Bogleheads® Conference 2019 - Bill McNabb & Bill Bernstein Fireside Chat

00:00:00.000 | (silence)

00:00:02.160 | - This is a very sad day for me and for the Bogleheads.

00:00:15.000 | At this point in the conference,

00:00:17.120 | I'd normally be introducing Jack Bogle,

00:00:19.920 | who would then proceed to impart his words of wisdom

00:00:24.700 | on those of us in attendance.

00:00:27.320 | Today represents the first time in our event's

00:00:30.040 | 18 year history that we know in advance

00:00:32.560 | that Jack won't be joining us.

00:00:34.960 | However, I think that Jack is looking down on us

00:00:37.800 | and saying, "Keep the conference going.

00:00:40.140 | "I'm with you in spirit."

00:00:41.580 | Years ago in Las Vegas, Jack asked me

00:00:45.120 | if he could have an informal, non-scripted chat

00:00:48.400 | with Bill Bernstein.

00:00:49.920 | And we all know that what Jack wants, he gets.

00:00:52.580 | So that was the start of what I dubbed

00:00:55.400 | the Farside Chat with Jack and Bill.

00:00:58.500 | And it's continued as part of the conference agenda

00:01:00.920 | ever since then.

00:01:02.060 | Today, we're going to have a very special guest

00:01:05.680 | sit in for Jack and continue the Farside Chat.

00:01:09.420 | Bill McNabb is the former CEO and chairman of Vanguard,

00:01:14.400 | leading the firm for a decade until he stepped down

00:01:17.240 | as chairman at the end of last year.

00:01:19.360 | He assumed the role of CEO in 2008,

00:01:23.900 | just two weeks before the collapse of Lehman Brothers,

00:01:27.380 | which marked the beginning of the global financial crisis.

00:01:30.500 | Bill's consistent focus on doing the right thing for clients

00:01:34.480 | helped Vanguard, its crew, and its clients

00:01:37.520 | navigate one of the most economically tumultuous periods

00:01:40.920 | in the nation's history.

00:01:42.260 | During his tenure as CEO, Vanguard grew to serve

00:01:46.720 | more than 20 million investors around the world.

00:01:50.340 | And assets quadrupled from $1 trillion in 2008

00:01:54.780 | to more than 5 trillion at the end of 2018.

00:01:59.260 | He always attributed this success

00:02:01.840 | to putting clients' interests first

00:02:03.960 | and working hard to earn and maintain investors' trust.

00:02:08.800 | Today, Bill serves as chairman

00:02:10.280 | on the board of the Philadelphia Zoo

00:02:12.540 | and is a member of the board of directors

00:02:14.600 | of United Health Group and IBM.

00:02:18.020 | He's an active alumnus of Dartmouth College

00:02:20.760 | and the Wharton School of the University of Pennsylvania

00:02:23.680 | and was awarded an honorary doctorate

00:02:25.920 | from St. Joseph University.

00:02:27.640 | He continues to be an active member

00:02:30.160 | in the investment management industry,

00:02:32.040 | championing good governance practices

00:02:36.720 | among public companies.

00:02:38.280 | Please welcome Bill McDabb.

00:02:40.540 | (audience applauding)

00:02:43.880 | - Thank you.

00:02:44.880 | - And Bill McDabb's companion for this Fireside Chat

00:02:52.160 | is a retired neurologist

00:02:54.400 | who helped co-found Efficient Frontier Advisors.

00:02:57.680 | He's written a number of bestselling titles

00:02:59.680 | on both finance and economic history.

00:03:02.520 | He holds both a PhD in chemistry and an MD.

00:03:06.020 | Please welcome one of the brightest guys I know,

00:03:08.320 | Dr. Bill Bernstein.

00:03:09.960 | (audience applauding)

00:03:14.100 | - And how about it, guys?

00:03:16.500 | Everything is fair game except politics.

00:03:19.920 | (audience laughing)

00:03:21.540 | - Of course.

00:03:22.380 | Yeah, well, you know,

00:03:25.340 | we got three, four hours every year

00:03:29.780 | of the public Jack Bogle

00:03:31.980 | and it was quite an education.

00:03:35.300 | It was quite a personal and emotional experience.

00:03:38.660 | So we saw a lot of what I suspect was the public Jack,

00:03:41.920 | even in front of this group.

00:03:43.900 | What I'd like you to speak to, Bill,

00:03:46.780 | is what you saw as the private Jack,

00:03:50.780 | not only him personally,

00:03:52.000 | but what I'm really more interested in

00:03:53.940 | is what he told you about the capital markets

00:03:57.740 | and retirement investing

00:04:00.020 | and just investing in general for small investors

00:04:04.340 | that he might not have said in public.

00:04:06.820 | - Whoa.

00:04:08.020 | (audience laughing)

00:04:11.460 | We might be a couple of days here.

00:04:13.920 | First of all, Mel, thank you

00:04:15.280 | and thank all of you for being here.

00:04:17.520 | This is a very emotional time.

00:04:18.840 | I think we held a service for Jack in March on the campus

00:04:23.840 | and the entire company was tuned in

00:04:29.480 | and we actually were able to have all of Jack's successors,

00:04:34.480 | Jack Brennan, Tim Buckley, myself,

00:04:37.640 | as well as Jack's son, John, speak to the entire company.

00:04:41.900 | So you think about it,

00:04:42.740 | four generations of leadership represented.

00:04:44.660 | I can't think of another company in America

00:04:46.380 | where that could happen.

00:04:48.140 | And again, you've got to give Jack Bogle so much credit

00:04:51.700 | for sort of creating that legacy.

00:04:53.940 | So again, I know he is looking down.

00:04:56.620 | He would greatly appreciate seeing all of you here.

00:05:00.220 | Bill, I thought what I might do

00:05:02.420 | is I might start with just a couple of quick Bogle stories

00:05:05.540 | because I think they actually will give you a sense

00:05:07.880 | of the man, what it was like to work for him.

00:05:11.060 | And I tell this because the day we heard

00:05:15.480 | about Jack's passing, I happened to be on campus

00:05:17.740 | and I was walking, just walking around,

00:05:20.980 | just crisscrossing building to building.

00:05:23.620 | And I had so many different crew members come up

00:05:25.980 | and say something.

00:05:27.180 | And people I knew, I've worked at Vanguard for 33 years,

00:05:31.060 | so I know a lot of our crew,

00:05:33.220 | but there were also some folks I don't know and new people.

00:05:37.140 | And the most common question was,

00:05:39.700 | what are your favorite memories?

00:05:41.860 | What are your favorite memories?

00:05:43.140 | And there's a lot, but there were three

00:05:46.820 | that I sort of told on a repeated basis.

00:05:49.300 | So I thought I'd start with that

00:05:50.140 | and then we can delve into some of the more deeper questions

00:05:53.780 | about the markets and so forth.

00:05:55.060 | So I had the privilege of,

00:05:59.060 | I came to Philadelphia right after college

00:06:02.780 | to teach, I was teaching at a boys' school

00:06:04.980 | and coaching through sports.

00:06:07.300 | Sort of stumbled my way to Penn

00:06:10.420 | and sort of worked my way through Wharton.

00:06:13.060 | Went up to New York for a couple of years

00:06:14.580 | and was, frankly, pretty dissatisfied where I was working.

00:06:19.160 | I love the work, actually.

00:06:21.280 | I was an analyst working for what's now JPMorgan Chase,

00:06:24.560 | but I didn't like the culture.

00:06:25.460 | I didn't like a lot of the,

00:06:27.220 | I call it strategic direction.

00:06:28.580 | So I began to get itchy.

00:06:30.380 | My wife is from Philly.

00:06:31.500 | I love my time here.

00:06:33.100 | So we began thinking about coming back.

00:06:36.140 | Her family's all from here.

00:06:38.420 | And I got a call from a friend of mine

00:06:41.380 | from business school who had gone into executive search.

00:06:43.780 | He goes, "I've got sort of good news and bad news."

