

00:04:19.480 | in a town called Uranium City.

00:04:21.960 | Which, if you look at a globe, where Saskatchewan turns

00:04:25.480 | from green to white, Uranium City is well up into the white.

00:04:29.760 | So dad and four or five local 20-year-olds went over there.

00:04:33.720 | And that's where he made his money.

00:04:35.320 | And my mom, he came back and they got married.

00:04:40.240 | And I was born in Uranium City, Canada.

00:04:42.640 | >> Oh, isn't that right?

00:04:43.200 | >> And when I was two years old, they brought me back to Ireland.

00:04:46.640 | And mom is from outside Cowles, too.

00:04:49.760 | And yeah, grew up in Ireland.

00:04:52.280 | And then, you know, things --

00:04:54.680 | >> Well, okay.

00:04:55.680 | So you were a track star.

00:04:58.280 | And you were recruited to go to college here

00:05:01.920 | in the United States.

00:05:02.960 | >> Yep.

00:05:03.600 | >> And then you were actually an Olympic athlete.

00:05:07.600 | >> I was, yes.

00:05:09.200 | >> Tell us about that.

00:05:11.200 | >> So it was a few pounds ago, Rick.

00:05:14.200 | I used to be 152.

00:05:17.120 | But that's what happens when you run, you know,

00:05:19.840 | 90, 100 miles a week training.

00:05:21.800 | But yeah, I mean, I -- from 1976 was a pivotal year for me.

00:05:27.680 | I was 12 years old.

00:05:28.880 | So you guys are all doing the math now.

00:05:30.520 | You're like, hmm, okay, I see what age he is.

00:05:32.480 | I was watching the Montreal Olympics.

00:05:36.520 | And there was a guy from Ireland who was like our LeBron James.

00:05:40.400 | His name was Eamon Coughlin.

00:05:41.360 | He was a runner.

00:05:42.000 | He was at Villanova.

00:05:43.200 | And he was favorite to win the 1500 meters.

00:05:45.920 | And I had started running at that point.

00:05:47.640 | And I was fairly good.

00:05:49.520 | And I remember watching a documentary on Eamon

00:05:51.440 | and seeing like, hey, he's going to school.

00:05:53.840 | He's representing Ireland.

00:05:55.720 | And he was a favorite.

00:05:56.880 | As it turns out, he finished fourth.

00:05:58.440 | And it was a great disappointment.

00:05:59.520 | But I remember he just planted a seed with me thinking, man,

00:06:02.800 | if I was good enough as a runner,

00:06:04.680 | I could actually get a scholarship.

00:06:06.640 | I could, you know, potentially set me off for a career.

00:06:10.000 | And I would go -- you know, we lived

00:06:12.160 | out in the country back home.

00:06:13.880 | And I would come home from school, drop the bag off

00:06:16.240 | when the family was having dinner.

00:06:18.200 | And I'd go out and run seven,

00:06:19.400 | eight miles by myself on country roads.

00:06:21.240 | And at the back of my head was this --

00:06:22.760 | fueling me was this potential

00:06:24.720 | that someday maybe I'll have an opportunity

00:06:26.760 | to get a scholarship.

00:06:28.120 | And when I was a senior in high school,

00:06:30.000 | I won the Irish National Championships.

00:06:32.080 | And all of a sudden, I had 12 scholarship offers.

00:06:34.680 | And my mom, being Catholic from Ireland, she's like,

00:06:38.840 | Villanova's a Catholic school.

00:06:40.360 | That's where you're going.

00:06:42.160 | And so that was the end of it.

00:06:44.120 | And so I ended up in the fall of '83,

00:06:47.760 | showing up at Villanova campus, yeah.

00:06:49.880 | >> Well, I just have to -- I just have to --

00:06:51.120 | because you did walk into the stadium at Seoul, Korea.

00:06:53.840 | And, you know, all those people in the opening ceremony.

00:06:56.200 | I mean, just tell us just a little bit

00:06:58.080 | about that experience.

00:06:59.080 | >> Yeah. I was fine until someone yelled from the stands

00:07:02.400 | that there's 200 million people watching you.

00:07:04.800 | The thing about the Seoul Olympics,

00:07:07.400 | and you can Google this, they brought all the teams in.

00:07:10.840 | And I was -- there was maybe 100 people on the Irish team

00:07:13.320 | between, you know, all the different sports,

00:07:15.320 | officials, and everything else.

00:07:16.360 | Phenomenal.

00:07:17.200 | The whole day just was incredible.

00:07:19.800 | They bring you into the stadium, and you line up on the infield.

00:07:23.800 | And, of course, it's time to light the torch.

00:07:25.560 | The cauldron.

00:07:26.880 | And what they did was they released a couple

00:07:29.160 | of hundred doves as a sign of peace.

00:07:32.160 | And where do you think the doves landed?

00:07:34.400 | On the cauldron.

00:07:35.120 | And then two athletes went up and lit the cauldron.

00:07:37.560 | And that's the last time the Olympic Games have let

00:07:40.440 | off live birds.

00:07:41.920 | It's not a pretty sight.

00:07:44.000 | I showed it to my kids on my daughter's jaw

00:07:45.880 | like she was 10 at the time, and her face just dropped.

00:07:48.560 | She's like, the birds.

00:07:50.240 | But, yeah, you can Google that.

00:07:51.960 | But phenomenal experience.

00:07:53.480 | Just as a 24-year-old, oh, incredible to be there.

00:07:57.960 | And then how did you get a job at Vanguard?

00:08:02.080 | So there was a guy who Mike knows well

00:08:06.240 | who used to compete against me named Jim Norris.

00:08:08.160 | And Jim ended up being--

00:08:09.440 | he was an assistant to Mr. Bogle for a number of years.

00:08:11.720 | He would have been involved in some of the earlier books,

00:08:13.680 | whereas Mike was involved in some of the later books.

00:08:16.200 | Jim and I would meet at--

00:08:18.320 | would race each other.

00:08:19.440 | He went to St. Joe's.

00:08:20.400 | I went to Villanova.

00:08:21.280 | They're literally four miles apart.

00:08:24.640 | And I got to a point in my career

00:08:26.960 | where I was making some money from running

00:08:29.720 | Rick, but not enough to walk in and potentially buy a house

00:08:33.640 | or even buy a car.

00:08:36.240 | And I remember thinking, I need to find something

00:08:38.720 | a little more stable.

00:08:39.560 | And Vanguard was half an hour away,

00:08:41.360 | and Jim was working there already.

00:08:43.400 | And he said, listen, I'll drop off your resume.

00:08:45.360 | And that's how he got my foot in the door,

00:08:47.120 | as I said, as an entry-level person on the phones.

00:08:50.920 | And within like a month or two, I

00:08:52.680 | knew that I was going to be here for a while.

00:08:54.840 | And it's interesting.

00:08:55.800 | You've been there for 31 years now?

00:08:58.040 | 31 years in March, yeah.

00:08:59.120 | And that's a real testament to me to Vanguard,

00:09:01.000 | because they hold their employees for so long.

00:09:03.080 | Yeah, I mean, I think when we hire--

00:09:07.040 | I mean, when I interview people, I'm not interviewing somebody

00:09:11.120 | that I want to be on the desk for two or three years.

00:09:13.480 | I'm hiring somebody that I can see 20 years,

00:09:16.400 | 25 years down the road.

00:09:18.760 | And I think Vanguard does a really good job of making sure

00:09:21.240 | that just the whole quality of just your work-life balance

00:09:27.000 | is good.

00:09:27.500 | I mean, I have four kids, and they're all in their 20s now.