00:06:46.900 | And I said, "Well, give me the good news."

00:06:49.740 | And he said, "I've just been hired

00:06:50.900 | "by this little company you've probably never heard of,

00:06:54.040 | "Vanguard, to do a search and I think you'd be perfect."

00:06:57.200 | I'm like, "Well, what could the bad news be?"

00:06:59.020 | And he says, "It's not exactly the kind of role

00:07:02.540 | "you would envision yourself doing."

00:07:04.620 | And I said, "What do you mean?"

00:07:06.140 | He says, "Well, you know, you're doing leverage buyouts

00:07:09.060 | "and M&A transactions, all this fancy stuff

00:07:12.060 | "on Wall Street."

00:07:12.900 | He goes, "They're looking for a GIC product manager."

00:07:17.240 | (audience laughing)

00:07:18.420 | Now I'm gonna ask this audience.

00:07:19.260 | This audience is pretty,

00:07:20.620 | how many of you know what a GIC is?

00:07:23.060 | Yeah, all right, so almost a third.

00:07:26.340 | Guaranteed investment contract.

00:07:27.860 | It was kind of like a certificate of deposit, if you will,

00:07:31.300 | issued by an insurance company to a qualified plan.

00:07:34.340 | So it was the most popular option along with company stock

00:07:37.500 | in the early 401(k) days.

00:07:39.500 | And we were just getting into 401(k) business

00:07:41.540 | and we had just begun work there.

00:07:45.200 | And so Jack and others within Vanguard decided

00:07:50.200 | we needed to sort of beef up our efforts there

00:07:52.340 | if we were gonna be successful.

00:07:54.180 | I didn't know what it was.

00:07:55.700 | You know, it's before the internet.

00:07:56.960 | So I'm running around, going to libraries, looking it up.

00:07:59.660 | (audience laughing)

00:08:01.340 | Trying to find out stories.

00:08:04.300 | Anyway, I had to come down.

00:08:06.860 | And one thing that has not changed at Vanguard

00:08:10.000 | is we're very rigorous in our interview process.

00:08:12.860 | So I think I came three different times.

00:08:16.020 | Probably went through 20 some odd interviews.

00:08:18.260 | And remember, we were a few hundred people.

00:08:20.220 | And at that point, about 20 billion under management.

00:08:24.140 | And finally, the last interview,

00:08:25.860 | they're like, "We want you to meet the founder."

00:08:28.340 | And again, this is a pretty junior level role

00:08:31.740 | within the company.

00:08:32.740 | So I was surprised.

00:08:36.160 | But if you made more than, I think, 15 or $20,000

00:08:38.860 | in those days, Jack had to interview you

00:08:40.380 | and had to sign off.

00:08:41.780 | You know, the attention to detail was pretty great.

00:08:45.260 | So anyway, I come in to do the interview

00:08:49.020 | and Jack kind of picks up my resume and he looks at it

00:08:53.500 | and he goes, "You know, I bet you're an ambitious

00:08:55.900 | "young fella."

00:08:57.160 | (audience laughing)

00:09:00.340 | "I don't know why you'd come here."

00:09:03.660 | And that was literally.

00:09:04.700 | And I'm, "Well, Mr. Bubble, you asked me to interview you."

00:09:08.000 | And then for the next hour and a half,

00:09:09.700 | Jack proceeded to tell me why I should be there.

00:09:12.860 | And you know, he held court.

00:09:14.300 | He was lying on his couch.

00:09:15.540 | He had just come back from a heart incident,

00:09:18.140 | as he called it.

00:09:19.100 | And the doctors were making him put his feet up.

00:09:21.340 | And so we went through this about an hour and a half.

00:09:24.620 | I think I got two words in edgewise.

00:09:26.860 | So I go home and my wife says, "Well, how'd it go?"

00:09:31.620 | 'Cause she was really, by this time,

00:09:32.700 | she was ready to come back to Philly.

00:09:33.920 | And I said, "I have no idea.

00:09:36.500 | "I didn't say anything."

00:09:37.500 | (audience laughing)

00:09:39.500 | And she goes, "Well, what are you gonna do?"

00:09:40.980 | I said, "Well, if I'm offered the job, I'm going."

00:09:43.060 | I said it was compelling.

00:09:44.540 | 'Cause you could feel the passion.

00:09:46.220 | You could feel the energy.

00:09:47.380 | You could feel there was something different.

00:09:52.060 | You know, there was something obviously different

00:09:53.380 | about Jack.

00:09:54.220 | You all know that.

00:09:55.040 | But there was something different

00:09:55.880 | about the mission of the company.

00:09:56.900 | And it really appealed to me.

00:09:58.720 | So I accepted.

00:10:00.580 | I was fortunate.

00:10:01.420 | I got the job.

00:10:02.460 | I really wasn't qualified for it.

00:10:03.940 | But I'm forever grateful that somebody took a bet.

00:10:07.780 | And then I was here only about a week.

00:10:11.140 | And I got a call from Jack saying, "Hey, let's have lunch."

00:10:15.300 | And so we go and we have lunch.

00:10:16.660 | This is really the second part of the story.

00:10:18.580 | And we go to our galley.

00:10:22.060 | As you know, everything's nautical.

00:10:23.860 | Even in those early days.

00:10:25.420 | We had two buildings back then.

00:10:27.380 | And we're going through the line.

00:10:29.260 | And Jack is negotiating with the chef

00:10:34.260 | over an order of French fries.

00:10:36.860 | And the chef is saying, "Mr. Bobo,

00:10:39.400 | "you can't have French fries.

00:10:40.240 | "They're not good for your heart."

00:10:41.340 | And he's like, "Well, how about a half an order?"

00:10:43.520 | And they're going back and forth.

00:10:44.620 | And again, I had just left J.P. Morgan Chase.

00:10:48.220 | You know, I'd been privileged, quote unquote,

00:10:52.020 | to have lunch with the vice chair of the bank

00:10:55.140 | who would push a button under the table

00:10:57.100 | and like six waiters would come running in.

00:10:59.700 | So I'm watching this going,

00:11:02.140 | like I think my eyes are popping out of my head.

00:11:03.940 | And he turns to me and he goes, "What are you staring at?"

00:11:06.480 | (audience laughing)

00:11:08.260 | I said, "I've never seen anything like this."

00:11:10.820 | And he says, "Well," he goes,

00:11:12.260 | "let me make a point really clear."

00:11:14.580 | He goes, "Everybody's job here matters.

00:11:18.500 | "And it doesn't matter whether you're a chef

00:11:22.340 | "in the cafeteria or you're an executive

00:11:25.680 | "or you're a portfolio manager.

00:11:27.700 | "Everybody matters."

00:11:29.520 | And he goes, "The only thing

00:11:30.360 | "that's gonna really get me upset

00:11:32.260 | "is if I see a big shot kicking a little shot,

00:11:34.240 | "I'm gonna kick the big shot out of the company."

00:11:36.500 | And it was one of those object lessons, right?

00:11:39.200 | You know, I was 29 years old,

00:11:41.860 | trying to figure out what I wanted to do with my life.

00:11:43.460 | And you get this sort of wisdom imparted to you.

00:11:46.660 | And I never forgot that conversation.

00:11:49.700 | And then the third story, and then we will get serious.

00:11:53.180 | But again, I just wanna give you the flavor

00:11:55.500 | for what it was like to work with Jack.

00:11:56.980 | So many of you know, he was a very avid squash player.

00:12:01.060 | And despite all the heart issues,

00:12:03.220 | he would find a doctor who would sign off

00:12:04.780 | and let him play squash.

00:12:05.620 | You know, he would just sort of rotate from,

00:12:07.420 | I'm looking at his daughters and they're like,

00:12:08.780 | "Yeah, yeah, they knew the story."

00:12:10.220 | So 1994, late '94, I was privileged

00:12:15.220 | to be asked to join the executive team.

00:12:21.860 | Jack was still CEO.

00:12:23.140 | And so I was gonna join what we call senior staff

00:12:26.660 | and run the 401k business

00:12:29.540 | and the other institutional businesses.