00:09:32.560 | But when they were 8, 10, if there was a dance recital,

00:09:38.480 | a ball game, it was no problem for me to run out and catch

00:09:43.400 | that, and you feel kind of like-- and then

00:09:45.880 | when you work with people like Mike Buick, Gus Sauter,

00:09:50.480 | and you learn from people like that, and you just--

00:09:54.440 | Gus was probably one of those guys, the most humble person.

00:09:57.920 | And I know he's spoken to the Bogleheads

00:10:00.040 | on a number of occasions.

00:10:01.520 | But it's just contagious.

00:10:04.400 | I would have ran through a wall for Gus, that type of person.

00:10:08.080 | And it just--

00:10:08.840 | I mean, I just absolutely--

00:10:10.320 | I tell people, interns who come by the desk looking

00:10:13.240 | for a little-- I say, listen, I'm 31 years at Vanguard.

00:10:15.860 | On a Sunday night, when I hear the 60 minutes clock,

00:10:20.040 | I'm like, OK, works tomorrow.

00:10:21.280 | Awesome.

00:10:22.120 | I'm looking at the futures.

00:10:23.440 | I'm figuring out what we're going to be doing tomorrow.

00:10:25.760 | And it just, to me, it doesn't feel like a job.

00:10:28.880 | Well, let's go ahead and get into the portfolio management.

00:10:32.360 | Let's first talk about the Vanguard Total Stock Market

00:10:36.120 | Index Fund, $1.4 trillion, roughly?

00:10:39.680 | Yeah, a tad under, yeah.

00:10:41.080 | And that includes both all share classes.

00:10:43.760 | All share classes, yeah.

00:10:44.800 | Just for clarification, Vanguard has a little different

00:10:48.380 | approach to ETFs versus mutual funds,

00:10:51.540 | where it's all the same pool of money.

00:10:54.500 | Yes.

00:10:55.220 | Could you talk about that and how it's split up, then,

00:10:57.580 | at a different level?

00:10:58.540 | It is, yeah.

00:10:59.060 | So in total stock market, we have the VTI share class.

00:11:03.020 | We have admiral share class.

00:11:04.220 | We have institutional share class.

00:11:05.740 | To me, it's all just one large pool of money,

00:11:08.140 | which makes it easier to manage.

00:11:09.880 | And there's also benefits to that multi-share class.

00:11:12.100 | So for example, whenever there's corporate actions going on

00:11:16.720 | where you potentially have adds to the index,

00:11:18.720 | if it's a standalone, I would need to sell, basically,

00:11:23.320 | to raise money to buy the stock that's

00:11:25.160 | getting added to the index.

00:11:26.620 | But in total stock market, on any given day,

00:11:28.400 | I could have $500 million coming in in cash flows.

00:11:31.640 | I could have corporate actions.

00:11:33.000 | For example, yesterday, I came in in the morning

00:11:35.520 | thinking it was going to be a nice, quiet day.

00:11:37.480 | And all of a sudden, Activision is halted.

00:11:41.320 | And I have to spend $2.2 billion at the end of the day

00:11:44.160 | because I get $95 a share times all the shares of Activision

00:11:49.000 | I have.

00:11:49.920 | And now I'm talking to NASDAQ about potentially,

00:11:53.840 | is it going to be halted all day?

00:11:55.200 | Is it just for the morning?

00:11:56.720 | And what's the repercussions of that for all of the funds

00:11:59.140 | that we manage?

00:11:59.960 | And for my funds, I needed to spend that cash

00:12:03.240 | and spread that across the rest of the 4,000

00:12:06.040 | on securities in the index.

00:12:08.640 | The share class also, when we have redeemed--

00:12:10.880 | so if somebody does a create--

00:12:13.000 | I'm talking about APs who are dealing in $20, $50, $100

00:12:16.800 | million.

00:12:17.920 | Authorized participants are the people who create

00:12:21.920 | and redeem the ETF shares.

00:12:24.360 | Yeah, when they redeem, we're able to give them

00:12:27.840 | the lower cost basis stocks.

00:12:29.160 | So take a stock, for example, like NVIDIA,

00:12:30.920 | which is up close to 200% for the year.

00:12:33.760 | We can give them the NVIDIA shares

00:12:35.560 | that we have at low cost basis, which

00:12:37.240 | tends to make the fund more tax efficient overall.

00:12:40.080 | So I want to just dig into that a little bit.

00:12:41.960 | Because you do have this--

00:12:43.040 | I call it a double-edged sword on tax efficiency of a fund

00:12:49.360 | like the Vanguard Total Stock Market Fund.

00:12:51.360 | If you have a stock that went down in value,

00:12:56.440 | so the basis is higher, and you're actually losing money,

00:12:59.440 | you would redeem that for cash and take the loss in the fund?

00:13:03.960 | You potentially have the option--

00:13:05.520 | so you can basically determine, when

00:13:07.340 | you're talking to our fund accounting,

00:13:08.960 | which shares do we want to hand out?

00:13:11.800 | So potentially, you could do that.

00:13:14.520 | The primary goal, Rick, is to make sure

00:13:17.020 | that we're tracking the benchmark.

00:13:18.440 | But there are different tools available.

00:13:20.400 | One would be the in-kind process.

00:13:22.360 | The other would be potentially tax harvests

00:13:24.440 | at certain times of the year.

00:13:25.640 | So names like, for example, that we

00:13:27.400 | might have a cost basis of here that are down here,

00:13:30.040 | if you sell those names, as long as you don't buy them back

00:13:32.520 | within 30 days because of the wash sale rule,

00:13:34.800 | you're able to realize a loss.

00:13:36.040 | So we do look to try and keep about 170 to 200 basis

00:13:41.080 | points of a cushion of realized losses in the fund

00:13:43.720 | so that we're not distributing gains to the shareholders.

00:13:46.240 | I think one of the big concerns is,

00:13:48.400 | when you look at the data on Vanguard Total Stock Market,

00:13:52.760 | it says unrealized gains.

00:13:54.600 | And it would look like there's a huge, huge amount.

00:13:57.480 | And sometimes the media gets a hold of this.

00:13:59.380 | And they say, oh, if people started selling this fund,

00:14:03.240 | you're going to get hit with big capital gain distributions.

00:14:07.760 | But it's not really true, is it?

00:14:09.120 | No, I mean, it is something that we monitor literally

00:14:11.560 | on a weekly basis in terms of the capital gains.

00:14:13.960 | And if we start to see that realized losses are getting

00:14:16.520 | below that kind of 170 basis points,

00:14:19.000 | we start to take action on it.

00:14:20.800 | And sometimes it's like we have, as you mentioned,

00:14:24.000 | the CRISP indexes.

00:14:25.680 | They do rebalances once a quarter.

00:14:28.680 | So if you think about it, we just had one in September.

00:14:31.940 | If we sell names in the third Friday in September

00:14:36.120 | or during the five-day period, if they're not

00:14:40.240 | large names in the fund and they're

00:14:42.560 | stocks that we have a significant loss in the name,

00:14:45.920 | we can just put those names on hold for a period of 30 days.

00:14:49.320 | Now, these might be stocks that have

00:14:50.780 | a weight in the index of less than a basis point.

00:14:52.960 | But they could be very tax-efficient when

00:14:54.620 | it comes to realizing losses.

00:14:56.480 | So we have a whole team that kind of works with us

00:14:58.480 | in terms of helping us identify what those names are

00:15:01.200 | and making sure that you don't have any concentration

00:15:03.400 | in any industries or sectors, or if that sector rebounded

00:15:07.080 | over the 30 days, you would be hurt.

00:15:08.880 | So making sure we do it in a diversified manner.