00:12:31.860 | And Jack's health had begun to turn,

00:12:34.860 | but he was still feisty as ever.

00:12:36.300 | And he's like, "Let's go play squash."

00:12:39.140 | Now, I'm not much of a squash player, just to be very clear.

00:12:42.020 | But you know, I had 30 years on Jack and I was an ex-rower.

00:12:46.820 | So I had a fair amount of fitness

00:12:49.340 | so I could run around the court.

00:12:51.100 | So we go and he goes, "Hey," he goes, "I hate to do this,

00:12:55.140 | "but I don't think he hated to do it at all."

00:12:57.100 | He goes, "He taught me to work the defibrillator."

00:13:00.060 | (audience laughing)

00:13:02.620 | So you wanna talk about intimidation, right?

00:13:05.900 | (audience laughing)

00:13:07.700 | You got the founder and the lifeblood of the company

00:13:10.900 | and he's teaching you how to work the defibrillator.

00:13:12.540 | He goes, "I don't think we'll need it, but just in case."

00:13:14.620 | (audience laughing)

00:13:16.300 | So forget my strategy of just running around.

00:13:18.420 | I'm like one shot and I'm done.

00:13:19.980 | Like go for the winner all the time.

00:13:22.220 | So we played in the first two games, Jack won.

00:13:26.340 | Next two games, I won.

00:13:28.980 | And then he sort of slumped, "Oh my God, here it comes."

00:13:31.700 | And he said, "You know, I don't think I," he goes,

00:13:34.660 | "You know me, I never quit."

00:13:35.940 | But he goes, "I just don't think I can finish."

00:13:37.540 | I'm like, "Thank you, thank you, thank you.

00:13:38.900 | "We're gonna get out of here.

00:13:39.740 | "He's gonna be alive.

00:13:40.620 | "I don't have to work the defibrillator."

00:13:42.500 | So we left and then Jack's health deteriorated further

00:13:47.500 | and he was in and out of the company a lot.

00:13:50.540 | And he ended up going to the hospital

00:13:52.460 | and waiting for the transplant.

00:13:54.780 | So about nine months after the transplant, I get a call

00:13:58.860 | and it's not, "Hey Bill, how you doing?"

00:14:00.620 | It's not, it's, "We have unfinished business."

00:14:03.740 | (audience laughing)

00:14:06.220 | And it's Jack and his son, John,

00:14:09.380 | had given him a new squash racket.

00:14:12.340 | And so we had to go play squash.

00:14:15.100 | I had not looked at a squash racket since then.

00:14:17.260 | Jack had been playing nonstop.

00:14:18.860 | But it was, and trust me, this was one of those,

00:14:21.860 | you've heard of boss's golf.

00:14:22.980 | There was boss's squash.

00:14:24.060 | There was no way I was gonna win this match.

00:14:26.140 | So, but we, but you know, it was just classic Jack.

00:14:30.140 | And, you know, you mentioned that he would always,

00:14:34.860 | you know, encourage people to keep going.

00:14:37.620 | You know, his phrase was, "Press on regardless,"

00:14:39.540 | as you know, and it was a great, great lesson

00:14:43.980 | about press on regardless.

00:14:45.380 | And, you know, again, these are things

00:14:46.700 | that are imprinted on you.

00:14:48.340 | And, you know, as you're joining the executive team

00:14:50.500 | to see that kind of fire and that kind of passion

00:14:54.100 | was really important.

00:14:55.260 | So those are, you know, a couple of fun stories,

00:14:59.140 | if you will, to give you a sense

00:15:00.260 | of what it was like to work for him.

00:15:01.660 | You know, in terms of the business stuff,

00:15:03.780 | I think the most important lesson he imparted,

00:15:09.460 | and it's interesting, I'm not sure he would say this,

00:15:14.340 | so I say it with, you know, all respect.

00:15:18.380 | He had this phrase that he loved to use

00:15:21.220 | in a lot of his speeches around creative destruction.

00:15:25.060 | And Joseph Schumpeter, the great Austrian economist,

00:15:29.100 | had really, you know, written extensively about this,

00:15:33.140 | and Jack just loved it.

00:15:34.700 | And I think Jack looked at himself

00:15:36.060 | as the creative destroyer, and, you know,

00:15:38.780 | somebody who would upend the markets,

00:15:41.100 | upend the way business was done.

00:15:43.620 | And so he took Schumpeter's words very, very much to heart.

00:15:48.620 | And we talked a lot about that in my early days as CEO,

00:15:55.180 | and, you know, what was interesting

00:15:57.260 | is it gave you confidence as a leader.

00:16:02.260 | It also provoked you to think about

00:16:05.460 | how do you actually disrupt yourself?

00:16:10.460 | And if you think about Vanguard,

00:16:12.180 | and many of you have lived through multiple generations

00:16:14.780 | of the organization, we have changed quite a bit

00:16:17.660 | with the times, you know, from a little startup

00:16:22.820 | where, you know, the virtual relationship

00:16:25.900 | was through the post office box,

00:16:27.580 | and a huge technological revolution

00:16:29.540 | was the 800 phone number,

00:16:31.700 | to, you know, the creation of Vanguard.com,

00:16:34.500 | to now all the virtual advice,

00:16:36.500 | and, you know, things you can do in that space.

00:16:39.620 | And, you know, it was Jack's philosophy

00:16:43.620 | about creative destruction,

00:16:45.740 | which was way ahead of all the other writers

00:16:49.300 | who talked about disruption.

00:16:51.540 | And, you know, whether it was Andy Grove,

00:16:53.700 | "Only the Paranoid Survive,"

00:16:55.580 | or, you know, some of the other,

00:16:57.580 | Clay Christensen, who, you know,

00:16:59.540 | has written extensively about this,

00:17:00.860 | Jack was really ahead of them,

00:17:02.580 | and actually viewed his life's work, if you will,

00:17:06.220 | as being a disruptor.

00:17:08.180 | That wisdom, more than all the market stuff,

00:17:12.340 | believe it or not, was actually the most valuable lesson

00:17:16.100 | that he imparted, at least for me,

00:17:18.300 | because what it challenged us to do as a leadership team

00:17:21.620 | is to think about how would you beat Vanguard?

00:17:25.500 | How would you do a better job serving our clients

00:17:29.100 | than we can do?

00:17:30.340 | And then, what do you have to do

00:17:31.820 | to respond to that as an organization?

00:17:34.060 | And we certainly don't always get it right,

00:17:35.500 | but that's what we've tried to do.

00:17:37.060 | That's been, you know, that's been at the heart of,

00:17:40.140 | the heart and soul of who we are.

00:17:42.340 | And if you think about it, you know,

00:17:44.060 | Jack's initial revolutions, if you will,

00:17:47.740 | were all around our structure, and then around low cost,

00:17:51.860 | and then indexing being the, you know,

00:17:54.660 | purest expression of the low cost.

00:17:57.300 | But so many of the other things that we've done since

00:18:00.220 | are really built upon the foundation of creative destruction

00:18:04.980 | and finding ways to disrupt yourselves

00:18:07.100 | before somebody else does it to you.

00:18:08.620 | So, again, when I think back,

00:18:10.820 | when I think back to all the different lessons

00:18:13.580 | Jack imparted, that probably

00:18:15.020 | was the single most important, Bill.

00:18:17.260 | Now, there are lots of things we could talk about

00:18:18.700 | in terms of capital markets and structure and whatnot,

00:18:22.020 | and I'm happy to go there, but it was that notion,

00:18:25.620 | at least for me, and, you know, again,

00:18:27.820 | some of it may have been timing,

00:18:29.460 | coming into my role in the middle, you know,

00:18:31.900 | at the beginning of the crisis,

00:18:33.660 | that actually was very liberating.

00:18:35.620 | And Jack and I did have a lot of conversations

00:18:38.660 | in those early days, and it was very, very good advice,

00:18:43.220 | you know, sort of, I'll call it a lesson imparted.

00:18:47.420 | - Well, that brings up a second question then,

00:18:52.820 | which is, you know, we all know about

00:18:54.780 | his 1951 senior thesis at Princeton,

00:18:59.020 | which, you know, the heart of which

00:19:00.580 | was the disruption of the industry.

00:19:03.980 | So, obviously, you know, the desire to do that

00:19:07.220 | and that drive arose, you know,

00:19:11.260 | when he was a very young man.

00:19:12.660 | And do you have any sense of where that came from?

00:19:16.340 | - Yeah, I think so.

00:19:19.460 | So, you know, his, I think it's, you know,

00:19:24.460 | most of you have heard Jack's family story,

00:19:27.620 | and, you know, he ended up,

00:19:30.060 | his family had been very successful and fairly well-to-do,

00:19:34.860 | and then, during the Great Depression,

00:19:37.420 | lost everything, essentially, and had to start over.

00:19:40.900 | And Jack actually was a scholarship student

00:19:43.220 | at Blair Academy.

00:19:44.260 | Again, I had the privilege of being at Blair

00:19:46.780 | a couple months ago, doing a memorial for Jack,

00:19:50.620 | and it was extraordinary to see his impact on Blair Academy.

00:19:55.620 | I actually think some of it started there, Bill.

00:20:00.860 | You know, he had the weight tables,

00:20:02.700 | he was, you know, he was very aware he was on scholarship,

00:20:06.340 | and, you know, there were a lot of other

00:20:07.860 | very well-to-do students there.

00:20:10.180 | And I think that created a restlessness in him

00:20:14.660 | that made him question things a little bit more deeply

00:20:19.340 | than others might have done at the same age,

00:20:24.020 | or with the same sets of experiences.

00:20:27.020 | And it was that restlessness and questioning

00:20:30.660 | about how things could be better,

00:20:32.540 | I think that was fundamental to who he was.

00:20:35.740 | You know, interestingly, when he came out of Princeton,

00:20:40.740 | the two choices he had were to go work

00:20:46.300 | for Philadelphia National Bank,

00:20:47.860 | which was kind of the thing you should have done,

00:20:51.180 | or go work for this little mutual fund company

00:20:53.420 | that he, you know, he'd written about the industry.

00:20:56.780 | And I think he actually wrestled with that decision,

00:21:00.020 | but then, you know, decided to go with Walter Morgan,

00:21:02.660 | as you all know.

00:21:04.220 | And again, I think the, you know,

00:21:09.100 | what was exposed in the 1951 thesis

00:21:13.300 | got reinforced by being with Mr. Morgan.

00:21:16.500 | Again, I had the privilege of interacting

00:21:19.700 | with Walter Morgan for a number of years

00:21:21.980 | before he passed away.

00:21:23.900 | And 'cause he would come to board meetings,

00:21:25.780 | and he would come to events, and so forth.

00:21:27.980 | And he took great pride, obviously,

00:21:29.300 | in what Jack had accomplished.

00:21:31.940 | Again, he was kind of a revolutionary in his day,

00:21:34.420 | in that the Wellington Fund was a balanced fund,

00:21:38.420 | focused on high-quality companies, and high dividends,

00:21:41.820 | and, you know, really high-quality bonds,

00:21:44.340 | during a period where it was leverage,

00:21:47.020 | and really aggressive growth, if you will,

00:21:49.860 | were the mantras of the day.

00:21:51.420 | So I think he found a kindred spirit,

00:21:53.460 | which sort of reinforced some of those notions.

00:21:55.940 | But I think a lot of it came from the way, you know,

00:21:59.420 | came from Blair, and came from the restlessness

00:22:01.460 | that was created there.

00:22:02.540 | And, you know, this, I don't know how you teach this,

00:22:06.620 | because I'm not sure it can be,

00:22:07.460 | I think it's just something that is sparked in an individual,

00:22:10.020 | but his creativity was one of his great strengths.

00:22:15.020 | And, you know, when you would be in meetings with him,

00:22:18.580 | the questions that would come from Jack

00:22:22.460 | were different than the questions that would come

00:22:24.700 | from 98 out of 100 other people.

00:22:27.740 | And, you know, I don't know exactly where that comes from,

00:22:31.460 | except, you know, the background certainly

00:22:32.860 | had something to do with it, and the restlessness.

00:22:34.420 | But he was never satisfied

00:22:36.500 | with just sort of conventional thinking.

00:22:38.220 | And I think that lack of satisfaction,

00:22:41.460 | and that embracing of, I'll call it disruptive ways

00:22:44.620 | of doing things, started at a young age,

00:22:48.020 | and became just part of his mantras as time went on.

00:22:52.580 | - Yeah, Mel Turner last night reminded me

00:22:55.940 | of one of my favorite passages from Fred Schwed's

00:22:58.900 | "Where Are the Customers' Yachts?"

00:23:01.460 | which was, you know, when brokers were explaining

00:23:04.580 | to the younger brokers how the business worked,

00:23:07.220 | they explained that they would throw all the money

00:23:09.180 | at the ceiling, and what stuck to the ceiling

00:23:10.900 | was the clients.

00:23:12.060 | And so it was obvious that that was the world back then,

00:23:18.020 | that Jack wanted to disrupt.

00:23:20.180 | What made Jack unhappy about the capital markets

00:23:24.700 | in the last decade or two?

00:23:26.060 | What did he see now that he wanted to disrupt?

00:23:30.380 | - Yeah, so, and this is where Jack and I sometimes had,

00:23:35.380 | I will say, spirited discussions.

00:23:39.620 | (audience laughing)

00:23:41.460 | You know, Jack worried about ETFs initially.

00:23:44.860 | He thought that they were a trading vehicle.

00:23:47.740 | I think as many of you have read,

00:23:49.980 | and Jack didn't speak about it a lot,

00:23:51.660 | but he did talk about it, especially later in life,

00:23:54.180 | you know, we'd actually had the opportunity

00:23:55.900 | to launch the first ETF, you know, what became the Spider,

00:23:59.700 | you know, State Street did,

00:24:02.020 | and then the, you know, the Quadruple Q,

00:24:05.420 | or whatever it is, you know, on NASDAQ.

00:24:08.860 | He passed on that because he felt

00:24:11.140 | they were just trading vehicles.

00:24:12.540 | And in the early days, that's actually what they were.

00:24:15.740 | They were essentially a derivative substitute.

00:24:19.540 | And so he really was not very aligned

00:24:23.220 | with the whole creation of that.

00:24:26.180 | And, you know, he continued to worry about it

00:24:29.260 | even as, you know, we got more into that business.

00:24:33.540 | And, you know, I think the point, you know,

00:24:36.060 | I tried to make to him, I know Gus Sautter,

00:24:37.940 | our CIO at the time who, you know,

00:24:39.740 | invented our class structure for ETFs.

00:24:43.700 | You know, we made the point that you don't have

00:24:46.140 | to use these as a trading vehicle.

00:24:47.940 | You know, the beauty is they can actually serve

00:24:50.820 | that purpose, but they can also be a buy and hold strategy

00:24:53.260 | and be incredibly effective as well,

00:24:55.620 | especially for an advisor putting a portfolio together

00:24:59.340 | in a very low cost way for someone.

00:25:01.420 | And you may have seen Jack soften on that

00:25:05.060 | a little bit over time, and he would talk about that.

00:25:07.740 | He would talk about the difference.

00:25:08.900 | But, you know, Bill, I do think he really worried

00:25:11.900 | about the product proliferation there.

00:25:14.180 | He worried about some of the, you know,

00:25:16.540 | crazy structures that were coming out.

00:25:19.460 | He worried about leverage in ETFs,

00:25:22.060 | implicit leverage in particular.

00:25:24.500 | So I think that was a fairly big concern.

00:25:27.220 | But, you know, for me, what was interesting was

00:25:29.660 | it was actually the same set of concerns

00:25:32.180 | that Jack had always had about the mutual fund industry.