00:15:11.120 | So on the mutual fund side, you're

00:15:14.040 | able to take losses and build up these capital losses

00:15:16.840 | because you're going to do it in cash.

00:15:18.840 | You're going to sell in cash.

00:15:20.080 | But on the ETF side, if you have a big gain

00:15:24.400 | and you want to push that gain out of the fund

00:15:30.040 | without the shareholders incurring a capital gain,

00:15:33.360 | you'll go through authorized participants.

00:15:35.840 | So explain that process.

00:15:37.000 | I mean, how does that work, where

00:15:38.360 | you are able to push the stock out and the fund itself

00:15:41.800 | not actually take the gain?

00:15:43.040 | Yeah, I mean, it's, I think, all ETF providers,

00:15:47.520 | because of the in-kind mechanism,

00:15:49.680 | where if you have a stock, for example, that

00:15:53.800 | has a significant gain, if an AP comes in and does

00:15:58.880 | a create, and on the way out, they receive that stock,

00:16:04.440 | because it's done in-kind, the NAV of the fund

00:16:08.160 | really has the gain in it.

00:16:10.640 | And it's not realized until a shareholder sells,

00:16:14.720 | whether that's in six months.

00:16:16.320 | So it's just deferring the gain is really

00:16:18.600 | what it's doing through the ETF mechanism.

00:16:20.720 | So the create, then, is this basket

00:16:23.840 | of stocks that comes in from the authorized participant, which

00:16:26.800 | is maybe a JP Morgan, or Goldman Sachs, or somebody.

00:16:30.640 | This whole basket of stocks comes in.

00:16:33.280 | And that comes into the fund.

00:16:37.080 | You're not buying this.

00:16:38.160 | This comes in through the ETF mechanism.

00:16:40.080 | So they would give us the shares of the basket.

00:16:42.040 | We would give them shares of the ETF.

00:16:44.000 | And on the other side, when they want to redeem those ETF shares,

00:16:48.280 | they bring the ETF shares in.

00:16:49.760 | And you have to hand out stock.

00:16:52.160 | And the stock you give them is high-cost basis stock.

00:16:55.040 | 100%.

00:16:55.920 | There we go.

00:16:56.600 | Yep.

00:16:57.520 | OK.

00:16:58.040 | And that's how it becomes more tax efficient, even

00:17:01.040 | to the opened-end fund shareholders,

00:17:03.800 | because it's all part of the same money.

00:17:05.880 | Same pool of money, yeah.

00:17:07.000 | Very good.

00:17:07.680 | And I always thought that was fascinating.

00:17:09.420 | And I read the paper that I think

00:17:10.880 | it was Gus wrote on this back, I don't know, 2000

00:17:13.200 | or whenever it was, where then you went out

00:17:15.440 | and got a patent on this.

00:17:17.600 | And now the patent has come off, has it not?

00:17:19.440 | The patent has expired.

00:17:20.400 | And I think there are a couple of asset managers

00:17:22.400 | that are doing it.

00:17:23.320 | I think DFA is looking at it.

00:17:25.000 | Yeah.

00:17:25.960 | Interesting.

00:17:26.720 | Well, very good.

00:17:28.040 | I'm curious.

00:17:30.800 | We did mention the index.

00:17:32.560 | So the index that the Total Stock Market Index Fund tracks

00:17:36.720 | now is the CRISP Total Stock Market Index.

00:17:42.280 | And CRISP is-- well, we call it CRISP.

00:17:44.480 | It's the Center for Research in Security Prices,

00:17:47.480 | which is owned by the University of Chicago.

00:17:49.600 | Currently, 3,800 stocks in that index.

00:17:55.200 | But it wasn't always that index.

00:17:56.840 | I mean, back in the day, it was the Wilshire 5,000.

00:18:00.360 | And then it turned into an MSCI index for a while.

00:18:03.400 | And then it moved over to the CRISP index.

00:18:05.280 | So these indexes do change once in a while.

00:18:08.400 | That's a huge event for your desk

00:18:13.560 | when an index changes, correct?

00:18:15.560 | Correct.

00:18:16.060 | And what do you have to do?

00:18:17.600 | How do you get it aligned?

00:18:19.000 | Well, lots of times--

00:18:22.280 | so I remember those days, Rick, where

00:18:24.200 | we had the Wilshire 5,000.

00:18:25.400 | And I think going from Wilshire to MSCI,

00:18:28.920 | there were reasons that we had concerns about Wilshire, which

00:18:32.120 | back then--

00:18:33.240 | I mean, index methodology has become somewhat commoditized

00:18:36.600 | now.

00:18:37.320 | It's got little flavors on the margins

00:18:39.180 | that are a little bit different.

00:18:40.520 | But in terms of just the basic--

00:18:42.200 | and Gus contributed to this in a paper

00:18:43.920 | he wrote back in the early 2000s as well.

00:18:46.480 | But for example, a simple thing like float.

00:18:49.040 | So let's say, for example, you have a company, a biotech

00:18:52.520 | company, and the insiders own 80%.

00:18:54.840 | So really, there's only 20% of the shares outstanding

00:18:57.160 | or available to the public.

00:18:59.160 | Wilshire would say, nope, all the shares

00:19:01.800 | available to the public.

00:19:03.200 | So when a name got added, you had indexers trying

00:19:06.120 | to buy as if there was 100% of the shares outstanding

00:19:08.820 | available.

00:19:09.840 | And we would cause huge impact on these names.

00:19:12.720 | So the idea of float adjustment came about.

00:19:15.320 | And MSCI had some things that we thought were desirable.

00:19:18.280 | So we moved.

00:19:19.160 | But when we move from one index to another, it's a big deal.

00:19:22.400 | And oftentimes, it takes months to convert from your existing--

00:19:27.000 | here's your current index--

00:19:28.440 | to the pro forma, the one that you're heading towards.

00:19:31.520 | It needs to be done.

00:19:32.520 | I mean, because ideally, what you're trying to do

00:19:34.520 | is do it without realizing gains,

00:19:37.440 | without having any kind of substantial tracking error.

00:19:40.480 | And CRISP, when we moved to CRISP,

00:19:42.920 | I think that was primarily for cost certainty.

00:19:45.960 | So as you guys know, when I started at Vanguard,

00:19:48.620 | I think our average expense ratio

00:19:50.040 | was around 30 basis points.

00:19:51.960 | And it's come down to, on an asset-weighted basis now,

00:19:55.440 | around eight basis points.

00:19:57.320 | And I think Vanguard felt like, hey, if we're offering funds

00:20:01.040 | and we're giving investors the benefit of economies of scale

00:20:05.340 | because of our size, we had this index licensing thing out there

00:20:10.320 | that we felt like we need to get this under control

00:20:13.920 | for the long term so that we're not--

00:20:17.000 | like, if you think about VTI, it's got a three basis point

00:20:19.040 | expense ratio.

00:20:20.020 | It wouldn't make sense to be paying a licensing fee

00:20:23.040 | close to that number.

00:20:24.300 | So I think with CRISP, we got a long term

00:20:27.000 | where we got cost certainty.

00:20:28.360 | And it also helped that CRISP's methodology, we thought,

00:20:31.080 | was best in class.

00:20:32.640 | MSCI is still really, really good in terms--

00:20:35.000 | we use it for the sector funds.

00:20:36.480 | But as I mentioned, a lot of the indexes

00:20:38.280 | have become somewhat commoditized now.

00:20:41.480 | So you've got 3,800 US stocks in the CRISP index, of which

00:20:48.240 | you own all 3,800?

00:20:51.120 | Give or take.

00:20:51.680 | Yeah, there may be some at the very bottom decile that

00:20:54.120 | just trade by appointment.

00:20:56.320 | That's where I actually want to go to.

00:20:58.680 | So how many of these 3,800 stocks are actually liquid?

00:21:02.520 | You could go out to the market.

00:21:03.880 | You can buy them.

00:21:05.400 | And how do you handle those trades?

00:21:07.640 | And then how many of them are illiquid,

00:21:10.360 | where you've got to handle them differently,

00:21:12.640 | and then explain that process?

00:21:14.160 | Yeah, great question.

00:21:15.440 | So I would say the top 1,500 names, very liquid.

00:21:20.760 | No issues at all trading them.

00:21:22.320 | If you have a-- like that list I mentioned yesterday

00:21:25.320 | for Activision, when we had to spend all the cash from it.

00:21:28.120 | When I generated a trade list around 3 o'clock yesterday,

00:21:30.560 | I think I had 1,400 names, and very, very liquid names.

00:21:36.480 | The issue and the names that I spend most of the time trading

00:21:42.720 | are the tail, the exact names that you

00:21:44.800 | referred to, Rick, which are the ones in the bottom,

00:21:46.960 | say, three deciles, 7, 8, 9, and 10,

00:21:49.600 | the ones that are very difficult.

00:21:51.000 | And what we do there is, every Monday morning, we'll come in.

00:21:53.560 | I'll run a $200 million list of those names that are--

00:21:56.640 | so we have the ability to basically say,

00:21:58.920 | on our trading platform, to say, I want to generate a trade list,

00:22:02.280 | but I want you to focus on the bottom four deciles.

00:22:05.200 | And by deciles, you mean-- so we rank them 1 through 10,

00:22:08.600 | the ones that are the most liquid.

00:22:10.160 | Apple would be up in decile 1, all the way down to the bottom.

00:22:13.320 | And then focus on those.

00:22:15.040 | And those are the names that are really bad.

00:22:16.880 | And then what we do is we break it up between five or six

00:22:19.080 | traders.

00:22:19.580 | So every trader gets 40 or 50 names.

00:22:21.760 | And we keep them out there for the entire week.

00:22:23.720 | And I tell the traders, let's be opportunistic.

00:22:26.120 | So in the US, we have 16 different exchanges.

00:22:29.320 | We have 40 pools of liquidity.

00:22:31.200 | So it's a little bit like whack-a-mole when you're trying

00:22:33.240 | to trade one of these names.

00:22:34.400 | You don't know where the seller is at.

00:22:36.240 | We have access to brokers who focus just

00:22:39.020 | on illiquid small cap names.

00:22:41.120 | We have-- we'll run these names through all sorts

00:22:44.240 | of dark pools, ATSs.

00:22:47.240 | If a broker happens to be doing a small cap rebalance where

00:22:51.680 | maybe a manager is getting out of some small cap names,

00:22:55.440 | they might call and say, hey, we've

00:22:56.940 | got a lot of small caps on our pad today

00:22:58.600 | and see if we can get a match with those names.

00:23:00.720 | And for the entire five days, we'll just focus on those.

00:23:04.460 | And then the bigger names, Rick, those

00:23:06.040 | are the names that we will, if we have a trade list,

00:23:08.920 | cash coming into the fund around 3 o'clock

00:23:11.200 | is when we'll generate a trade list.

00:23:12.700 | That's when we're buying the Apples, Microsofts.

00:23:15.320 | And those are the easy names to trade.

00:23:16.920 | It also is very nice that the most liquid time

00:23:20.320 | of the day in the market is that last 45 minutes.

00:23:23.460 | I think 25% of the total day's volume

00:23:25.680 | is in that last 25 minutes.

00:23:26.880 | So you're trading when the spreads are the narrowest

00:23:30.280 | and the top-of-the-book liquidity is at its greatest.

00:23:32.840 | So it is very easy to trade in that type of environment.

00:23:35.540 | But that's kind of how we get the exposure to the small cap,

00:23:38.080 | running that list and then being opportunistic if there

00:23:41.320 | are small caps available.

00:23:42.480 | And those are names we'd be happy to get an execution

00:23:44.680 | at 10, 30, 11 in the morning.

00:23:45.920 | It doesn't matter.

00:23:46.680 | Because they're such tiny names in the index,

00:23:48.880 | it's not really going to impact at all.

00:23:51.120 | Let me ask a question about new issues, IPOs,

00:23:53.800 | brand new companies coming to the market.

00:23:55.560 | Now, they don't go right into the index right away.

00:23:57.800 | That's right.

00:23:58.320 | It takes a little bit of time.

00:23:59.600 | Like you said, Chris adds them periodically.

00:24:04.000 | Yeah, so on that, Rick, if it's large enough,

00:24:08.560 | Chris will add it in five days.

00:24:10.960 | Five days for a large IPO.

00:24:13.520 | And that's incredible, because back in the day,

00:24:16.640 | it sometimes would be three months, six months.

00:24:19.240 | And considering our size, if you have the ability,

00:24:22.400 | there is this massive liquidity event when an IPO happens.

00:24:27.760 | And you probably saw it this week with Birkenstocks,

00:24:30.480 | even though it wasn't added to any of the indexes,

00:24:32.560 | because it doesn't have a US domicile,

00:24:35.160 | or it's not incorporated in the US.

00:24:37.040 | So I'm not sure where it's going to end up.

00:24:39.120 | But you have this massive volume rush.

00:24:42.560 | And to be able to trade in that is really beneficial,

00:24:45.480 | because you're not going to have impact if you have size to do.

00:24:48.160 | But if that name gets added to an index in six months,

00:24:50.760 | when the volume has kind of dropped off,

00:24:53.160 | you potentially could have a lot of impact.

00:24:55.160 | So Chris adds within five days.

00:24:57.600 | And then some of the other index providers,

00:24:59.440 | you might have to wait until the next rebalance.

00:25:01.400 | And now it might be December before an IPO would get added.

00:25:05.480 | 2023, 2022, relatively quiet times on syndicate and IPO.

00:25:10.520 | Back in 2022, we participated in over 400 syndicate offerings

00:25:16.680 | and added over $350 million worth of value

00:25:19.760 | added to the portfolios by participating

00:25:22.400 | in syndicate and IPOs.

00:25:24.840 | So I want to understand this.

00:25:27.680 | When an IPO is coming out, you get the roadshow.

00:25:31.320 | And Vanguard, can you buy on the IPO at the IPO price Vanguard?

00:25:40.760 | But does it go into index funds, or does it go somewhere else?

00:25:44.960 | No, good question.

00:25:45.880 | So if it's a large IPO that it's getting added in five days,

00:25:50.640 | we will potentially go in for a piece of it.

00:25:53.160 | In the fund itself?

00:25:54.120 | In the fund itself.

00:25:55.080 | Even before it's in the index?

00:25:55.800 | It has not been added to the index yet.

00:25:57.460 | Now, we know it's going to be added in five days.

00:26:00.280 | Now, do we go in for the full amount?

00:26:02.640 | Absolutely not.

00:26:03.440 | We might go in for a small portion of our order

00:26:05.440 | and take advantage of the IPO price.

00:26:06.920 | Now, it's not an automatic, hey, there's an IPO coming.

00:26:10.120 | You guys are going to go in on it.

00:26:11.560 | We do analysis of it to see how many times oversubscribed

00:26:14.560 | it might be.

00:26:15.600 | If it's an IPO that feels like it's going to be a little flat,

00:26:18.760 | we're not going to have any part of it.

00:26:20.380 | But if it's multiple times oversubscribed,

00:26:22.800 | then we have the ability to go in on the IPO.