00:25:35.180 | It was a very parallel set of concerns,

00:25:37.780 | because again, I sat through all the meetings

00:25:39.820 | during the late '80s and early '90s with him

00:25:41.980 | on product development stuff, where he worried

00:25:45.380 | that there was a new fund coming out every hour,

00:25:48.220 | you know, different flavor or something.

00:25:49.740 | And he just thought it was all being done

00:25:52.420 | just for salesmanship as opposed

00:25:55.180 | for really good investment principles.

00:25:58.260 | And, you know, one of the things he charged us with

00:26:01.860 | as a result was any time we brought a new fund out,

00:26:05.380 | we really had to be asking the fundamental question about,

00:26:08.780 | is this a needed and useful solution for people?

00:26:13.780 | And, you know, it was a really good test for us.

00:26:18.100 | But I think he continued right up to his last days

00:26:21.980 | to worry about the product proliferation,

00:26:23.620 | in particular on the ETF side.

00:26:25.300 | You know, I think on the capital market side,

00:26:28.620 | the other concern he had, and one which I share

00:26:30.900 | pretty deeply, was the rise of algorithmic trading

00:26:34.900 | and what's happening in that world.

00:26:39.340 | And he spoke about that several times.

00:26:42.980 | You know, it's a really, really complex topic,

00:26:45.660 | as some of you know, because, in a sense,

00:26:49.620 | without some of this trading now,

00:26:52.420 | I'm not sure markets would actually work

00:26:53.700 | as well as they work.

00:26:54.740 | And that has more to do with the structure

00:26:58.260 | of the U.S. markets than anything else.

00:27:01.060 | But a lot of the knitting, if you will,

00:27:04.300 | that's there is, you know, these algorithmic traders

00:27:08.620 | actually provide an incredible amount of liquidity.

00:27:11.740 | You know, the problem is they don't necessarily

00:27:14.260 | provide the liquidity when you most need it,

00:27:16.820 | because they're not regulated in that way.

00:27:18.220 | And I think there's, you know, Jack was always

00:27:20.900 | sort of pushing the SEC to think about that,

00:27:22.940 | and I think the SEC actually is looking at that.

00:27:25.340 | Many of the rule changes that have occurred

00:27:28.420 | to sort of reign some of that in,

00:27:31.220 | they may have had their origins in some of Jack's speeches,

00:27:35.060 | and then certainly some of our policy advocacy

00:27:37.260 | to tighten things up there.

00:27:39.300 | And I would say we're in a better place

00:27:40.980 | than we were as a result.

00:27:43.700 | - Yeah, a couple of thoughts about that.

00:27:48.180 | You know, whenever I hear a hedge fund manager

00:27:50.340 | talk about benefits of hedge funds to society,

00:27:53.940 | that they in particular provide liquidity,

00:27:56.460 | whenever I hear the words we provide liquidity,

00:27:58.740 | I hold onto my wallet.

00:28:00.540 | (audience laughing)

00:28:03.780 | Vanguard, like all large corporations,

00:28:06.500 | you know, faces challenges from within and without.

00:28:12.020 | And I'd like you to address each of those,

00:28:15.860 | and I'll direct you to start with the easy one,

00:28:20.180 | which is what do you see as the external challenges

00:28:23.060 | to Vanguard, then we'll get to the internal ones.

00:28:25.660 | - Yeah, so, you know, on the external side,

00:28:27.940 | there's no shortage of challenges right now.

00:28:30.500 | I mean, there are many competitors

00:28:32.540 | who are actually trying to come at us on the price side,

00:28:35.660 | being very selective about how they do that.

00:28:38.940 | And, you know, the interesting thing is

00:28:41.260 | the market's actually been pretty discerning about that.

00:28:46.260 | So when, you know, some people come out with,

00:28:49.180 | you know, really low-cost funds or ETFs,

00:28:52.260 | they look at the other prices of the other product suite

00:28:54.980 | that gets sort of blended together.

00:28:57.220 | And, you know, again, a lot of analysts

00:28:59.900 | have actually called our competitors on that,

00:29:03.340 | and it actually hasn't reversed that much.

00:29:04.740 | But the fact is, low-cost is no longer our domain alone.

00:29:09.740 | And I actually think this is a good thing.

00:29:11.940 | And, you know, the competitor in me hates it,

00:29:15.820 | but the societal person in me loves it

00:29:19.100 | because investors are better off.

00:29:21.020 | And at the end of the day, you know,

00:29:23.420 | Jack's dream of changing the industry

00:29:27.700 | is actually happening.

00:29:29.020 | People are actually paying attention to cost.

00:29:31.060 | So from a competitive standpoint,

00:29:32.820 | that's certainly an issue for us.

00:29:34.660 | But the second one is we're big,

00:29:38.540 | and we're increasingly the largest shareholder

00:29:42.780 | in most companies.

00:29:44.740 | And so that puts you under the microscope,

00:29:47.740 | both from a regulatory and government standpoint,

00:29:49.900 | as well as from a just outside pundit standpoint.

00:29:54.900 | And we certainly hear a lot about those issues.

00:29:58.060 | You know, there have been a couple of papers

00:30:00.540 | written about, you know, Vanguard's too big.

00:30:04.580 | It needs to be broken up

00:30:05.780 | because it's gonna exert too much control

00:30:09.300 | on corporate America and so forth.

00:30:10.900 | And, you know, there's even a conspiracy theory out there

00:30:14.740 | that somehow Larry Fink and I were working together

00:30:18.020 | to raise airline prices

00:30:20.660 | because we both are the most significant owners

00:30:22.540 | in airlines, and that would be, you know,

00:30:24.180 | a really good thing for us.

00:30:25.340 | Which, this is a great example of somebody

00:30:29.540 | mixing correlation and causation

00:30:31.660 | and not really understanding the difference between the two.

00:30:34.900 | But I say it, you know, partly tongue-in-cheek,

00:30:37.820 | but seriously as well.

00:30:38.980 | I mean, we actually have to spend time on this stuff.

00:30:40.940 | You know, we have to spend a lot of time educating people.

00:30:43.700 | So I look at the, from the external standpoint,

00:30:48.100 | just the scrutiny that goes on

00:30:52.540 | because of the success of the firm.

00:30:55.300 | And it's a privilege to have that scrutiny, in a sense.

00:30:59.380 | But it's also, you know, it takes a lot of time

00:31:01.540 | for our leadership team,

00:31:02.500 | and time that you'd rather, frankly, devote to the clients

00:31:06.020 | and just being focused on the business.

00:31:08.740 | You know, internally, I think the biggest risk we have

00:31:12.500 | is our success.

00:31:14.340 | And it is becoming complacent.

00:31:16.500 | And I know Tim Buckley shares this with me.

00:31:21.060 | Again, you do not grow up in the house of Ogle

00:31:24.260 | with a notion that complacency is a good thing.

00:31:29.260 | I just say that.

00:31:29.980 | You know, it was so imparted,

00:31:33.020 | so frequently imparted to us

00:31:34.700 | that the minute complacency seeps in, you're dead.

00:31:39.380 | And one of the really interesting things,

00:31:43.900 | probably two months into Tim taking over as CEO,

00:31:49.100 | he put a book on all of his leader's table,

00:31:51.740 | leader's desk, called "The Founder's Mentality."

00:31:54.940 | And it was sort of getting back to the urgency

00:31:58.660 | of a brand-new company

00:32:00.780 | and having to, you know, earn your way each and every day.

00:32:07.500 | You know, again, no disrespect to the past,

00:32:11.940 | but just saying, have we maintained our sense of urgency?

00:32:17.100 | So I had a couple people come running into my office

00:32:18.980 | and go, you know, their hair's on fire.

00:32:21.180 | "Can you believe Tim's doing this?"

00:32:22.500 | I'm like, "Yeah, I think the board actually made

00:32:24.740 | "a great choice in the next generation

00:32:27.100 | "because that's exactly what he should be doing."

00:32:30.060 | And so, Bill, that's the thing that I think worries us.