00:26:24.880 | We will go in for a portion of our order,

00:26:26.760 | knowing that the bulk of our order

00:26:28.300 | is going to be bought in five days time

00:26:29.920 | when it goes into the index.

00:26:31.240 | But wasn't this active management?

00:26:33.200 | No.

00:26:35.160 | We see this as a value-add strategy,

00:26:39.000 | as long as it's done in a risk-controlled manner.

00:26:41.720 | But nice try, Rick.

00:26:46.000 | Well, I was always wondering about big IPOs.

00:26:48.120 | I know they're going to go into the index.

00:26:49.960 | And I know that a lot of them pop

00:26:52.800 | as soon as they start trading in the secondary market.

00:26:56.080 | And I was like, gee, are we able to participate in that

00:27:00.960 | through indexing, even though they're not in the index set?

00:27:03.880 | And your answer is, sometimes, at the discretion of Vanguard.

00:27:07.200 | Right, and it would be--

00:27:08.560 | I mean, sometimes, you could put in for a large order.

00:27:11.440 | You might get a very tiny piece of what you're looking for,

00:27:14.520 | just because of it.

00:27:16.040 | But yeah, you do have the ability to go in on them,

00:27:18.200 | especially if they're getting at it.

00:27:19.360 | Now, if an IPO is not getting at it for three or four months,

00:27:21.960 | that's a whole different story.

00:27:23.560 | Well, let me ask a question about this, then.

00:27:25.480 | So you're going to get a share of the IPO

00:27:27.720 | that you know is probably going to pop, and you like it.

00:27:31.000 | It's oversubscribed by however many times

00:27:33.320 | it needs to be oversubscribed for you to like it.

00:27:37.400 | But you have all these different funds out there.

00:27:40.960 | How do you decide who gets it?

00:27:44.360 | Yeah, so we prorate it, basically.

00:27:46.480 | Oh, you do.

00:27:46.980 | You do prorate it across all of the-- so for example,

00:27:49.320 | if it's crisp, and we know it's getting at it in five days,

00:27:52.360 | we're going to know, based on the size of the company,

00:27:54.640 | is it going to be small, is it going to be mid?

00:27:57.160 | And based on that, the good thing about total stock

00:28:00.040 | is it's almost involved in every one of them,

00:28:01.920 | because it is the entire market.

00:28:03.880 | But in terms of total stock, if it's small cap, small growth,

00:28:09.240 | they all get a portion of it.

00:28:10.700 | It all gets--

00:28:11.200 | Based on the size of the fund?

00:28:12.120 | Based on the size of the fund and the weight in the end.

00:28:13.760 | Yeah.

00:28:14.520 | All right.

00:28:15.360 | Well, you know, I know you use some derivatives

00:28:19.760 | during the day.

00:28:20.440 | Like, at the end of the day, you have a lot of cash.

00:28:23.120 | You need to equitize that cash.

00:28:24.960 | Talk with us about how you might use the futures markets

00:28:29.200 | versus the cash markets to square up your portfolio,

00:28:35.240 | if you will, by the end of the day.

00:28:37.000 | So futures are incredibly helpful.

00:28:39.520 | Now, I would say, ideally, we hold no more than maybe 30,

00:28:45.640 | 35 basis points worth of futures in total stock market.

00:28:49.680 | And the reason we use futures is multiple reasons.

00:28:52.920 | Number one, when stocks go ex-dividend--

00:28:56.240 | so say, for example, today is a Monday,

00:28:57.880 | and a stock goes ex-dividend tonight,

00:28:59.960 | we need to spend that ex-dividend amount

00:29:02.160 | on the close.

00:29:02.760 | And some days in total stock market,

00:29:04.260 | that can be $200, $300 million worth

00:29:06.400 | of names in the portfolio that are going ex-dividend.

00:29:09.240 | We need to spend that.

00:29:11.200 | The difference between ex-date and payable date

00:29:13.640 | can sometimes be two, three weeks.

00:29:15.680 | So it goes ex-today.

00:29:17.320 | We don't get paid for three weeks.

00:29:19.320 | If we had no futures in the fund,

00:29:21.680 | and we spent the ex-dividend, it's

00:29:23.280 | no different than if you guys spent money

00:29:25.000 | you didn't have in your bank account.

00:29:26.540 | You get hit with overdraft charges.

00:29:27.960 | And when rates were zero, overdraft charges

00:29:30.260 | were no big deal, right?

00:29:31.600 | But now that rates are 5%, 5.5%, the banks are coming back

00:29:35.160 | and say, hey, you overdraft.

00:29:36.600 | Here's what you owe us, because you spent money

00:29:38.680 | that you didn't have in your account.

00:29:40.120 | The beauty of the futures is that they kind of give you

00:29:42.620 | a cash cushion in your fund that allows

00:29:47.640 | you to spend the dividends without overdrafting.

00:29:49.800 | So that's one of the nice things about it.

00:29:51.560 | The other thing is that, believe it or not,

00:29:53.440 | we get calls at 358 to say, you either have cash

00:29:56.920 | in or out of your portfolio.

00:29:59.360 | It's physically not possible to generate a trade list

00:30:01.760 | and get it down to the floor in two minutes.

00:30:04.000 | Who do the calls come from?

00:30:05.640 | Within Vanguard, we have a large transaction area.

00:30:10.040 | So any institution maybe that was bringing cash in,

00:30:14.040 | it would get funneled through.

00:30:15.280 | And then we would get notified, hey--

00:30:17.160 | And you wouldn't get notified until two minutes

00:30:18.720 | before the market closes.

00:30:19.480 | It has happened.

00:30:20.180 | Now, do we ask for that?

00:30:21.680 | No, we say, hey, listen, please let us know by 3 o'clock.

00:30:24.680 | But it does happen.

00:30:26.400 | If it's a large purchase into the portfolio,

00:30:28.960 | we have the right to reject it.

00:30:30.280 | If we don't think we can equitize it in time

00:30:32.240 | and get it in, we have the right to say no.

00:30:34.080 | We cannot say no to a redemption,

00:30:36.760 | so a redemption we have to honor.

00:30:38.520 | So if we had a redemption in a fund,

00:30:41.140 | one of the nice things about having futures in the fund

00:30:43.440 | that we can sell futures.

00:30:45.120 | So I can sell the futures to fund that redemption that

00:30:47.440 | was called in late in the day.

00:30:49.840 | We also use futures if you're just trading

00:30:52.200 | and you have a rebalance where you have buys and sells,

00:30:54.560 | and you're trying to stay market neutral.

00:30:56.400 | If one side gets ahead of the other,

00:30:57.860 | say your buys are very liquid, your sells are not so liquid,

00:31:01.920 | you can sell futures to keep yourself

00:31:03.600 | dollar neutral in terms of trading in the market.

00:31:05.720 | So they are a great tool to have in terms of trading.

00:31:10.920 | But it is a small portion of the overall holdings in the fund.

00:31:15.240 | So it sounds like you've got a busy day.

00:31:16.920 | What I'd like you to do, if you could, for us,

00:31:19.680 | is walk through a typical day.

00:31:24.840 | You get in in the morning, or maybe you've

00:31:26.520 | thought about it on the way in.

00:31:29.000 | What does your day look like from when you get in,

00:31:32.400 | what time you get in, all the way through until you leave

00:31:35.360 | at whatever time you leave?

00:31:37.240 | Yeah, so one of the ways that you have really tight tracking

00:31:42.040 | is to make sure that you're 100% invested at all times.

00:31:45.880 | In addition to having the exact weights in your fund

00:31:48.160 | to the benchmark, you need to make sure

00:31:50.360 | that your fund, you're sitting on--

00:31:52.320 | when you come in in the morning, in an ideal situation,

00:31:55.320 | your fund says zero in terms of your liquidity.