00:32:33.780 | I think we've got the right leadership team to combat it,

00:32:37.460 | but it's a never-ending battle.

00:32:40.820 | The more successful you are,

00:32:44.540 | in some ways, the less willing you are to take risks

00:32:48.340 | and in creating new ways of doing things

00:32:51.420 | and thinking outside the box,

00:32:53.300 | which has, again, been our hallmark.

00:32:55.780 | I grew up in Rochester, New York,

00:32:58.140 | so I watched this up close and personal.

00:33:01.060 | Eastman Kodak, many of you probably know the story.

00:33:04.180 | Eastman Kodak actually invented digital photography.

00:33:09.860 | But Eastman Kodak did not, you know,

00:33:12.260 | this got to sort of the definition of what Eastman Kodak.

00:33:15.500 | Eastman Kodak considered itself a film company

00:33:19.060 | and that if you read their mission statement and so forth,

00:33:22.820 | that's what it was all about.

00:33:24.740 | And they missed this unbelievable revolution

00:33:27.140 | that was going on.

00:33:28.460 | If Eastman Kodak had considered itself

00:33:31.540 | its main mission in life,

00:33:33.540 | to be the preserver of memories,

00:33:37.660 | they would have approached it completely differently.

00:33:40.780 | So one of the things that we did, you know,

00:33:43.780 | as we were getting bigger and more successful,

00:33:46.100 | we actually restated our mission.

00:33:49.660 | And, you know, we went back.

00:33:50.780 | I actually, I reread everyone in Jack's speeches,

00:33:54.100 | looked at a lot of Jack Brennan's writings on this

00:33:56.340 | and so forth.

00:33:57.180 | And the team came up with, you know,

00:33:59.780 | our current purpose, if you will,

00:34:01.980 | which is to take a stand for all investors,

00:34:03.660 | treat them fairly,

00:34:04.940 | give them the best chance for investment success.

00:34:08.060 | And you might notice in there,

00:34:09.500 | there's nothing about being the low-cost provider

00:34:12.060 | of mutual funds or, you know,

00:34:14.860 | anything that's really limiting.

00:34:18.460 | That, and again, we're not going away

00:34:20.460 | from low-cost mutual funds, trust me.

00:34:22.340 | But the idea that our job is to give investors

00:34:26.300 | the best chance for success and to take a stand for them,

00:34:30.940 | it was so deeply embedded in the founding of this company,

00:34:33.740 | we felt it very important to make the statement.

00:34:36.660 | And, you know, Bill, for me,

00:34:38.380 | that's how you try to combat, you know,

00:34:40.860 | the thing I worry about.

00:34:42.060 | But look, I'd be, I would be less than honest

00:34:45.180 | if I didn't tell you I go to bed every night worried

00:34:47.700 | that success goes to our head.

00:34:49.980 | And again, I have great faith in the leadership team

00:34:53.860 | that's in place,

00:34:54.740 | but that will be a never-ending battle for us.

00:34:58.100 | - Yeah, there's something that I think about a lot,

00:35:01.060 | which is not just the differentiation

00:35:04.060 | between what the public sector does,

00:35:06.300 | what the government does and what the private sector does,

00:35:10.140 | but there's a third sector,

00:35:11.140 | which we don't think enough about,

00:35:12.260 | which is the non-profit sector.

00:35:15.220 | Almost all education in this country

00:35:18.020 | is done through non-profits.

00:35:20.660 | And, you know, the for-profit sector in education,

00:35:25.500 | for that matter, in prisons,

00:35:26.780 | hasn't exactly covered itself in glory.

00:35:30.940 | Healthcare, you know, most of us are going to wind up

00:35:32.860 | going to hospitals that are run by non-profits.

00:35:35.980 | So the question I have for you is,

00:35:39.820 | does Vanguard view itself as a non-profit corporation?

00:35:42.780 | - Short answer is no.

00:35:46.540 | We actually view ourselves

00:35:48.060 | as a very profit-oriented organization,

00:35:53.060 | but we define it differently than others do.

00:35:55.500 | We don't define it in the traditional P&L.

00:35:57.340 | We actually define it in

00:35:59.260 | what's the net return to our investors.

00:36:01.940 | At the end of the day, that's what matters.

00:36:04.140 | So, you know, our maniacal focus on cost over the years

00:36:08.100 | is to make sure that more of what an investor earns

00:36:11.500 | in the marketplace stays with the investor.

00:36:14.140 | That's actually how we measure profitability.

00:36:17.020 | Because if you think about it, being owned by the funds,

00:36:19.420 | and therefore the clients of the funds,

00:36:21.940 | at the end of the day, they're like,

00:36:24.220 | if you do the analogy to a shareholder,

00:36:27.380 | you know, creating earnings for your shareholders,

00:36:29.740 | which is what a public company does,

00:36:31.060 | is we're trying to create earnings for our shareholders,

00:36:33.140 | which are our fund holders.

00:36:34.660 | We try to do that in the most efficient, cost-effective way.

00:36:38.060 | And frankly, when we look at success of the firm,

00:36:42.980 | you know, there were four metrics that we focused on.

00:36:47.300 | Three external, one internal.

00:36:51.220 | And the metrics were externally,

00:36:54.540 | how are our funds performing versus our competitors.

00:36:57.500 | So how do we measure up?

00:36:59.020 | Because you all have a choice.

00:37:01.180 | Be it a Vanguard fund, or you can be in an ABC fund.

00:37:03.580 | And there's thousands of funds, as we know.

00:37:06.020 | There are more funds than there are securities now.

00:37:07.740 | So it's sort of an interesting factoid.

00:37:11.060 | And so we were maniacal about that.

00:37:16.060 | The second thing that we actually measure up,

00:37:19.300 | we sometimes survey people to death,

00:37:21.460 | and we hear that, I apologize for it,

00:37:23.780 | but we wanna know what our clients think.

00:37:25.380 | So we client loyalty, and we can measure this

00:37:28.820 | both mathematically as well as through survey data.

00:37:31.500 | The mathematical measure is the redemption ratio in a fund.

00:37:36.300 | So how long do people stay in a particular fund?

00:37:39.300 | And one of the things we're really proud of

00:37:41.020 | is our fund shareholders tend to stay with us

00:37:43.220 | three times as long as the average shareholder

00:37:46.420 | in the industry.

00:37:47.660 | I'm very loyal client base.

00:37:49.180 | And then we will use survey data to reinforce that message.

00:37:53.860 | The third metric was the expense ratio.

00:37:56.700 | Because we know the one thing we could control,

00:37:59.860 | we couldn't control the absolute return in market.

00:38:03.060 | We could control our expenses,

00:38:04.940 | and so we could have a real say

00:38:06.940 | on what the net return was.

00:38:08.820 | And so we were, that goes back to 1974 to 1975

00:38:13.260 | when we launched.

00:38:14.460 | And so those three metrics, fund performance,

00:38:16.940 | client loyalty, and expense ratio,

00:38:20.260 | were how we thought about the external side.

00:38:23.580 | And in a sense, fund performance and the expense ratio,

00:38:26.380 | if you sort of look at them together,

00:38:27.860 | that is in a sense a P&L for how you're doing

00:38:30.660 | for your investors.

00:38:31.700 | By the way, you might be interested,

00:38:33.900 | the fourth metric was our employee engagement,

00:38:37.780 | crew member engagement.

00:38:39.140 | So we wanted people to think this was a great place to work.

00:38:43.460 | And despite what the Philadelphia Inquirer says occasionally,

00:38:48.340 | we actually are a great place to work.

00:38:49.780 | Our turnover is extraordinarily low,

00:38:52.460 | and we have a great group of people

00:38:55.460 | who are just dedicated to the client.

00:38:56.940 | They love the mission, they love being here.

00:39:00.140 | I can't tell you how many 25, 30 year celebrations

00:39:02.900 | I've been to in the last few years.

00:39:05.060 | People who've been here since the beginning

00:39:07.660 | or near the beginning.

00:39:08.940 | So that metric was actually really important to us as well,

00:39:12.540 | because we thought without great people,

00:39:14.260 | none of the other stuff is gonna happen.

00:39:16.620 | - Okay, well, I'd like to shift gears now a little bit,

00:39:20.100 | and talk about some more general macro issues.

00:39:24.540 | And the way I want to segue into that,

00:39:26.060 | talking about ESG investing.

00:39:28.100 | I know you're an enthusiast about that.

00:39:32.660 | You think a lot about it.

00:39:34.100 | And I'm wondering if you think about those three

00:39:37.620 | components differently.

00:39:40.300 | People tend to put them all together.

00:39:44.540 | I don't think they're the same thing.

00:39:46.180 | I think they have different sets

00:39:47.660 | of returns and considerations,

00:39:49.260 | and I'm wondering if you'd address that.

00:39:51.900 | - Yeah, so ESG is quite the buzz word,

00:39:56.900 | or buzz phrase, if you will, in the industry.

00:40:00.500 | In Europe and parts of the Pacific,

00:40:03.300 | it's actually required to be stricter

00:40:08.140 | on some of these issues.

00:40:09.500 | - I should interrupt you for a second.

00:40:11.260 | Just to say for the audience,

00:40:13.020 | you have E means environmentally conscious,

00:40:15.460 | S means socially conscious,

00:40:16.740 | and then G refers to corporate governance.

00:40:18.780 | I just should have made that clear up front, I'm sorry.

00:40:21.100 | - Yeah, so let me start with G,

00:40:23.900 | because I think that's the easiest one

00:40:25.420 | to get your hands around for governance.

00:40:27.820 | And this is the one we think we can affect the most,

00:40:31.100 | to be blunt.

00:40:32.980 | How well are companies governed?

00:40:34.740 | And this gets into board composition,

00:40:38.900 | how boards compensate their management teams,

00:40:45.220 | how boards oversee strategy, risk, and so forth.

00:40:48.940 | And we think that there's a lot of influence

00:40:53.940 | that big investors can have here.

00:40:56.180 | And what's interesting is, just sort of a side note,

00:41:01.620 | people always are like,

00:41:02.540 | "Well, you know, if you're an index shareholder,

00:41:04.580 | "what do you care?

00:41:05.420 | "You should have your own stocks.

00:41:06.860 | "Why do you care about governance?"

00:41:08.380 | And then we'll hear the follow-on is,

00:41:11.060 | "You don't care, you guys don't pay

00:41:14.180 | "a lot of attention to this."

00:41:15.660 | And before we wrote our first letter,

00:41:17.820 | Jack Brenner wrote a letter in 2005,

00:41:20.460 | I think Jack Bogle gave a speech on this in maybe 2001.

00:41:23.700 | So before that speech, before Jack Brenner wrote the letter,

00:41:26.660 | no active manager in the US, except the activists,

00:41:30.620 | we're actually talking about governance.

00:41:32.220 | Like, it was not a topic.

00:41:34.780 | And so, our view is it's a really important role

00:41:39.100 | for a shareholder, because when we first started

00:41:42.780 | this journey, board members had frankly lost

00:41:45.860 | their way a little bit.

00:41:47.100 | If you would ask a board, like I gave a speech

00:41:50.740 | on this in 2008 or 9, I said, you know,

00:41:54.420 | "Boards should engage with their big shareholders.

00:41:56.460 | "They should be willing to hear what the shareholder

00:41:58.100 | "thinks about the company and so forth,

00:42:00.740 | "about the board composition."

00:42:02.660 | And I almost got run out of the room.

00:42:04.940 | The board members said, "Why would we do that?"

00:42:08.620 | I'm like, "Who do you think you represent?"

00:42:10.820 | And there was like this stunned silence,

00:42:13.820 | and, "Oh yeah, the shareholder, yeah,

00:42:16.620 | "you guys elect us."

00:42:18.500 | So, and I say that a little bit tongue-in-cheek,

00:42:21.140 | but it's a really important concept.

00:42:22.580 | So the G is something we think we can influence.

00:42:25.380 | Now, Bill, I mean, you've done more mathematical research

00:42:28.820 | on factors and all kinds of things,

00:42:31.740 | so you probably know this better than I do.

00:42:33.840 | There is no evidence yet that, quote-unquote,

00:42:38.020 | better-governed companies perform better.

00:42:41.380 | This is one of the holy grails, is to figure out

00:42:43.700 | if any of these factors actually drive return.

00:42:47.020 | And there's lots of debate in the industry about this,

00:42:49.460 | and you'll see different interpretations of data.

00:42:52.740 | And, you know, it's hard to actually define

00:42:54.740 | what is good governance.

00:42:56.020 | We have, our notion is good governance

00:42:58.900 | is that the highest level of the board

00:43:02.460 | is doing an effective job overseeing

00:43:05.380 | talent, strategy, and risk.

00:43:07.060 | And I say overseeing the processes,

00:43:09.380 | making sure management is doing the right things,

00:43:10.980 | not actually doing a board's job

00:43:12.660 | is to govern, not to manage.

00:43:14.140 | And they're putting the shareholder interests,

00:43:19.820 | you know, right there at the top.

00:43:21.180 | Doesn't mean other stakeholders don't matter.

00:43:24.060 | We'll get to that in a minute,

00:43:24.900 | because there's been a lot written about that,

00:43:26.540 | but the shareholder really has to be in the room.

00:43:29.980 | And, you know, look, I think over time,

00:43:32.500 | we will see that better-governed companies,

00:43:36.380 | as we define them, and we find ways

00:43:38.740 | to sort of look at that mathematically

00:43:40.900 | a little bit more effectively,

00:43:42.540 | I think we will see that it does lead

00:43:44.340 | to better performance generally,

00:43:45.780 | but it won't be no guarantee.

00:43:47.940 | It will be no guarantee.

00:43:49.100 | So we're spending a lot of time on that.

00:43:52.460 | When you get into the other two factors,

00:43:55.060 | societal and environmental,

00:43:57.020 | you know, everybody's definition is very different.

00:44:02.180 | And as you know, many ESG products

00:44:04.100 | that are out there today are,

00:44:07.100 | they're what I call exclusionary.

00:44:09.420 | They screen certain names out based on certain criteria.

00:44:14.340 | So, you know, you might have a carbon footprint fund.

00:44:18.980 | So companies with high carbon footprint,

00:44:21.580 | you're not going to invest in,

00:44:23.620 | you're only gonna invest in companies

00:44:25.020 | with low carbon footprint.

00:44:27.620 | Now, there's two theories on this that are out there.

00:44:31.100 | You know, there's the,

00:44:32.180 | there's one that's, I would say, the real story,

00:44:36.940 | which is some people just want that

00:44:38.860 | and they're willing to give up potential return for it.

00:44:41.540 | That's fine.

00:44:42.420 | Actually, I think that's something

00:44:43.660 | that's an individual's choice.

00:44:45.700 | And then there are people who will say,

00:44:47.060 | we know that these, you know,

00:44:50.060 | funds will outperform in the long run.

00:44:52.420 | I don't think we know that.

00:44:53.540 | You know, again, all math we've seen

00:44:55.020 | does not necessarily suggest that.

00:44:57.660 | So it doesn't mean that the fund has no reason to exist,

00:45:00.180 | but the promise that a factor like that

00:45:02.860 | is going to lead to outperformance,

00:45:04.900 | I think is misleading at best.

00:45:08.340 | And so we're actually spending quite a bit of time

00:45:12.020 | on the topic.

00:45:13.700 | I think the, from a product standpoint, if you will,

00:45:19.580 | creating indices and so forth,

00:45:22.380 | anything that you do there,

00:45:24.140 | you've got to be very clear with investors

00:45:26.980 | about the trade-offs that they potentially are making.

00:45:30.020 | Okay, so as long as you're clear on that,

00:45:32.460 | then I think it's fine to have these kinds of vehicles.

00:45:36.500 | But I think it's incredibly misleading

00:45:38.260 | to tell people that you think they're going to outperform.