00:31:58.200 | It never happens.

00:32:00.040 | You're either sitting on $10 or $15 million,

00:32:01.960 | or you're over-invested.

00:32:03.080 | So the first thing you do is tie out all of the activity that

00:32:06.920 | got processed overnight.

00:32:08.120 | Does it make sense that my fund is sitting where

00:32:10.280 | it should be in the morning?

00:32:11.840 | And I will sign off on that as the portfolio manager.

00:32:14.880 | And then we have someone from our risk area

00:32:16.720 | that will sign off on that.

00:32:17.840 | And then we have somebody on the desk

00:32:20.160 | that is basically overseas, a desk supervisor,

00:32:24.600 | to make sure that all of the index changes,

00:32:27.240 | all of the cash flow is got.

00:32:28.480 | So there's three sets of eyes that will sign off

00:32:30.520 | on my portfolios in the morning.

00:32:31.920 | That's generally completed by about 9 o'clock, 9:15.

00:32:35.880 | Before I even get in, there is a team

00:32:38.480 | from our data team that pulls in all the indexes from all

00:32:41.600 | the different index providers.

00:32:43.200 | And they make sure that the indexes that I'm looking at

00:32:45.480 | on my screen when I log in are exactly the same indexes

00:32:48.920 | that CRISP is giving out, that S&P is giving out,

00:32:51.120 | so that we know that, foundationally, we're

00:32:53.080 | tracking the right benchmark.

00:32:54.400 | And there are numerous corporate actions,

00:32:56.680 | splits, reverse splits, all kinds

00:32:58.920 | of things that might be happening that those indexes

00:33:01.320 | need to account for.

00:33:02.200 | And making sure that our indexes are good

00:33:04.200 | is really, really important.

00:33:06.160 | So when we tie out everything by 9 o'clock, 9:15, market opens.

00:33:11.520 | And then we start thinking about what's happening today.

00:33:14.440 | And so we have notifications that come out

00:33:17.240 | from CRISP, from S&P, from FTSE, from Russell, saying, hey,

00:33:20.200 | here are index changes that are happening on the close tonight.

00:33:23.560 | And our goal then, Rick, will be to make sure

00:33:25.600 | that we position those portfolios to make sure

00:33:27.560 | that at 4 o'clock, our funds are identical to the index.

00:33:31.200 | Any index changes that are happening,

00:33:32.960 | any syndicate offerings that might have happened overnight,

00:33:35.560 | we factor those in.

00:33:37.280 | Any Dutch tenders, any kind of corporate actions,

00:33:40.360 | all of that over the course of the day is--

00:33:44.160 | we'll have meetings about--

00:33:45.880 | we do a-- we generally will have one person on the desk

00:33:50.360 | becomes kind of the quarterback for a particular index change.

00:33:54.040 | So all of the information where brokers are calling us

00:33:56.280 | to say, hey, we know there's an increase in the shares tonight.

00:33:59.160 | We have a seller of this name.

00:34:00.400 | You funnel that all to whoever happens

00:34:02.120 | to be the trader that is responsible for that.

00:34:04.680 | So that person kind of becomes the expert.

00:34:07.080 | And before you know it, it's 9:30, and all of a sudden,

00:34:10.160 | it's 3:30, and we're getting ready to send trade lists down

00:34:13.200 | to the floor.

00:34:15.040 | And in between, we'll have meetings.

00:34:17.080 | We have-- I'm on a number of committees.

00:34:19.800 | For example, ITAC committees with New York,

00:34:21.600 | with NASDAQ, market structure-type issues

00:34:24.560 | that might be coming up over the course of a day.

00:34:27.400 | So there's-- it's incredibly--

00:34:30.640 | no day-- no two days are the same.

00:34:33.200 | So even though there might be things

00:34:35.200 | that you think you have to do when you come into work,

00:34:36.680 | like I mentioned yesterday with Activision,

00:34:38.560 | that was unexpected.

00:34:39.360 | I think most people thought it was going to close next week.

00:34:42.040 | But all of a sudden, yesterday I come in, and we have 20 of us

00:34:45.480 | huddled around the table at 8 o'clock in the morning,

00:34:47.760 | figure out, how do we handle this index change tonight?

00:34:51.200 | And what are the repercussions across all our portfolios?

00:34:53.920 | And before you know it, you're getting ready to trade at 3

00:34:56.360 | o'clock.

00:34:58.040 | Well, I'm going to--

00:34:58.880 | I have one more question, but before I do that,

00:35:01.160 | if people in the audience have questions--

00:35:03.160 | Mel, where's Mel?

00:35:04.520 | Mel?

00:35:05.120 | There's Mel.

00:35:06.720 | You could hand your question that you have.

00:35:09.280 | Just write it down on a piece of paper.

00:35:10.920 | Hand it to Mel, because we do have 10 minutes for Q&A

00:35:16.000 | at the end from the audience.

00:35:17.280 | So there is Mel.

00:35:18.400 | He can get up.

00:35:19.920 | Mel, get up.

00:35:20.800 | And walk around.

00:35:23.280 | And hand him your question.

00:35:24.600 | OK, so here we go with the last question.

00:35:27.880 | You know, indexing is an evil, evil thing.

00:35:31.640 | At least that's what the media says.

00:35:33.640 | It's worse than Marxism, I understand.

00:35:37.080 | I mean, you control the universe, right?

00:35:40.400 | I mean, you could bring down the entire financial system.

00:35:44.400 | But what do you say to these critics?

00:35:46.440 | Well, I would say, listen, think about all of the benefits

00:35:52.800 | that indexing has brought to investors.

00:35:54.920 | I think since 1993 up through 2021,

00:35:59.000 | I think I've seen estimates.

00:36:00.800 | Mike shared with me $334 billion worth of savings to investors

00:36:05.480 | when you compare the expense ratios of index funds

00:36:09.040 | versus some of the more higher active funds.

00:36:13.160 | So incredible benefits.

00:36:16.360 | There are just so many advantages

00:36:18.520 | that I see with indexing in terms of the low cost,

00:36:22.080 | the low turnover, helping people save.

00:36:25.000 | I mean, I've had so many good conversations, probably

00:36:27.260 | with some of the people in this audience,

00:36:28.640 | when bogleheads used to come, when you would come to campus,

00:36:31.920 | about people telling me, hey, I worked in this job

00:36:35.120 | for whatever number of years.

00:36:37.000 | And I put money away, and I've been in total stock.

00:36:39.080 | I've been in index 500.

00:36:40.160 | I've been in your total bond.

00:36:41.360 | I've been in your total international.

00:36:43.200 | And I'm going to be retiring at 52 years of age.

00:36:46.160 | And I can't tell you how good that feels.

00:36:48.960 | So it does irk me a little bit when

00:36:50.440 | I hear people bashing indexing.

00:36:52.360 | Because I look at all the benefits that it's brought.

00:36:54.920 | And listen, we have all the assets

00:36:57.360 | that you talked about, Rick.

00:36:58.600 | But at the end of the day, it's this audience.

00:37:01.600 | It's your money that we are managing.

00:37:03.200 | And we are incredibly privileged to be

00:37:05.120 | in a position to manage the money for investors like you.

00:37:08.280 | And we have 50 million shareholders

00:37:10.000 | that we take that incredibly seriously.

00:37:14.960 | The argument-- I've heard that indexing,

00:37:17.840 | it doesn't really contribute to price discovery.

00:37:20.400 | So that potentially, you would say, well,

00:37:24.440 | if there are disparities in price,

00:37:27.920 | it should be a gold mine for active managers.

00:37:30.080 | It should be so much easier for you to outperform.

00:37:33.280 | And we haven't seen that.

00:37:34.320 | It's incredibly difficult to outperform the markets.

00:37:36.960 | It's a zero-sum game.

00:37:38.040 | For every dollar that outperforms

00:37:39.560 | is a dollar underperforming.

00:37:40.720 | And when you factor in cost, it's just incredibly difficult

00:37:43.400 | to outperform.

00:37:44.520 | And I think a lot of these articles that have come out

00:37:47.200 | bashing indexing, I think if you dug a few layers,

00:37:52.520 | if you peeled a few layers, I think

00:37:54.280 | you'd find that there are people probably not happy

00:37:56.440 | that they're losing money.

00:37:59.160 | You look at the cash flows.

00:38:00.640 | Investors understand, if we look at where the net cash flows

00:38:04.600 | have come, it's to that lowest quartile of expenses.

00:38:10.160 | $1.5 trillion has come in since the '90s,

00:38:13.160 | whereas if you look at the two, three, and four quartiles

00:38:15.880 | in terms of expenses, that has been a net outflow

00:38:18.920 | of $1.6 trillion.

00:38:20.280 | So investors understand that, as Mr. Bogle used to say,

00:38:24.240 | you get what you don't pay for, right?

00:38:27.400 | So we're very proud of what we have.

00:38:30.600 | We understand what a privileged position

00:38:33.040 | we have to manage money for 50 million-odd investors.

00:38:37.480 | And yeah, we think indexing has a long way to go.

00:38:40.760 | Yeah, Rick.

00:38:41.400 | So while Mel is making his way up to the podium--

00:38:44.280 | Make your way up to the podium, Mel.

00:38:47.360 | Got one last question.

00:38:49.720 | You told me this in an interview that I did with you

00:38:51.800 | on the Bogle Heads on Investing podcast

00:38:53.600 | that it's a misnomer that index funds are

00:38:56.400 | doing a lot of trading.

00:38:57.360 | In fact, you trade very little amount

00:38:59.520 | of the shares that are actually traded on a daily basis.

00:39:02.480 | Could you just hit on that one?

00:39:03.800 | Yeah, absolutely.

00:39:04.800 | So if you look just a normal day,

00:39:06.960 | probably index strategies account for less than 5%

00:39:10.640 | of the trading that's out there.

00:39:13.000 | Even yesterday, when I mentioned Activision--

00:39:15.360 | and let's say Total Stock wasn't the only fund that was trading,

00:39:19.240 | but maybe in total, our desk might have traded

00:39:21.280 | around $3 billion yesterday.

00:39:25.120 | That sounds like a ton of money, and it is.

00:39:28.320 | But over the entire stock market,

00:39:31.520 | if you look at what traded yesterday for stocks

00:39:35.360 | and for ETFs, it's probably in the $600 to $700 billion.

00:39:39.840 | So that $3 billion is less than half a percent

00:39:43.840 | of the average volume.

00:39:45.920 | So one of the really good things about indexing, Rick,

00:39:49.000 | and we talked about it on your podcast, was the low turnover.

00:39:52.400 | So even Total Stock, which is, as you mentioned,

00:39:54.520 | the largest fund, when I have rebalances, they're small.

00:40:00.000 | So the total turnover is less than 10%.

00:40:03.360 | So turnover is the average assets.

00:40:05.920 | If you look at the lesser of buys and sells

00:40:08.520 | divided by the average assets in the fund,

00:40:10.800 | it tends to be below 10% a year.

00:40:13.600 | Active managers, you can have turnover 70%, 80%.

00:40:18.160 | And believe me, that's not a tailwind.

00:40:20.080 | When you're turning over a portfolio like that,

00:40:22.720 | you're incurring transaction costs, commissions, taxes.

00:40:28.680 | And we really don't trade unless we have to trade.

00:40:32.600 | And so one of the beauties of indexing

00:40:35.480 | is the fact, Rick, that you do have such low turnover,

00:40:38.080 | incredibly tax efficient.

00:40:39.800 | And it's a tough benchmark to outperform.

00:40:44.720 | I got a lot of questions in a lot of different areas.

00:40:47.000 | I will say that I'm just going to ask Jerry the questions that

00:40:51.440 | actually pertain to him.

00:40:54.600 | Questions like, will this be available by Vanguard?

00:40:58.320 | Or is Vanguard going to start offering this fund or that fund?

00:41:01.920 | He wouldn't know, honestly.

00:41:03.600 | And I'm not going to do that.

00:41:05.760 | So I'm kind of trying to stick with his area here.

00:41:10.760 | So first of all, do you also, on your desk,

00:41:17.960 | do international stocks?

00:41:20.560 | So the way our desk-- we have about 25 people on the desk.

00:41:23.720 | And it's roughly 13 on the domestic side

00:41:26.560 | and 12 on the international.

00:41:27.760 | So we kind of have dollar, which is the side that I'm on.

00:41:30.920 | And then we have non-dollar, which

00:41:32.640 | people like Mike Perry and Jeff Miller and Christine

00:41:35.800 | Franquan are the people who would

00:41:37.920 | focus on the international side of things.

00:41:40.160 | And that side of the desk does a ton

00:41:42.080 | of work with our trading desks in London

00:41:45.560 | and also in Australia.

00:41:46.720 | So if they have European names that they're trading,

00:41:49.120 | they're sending those to the London desk and trading.

00:41:52.160 | And we have about 12 traders in London,

00:41:55.080 | similar amount of traders in Melbourne.

00:41:57.160 | And the Melbourne traders, those guys

00:42:00.120 | would trade all of the Asia-Pac names that we're trading.

00:42:02.640 | So over the course, we have this concept

00:42:06.540 | of kind of past the book.

00:42:08.440 | So we'll generate a trade list in Melbourne,

00:42:11.880 | send it out to our Melbourne desk.

00:42:14.440 | They will trade the Asia-Pac names.

00:42:15.960 | When they're done trading that, they

00:42:17.500 | will pass it on to the European desk in the UK.

00:42:21.640 | Europe is done.

00:42:22.480 | They will send it back to us.

00:42:24.320 | And the international side of the desk

00:42:26.000 | then will trade Canada, LATAM, those types

00:42:28.160 | names in a global portfolio.

00:42:29.560 | So we do have an international side.

00:42:31.080 | I just don't happen to be on that side.

00:42:32.380 | I'm on the domestic side.

00:42:36.040 | And on the international side, do they

00:42:39.360 | go through the same process that you go through on the US side,

00:42:42.020 | as far as when they're trading and so forth?

00:42:43.820 | Yeah.

00:42:44.320 | I mean, they would interact.

00:42:45.960 | There's probably more trading done on the domestic side,

00:42:48.600 | because on the international side,

00:42:50.000 | they're generating trade lists.

00:42:51.560 | But then they're sending the trade lists

00:42:53.520 | to the desk, to the local coverage in London

00:42:56.680 | for European names and for Asia-Pac.

00:42:59.000 | But the concepts would be the same.

00:43:00.680 | The risk metrics, all that kind of stuff

00:43:02.220 | would be very, very similar.

00:43:03.200 | Yeah.

00:43:03.400 | So this, I know, is not in your area.

00:43:04.680 | But I'm going to ask it.

00:43:05.680 | It has to do with voting proxies and Vanguard, BlackRock,

00:43:15.400 | State Street, all being the big three.

00:43:20.400 | When you're out there trading stocks,

00:43:22.040 | do you run into BlackRock trying to do the same thing

00:43:24.880 | and State Street trying to do the same thing?

00:43:27.280 | There's three big index providers out there.

00:43:29.240 | And you're all trying to jockey for the same stocks

00:43:31.360 | at the same time.

00:43:32.480 | Do you see those trades out there?

00:43:33.920 | I mean, how does that affect your trading?

00:43:36.040 | Well, if you think--

00:43:37.900 | so I'll give you an example, Rick.

00:43:39.360 | So we mentioned Activision last night, right?

00:43:41.760 | So it got deleted.

00:43:43.880 | S&P announced that they are going

00:43:47.560 | to replace Activision in the 500 next Tuesday by Lululemon.

00:43:52.360 | So there's going to be lots of Lululemon

00:43:54.020 | that need to be bought.

00:43:55.080 | And we know that it's probably net.

00:43:56.960 | If you factor in all the folks that you mentioned,

00:43:59.400 | Vanguard, BlackRock, State Street,

00:44:00.820 | everyone else that manages 500, there's

00:44:02.960 | probably 18 million-odd shares of Lululemon

00:44:05.640 | that will need to be bought.

00:44:07.720 | Now, brokers make a living out of predicting

00:44:11.240 | which names they think is going to be added to the index.

00:44:13.640 | So Lululemon has been on the list for probably a year now.

00:44:18.120 | We know that, in total, we know how much needs to be bought.

00:44:21.680 | And we will put together a strategy on Monday morning

00:44:25.140 | about, of the total that needs to be bought,

00:44:27.680 | we know what we represent.

00:44:29.300 | And we can look at the volume numbers

00:44:30.840 | and start to see, OK, it looks like there's

00:44:33.720 | people that are starting to front run the order,

00:44:37.880 | try and get ahead of the indexing demand for Tuesday.

00:44:41.160 | And some of those may be competitors.

00:44:43.200 | Some of those might be hedge funds.

00:44:45.240 | And all of that gets built into the strategy in terms of,

00:44:48.120 | how are we going to buy Lululemon for our 500

00:44:50.720 | portfolios?

00:44:51.880 | But yeah, you're fully aware of it's

00:44:54.000 | all out there in terms of the holdings and the assets.

00:44:56.360 | So we know, as they know what we have to buy.

00:44:59.880 | And then it just comes down to the desk itself

00:45:02.040 | in terms of the traders, the experience, the strategies.

00:45:05.520 | And we feel really good about the position that we're in.

00:45:08.680 | I've been on the desk.

00:45:09.720 | I've been at Vanguard 31, on the desk about 28.

00:45:13.040 | Don Butler is about the same.

00:45:14.920 | We have probably-- we understand the different strategies

00:45:18.280 | involved.

00:45:19.960 | And it's our goal to make sure that when a name like Lululemon

00:45:23.720 | gets added, that we do it in a way

00:45:25.760 | that we feel we can potentially add a little bit of value

00:45:29.480 | add to the portfolios, but making sure, above all,

00:45:32.320 | that we track the benchmark closely.

00:45:34.560 | And on that point, I've noticed that you're actually

00:45:36.800 | able to make up some of the basis points.

00:45:39.680 | In other words, if the ETF is three basis points,

00:45:42.040 | you actually outperform.

00:45:43.640 | Yeah, so this year, year to date, I think we're--

00:45:46.240 | More active management, by the way.

00:45:47.680 | Go ahead.

00:45:49.520 | I think-- so if you think about it,

00:45:52.720 | we would call it value add, right?

00:45:54.440 | So if you think about it, so the expense ratio on VTI

00:45:57.440 | is three basis points.

00:45:58.880 | The value add, year to date, is about 3 and 1/2.

00:46:02.080 | And so it's a combination of some

00:46:03.960 | of the things we talked about.

00:46:05.240 | Some of it is syndicate.

00:46:06.600 | Some of it is complex corporate actions.

00:46:09.480 | For example, there was one large one a few weeks ago.

00:46:12.040 | Johnson & Johnson spun off KVUE.

00:46:15.280 | We were able to handle that action in such a way

00:46:18.520 | that we added $190 million to the funds in terms

00:46:22.320 | of how we handled the spinoff, how we elected shares,

00:46:26.680 | and how we traded around it.

00:46:28.360 | That moved the dial a little on some port--

00:46:30.840 | not quite a basis point in total stock,

00:46:33.080 | but somewhere between 0.6, 0.7 of a basis point.

00:46:36.840 | So those types of strategies.

00:46:41.880 | Also, our SEC lending.

00:46:43.400 | Our SEC lending is securities lending.

00:46:45.240 | So you think about a broker wants to short a stock.

00:46:48.560 | They need to get a locate.

00:46:49.680 | They'll come to a company like Vanguard and say, hey,

00:46:51.840 | can we borrow x number of shares?

00:46:53.980 | And they will give us collateral.

00:46:56.160 | We then can invest that collateral.

00:46:58.320 | And sometimes it's incredibly lucrative.

00:47:00.640 | So you're probably familiar with AMC movie theaters.

00:47:05.360 | They had a complex corporate action going on this year

00:47:08.720 | that everyone was looking to borrow AMC to the tune

00:47:13.600 | of it added some massive amounts of money to our shareholders.

00:47:18.840 | Now, we're a little different, I think,

00:47:20.880 | in that our securities lending, it

00:47:23.880 | cost a certain amount of dollars for that group to run.

00:47:26.200 | But all of the money that comes in through SEC lending,

00:47:29.720 | take out whatever it takes to run that group.

00:47:31.800 | The rest of that money goes directly

00:47:33.600 | to the funds that loaned it out.

00:47:35.400 | There's no company or management company

00:47:39.120 | keeping a portion of that to make sure their stock price

00:47:41.600 | remains at a certain level.

00:47:42.760 | It goes directly back to the shareholders.

00:47:44.680 | So you have a situation where, in total stock,

00:47:47.200 | close to two basis points this year

00:47:48.660 | has come from SEC lending.

00:47:51.560 | Extended market, it's 15 basis points

00:47:55.280 | has come from SEC lending.

00:47:56.440 | A lot of it is related to that AMC

00:47:58.000 | because it was so lucrative.

00:48:00.400 | But that group, this year, has brought in over $1 billion

00:48:03.840 | to Vanguard in terms of loaning out securities.

00:48:06.160 | And that money has gone back to help offset the expense ratio.

00:48:09.320 | 100% less the cost of the group.

00:48:10.760 | Less the cost, yes.

00:48:11.560 | Which is different than other index fund providers

00:48:13.640 | where they keep 50% of it.

00:48:16.200 | You only give the shareholders 50%.

00:48:19.080 | And so in the end, I made this comment yesterday in another--

00:48:22.200 | I said beta is free.

00:48:24.840 | Beta is free.

00:48:26.320 | And you're confirming that.

00:48:28.040 | Yeah, I mean, if you own VTI this year,

00:48:29.960 | in fact, you're getting a free lunch.

00:48:31.880 | Free lunch.

00:48:32.480 | Yeah.

00:48:32.980 | Well, thank you.

00:48:35.080 | I think that's all the time we have.

00:48:37.780 | Thank you, Jerry.

00:48:38.480 | It's been really fascinating.

00:48:39.640 | I really appreciate--

00:48:40.480 | Thank you.

00:48:41.240 | Thank you, Rick.

00:48:41.880 | --you coming in today.

00:48:42.820 | [APPLAUSE]

00:48:46.240 | Thank you, Rick.

00:48:47.040 | Anytime.

00:48:48.580 | [AUDIO OUT]

00:48:51.940 | [BLANK_AUDIO]

Bogleheads® Conference 2023 - A talk with Gerard O'Reilly, Mgr, Vanguard Ttl Stock Market Index Fund

Chapters