00:45:41.340 | You know, socially responsible investing

00:45:42.980 | was a big thing in the late '90s.

00:45:45.100 | And the way the screens worked

00:45:47.300 | is you had an overweight to tech.

00:45:49.260 | So 1998, 1999, you were socially responsible

00:45:53.540 | and you were outperforming the product market

00:45:55.140 | by 1,000 basis points a year,

00:45:56.340 | so everybody thought you were a hero.

00:45:58.260 | Then the tech wreck happened.

00:45:59.820 | And guess what, those products disappeared.

00:46:02.540 | People were so disappointed

00:46:04.620 | because they didn't understand actually the factors

00:46:07.820 | that they were exposed to.

00:46:09.820 | So that's the exclusionary side.

00:46:12.580 | So the more complex side is

00:46:16.260 | how do you engage with companies around these issues?

00:46:20.420 | And again, I'm going to bring you back

00:46:22.220 | to sort of our fundamental belief on governance,

00:46:26.100 | which is boards.

00:46:28.260 | Boards, you know, if you look historically,

00:46:30.260 | you would do a survey 20 years ago

00:46:32.580 | and say, "What's your primary job?"

00:46:34.180 | They would say, "Pick the CEO.

00:46:36.180 | "Pick the right CEO and all good things will happen."

00:46:39.380 | I think it's much more complex today.

00:46:40.900 | I think boards have a really important role to play

00:46:43.860 | in the oversight of not just the CEO selection,

00:46:46.620 | which is still important,

00:46:47.460 | but talent overall in the company.

00:46:49.060 | Does the company got sufficient talent

00:46:51.180 | for the evolving marketplace?

00:46:53.540 | Strategy, oversight, and risk.

00:46:58.340 | And many of these environmental

00:47:00.900 | and societal, social issues, if you will,

00:47:03.940 | fall in the risk category.

00:47:06.380 | So from a governance standpoint,

00:47:08.220 | we actually want to know how companies

00:47:10.820 | are thinking about these issues

00:47:13.380 | without necessarily saying one interpretation of,

00:47:18.260 | and let's use climate change as an example,

00:47:20.940 | we're less interested in somebody saying

00:47:25.500 | we believe the science or we don't believe the science.

00:47:27.540 | We're much more interested in a board saying,

00:47:30.580 | "Here's how we view it from a risk perspective

00:47:33.820 | "in terms of how consumers view our business,

00:47:36.420 | "how our supply chain works,

00:47:39.380 | "all of those sorts of things,

00:47:40.540 | "and here's how we're thinking about that."

00:47:42.100 | Because if there's greater clarity

00:47:44.420 | around how you interpret different types of risk,

00:47:48.740 | theoretically you have a more accurate stock price,

00:47:52.940 | if you will.

00:47:54.300 | And that kind of transparency

00:47:56.780 | we think is really necessary.

00:47:57.940 | So that's where we've been spending

00:47:59.860 | quite a bit of our time on the engagement side

00:48:02.460 | is really trying to understand

00:48:04.220 | how companies view these factors

00:48:06.100 | from a risk perspective.

00:48:08.060 | And can you learn something

00:48:09.780 | that actually makes the market,

00:48:12.140 | the pricing mechanisms work even more effectively?

00:48:15.020 | It's by no means an exact science at this point.

00:48:18.460 | And one of the things I think we're going to see

00:48:21.700 | as time goes on is there's a lot of pressure

00:48:25.500 | for shareholders to act on some of these issues

00:48:30.020 | because the government's not.

00:48:32.180 | And so you've got a lot of stakeholders out there

00:48:35.380 | who are frustrated with the lack of action

00:48:37.580 | in certain categories of these topics.

00:48:40.940 | And so they push really hard for other constituents

00:48:43.780 | to try to have an effect.

00:48:45.340 | And I think it's a very, very difficult thing

00:48:47.180 | for a shareholder to do

00:48:49.060 | because again, everybody's interpretation

00:48:50.860 | is really different.

00:48:52.620 | I'll give you just one practical example.

00:48:54.580 | So I have a great family friend.

00:48:57.220 | She's a very, very, very devout Quaker.

00:48:59.780 | Those of you familiar with Quaker beliefs,

00:49:03.620 | one of the fundamental beliefs is war cannot be tolerated.

00:49:07.900 | Just through military,

00:49:09.620 | therefore anything military related is bad.

00:49:12.580 | And so she asked me, she's young, very idealistic.

00:49:16.580 | She's like, "So what can I invest in?"

00:49:18.860 | And she started running through companies.

00:49:21.340 | And she started with some of the cool tech companies.

00:49:24.020 | And I'm like, you know, she starts with Google.

00:49:25.700 | And I'm like, "I don't think you can do that

00:49:27.940 | "if you're anti-military.

00:49:29.420 | "I mean, what do you think is doing all the satellite stuff

00:49:32.900 | "that drones are based on?"

00:49:34.260 | So she's horrified by that.

00:49:35.900 | "Well, what about Apple?

00:49:36.940 | "They make really cool stuff."

00:49:38.100 | Well, you know, look at Apple's military business.

00:49:40.780 | So by the time we worked our way through,

00:49:42.860 | I think we were down to about five companies

00:49:44.460 | out of the S&P 500 that she could invest in.

00:49:47.060 | I mean, it was really, you know,

00:49:49.420 | and I tell the story because I actually really felt

00:49:52.300 | maybe she wanted to express her beliefs

00:49:54.900 | in the way she invested.

00:49:56.460 | And she was willing to sacrifice return.

00:49:59.100 | But the problem was her definition

00:50:03.940 | of socially responsible was so broad

00:50:06.460 | that literally, I mean, Treasury Box

00:50:08.300 | would be the last thing she could own.

00:50:09.860 | So, you know, she couldn't invest.

00:50:13.060 | So, you know, to me, that's at the heart

00:50:18.060 | of all this discussion around ESG

00:50:21.740 | is everyone has a very different interpretation.

00:50:25.020 | What is environmentally sound to you

00:50:29.060 | may be very different than that.

00:50:32.140 | And how we as a provider actually get our hands around that

00:50:35.660 | is actually pretty complicated.

00:50:37.300 | - Yeah, I mean, I tend to look at it

00:50:39.700 | from a somewhat different angle.

00:50:43.500 | And I tend to separate them out.

00:50:46.060 | When I look at GE Governance,

00:50:47.340 | I see that as a positive return factor.

00:50:49.220 | I think there's pretty good data.

00:50:50.780 | There are pretty good data in the back of that.

00:50:53.740 | If you look, for example, at companies

00:50:55.940 | where the executives are spending all their time

00:50:59.620 | in private jets, flying around for personal purposes,

00:51:02.620 | they're spending $20 million for a house.

00:51:05.540 | You can actually isolate that as a negative return factor.

00:51:08.220 | You have a very big one.

00:51:09.420 | And that goes all the way back hundreds of years.

00:51:11.860 | You know, John Blunt with the South Sea Company.

00:51:14.260 | George Hudson with the English Railways.

00:51:17.260 | More recently, Adam Neufeld is a classic example,

00:51:20.780 | or is a classic example of that.

00:51:22.300 | These are bad actors that are pretty easy to identify.

00:51:25.580 | And so that's one, I think, negative selector.

00:51:28.580 | There's some more subtle things you can get out as well.

00:51:31.260 | S&G, I look at as a negative,

00:51:34.020 | strong negative return factors.

00:51:35.780 | For example, you look going back 80, 90 years.

00:51:39.220 | Alcohol, tobacco, firearms, okay?

00:51:42.740 | You know, there should be a government agency

00:51:44.380 | that deals with this, right?

00:51:45.660 | (audience laughs)

00:51:46.780 | All have held the market by 2% to 4%

00:51:49.500 | over an 80 or a 90 year period.

00:51:52.300 | And the reason is very simple.

00:51:53.500 | People avoid those companies.

00:51:54.980 | The prices will fall, their expected returns will rise.

00:51:58.380 | And so the idea that you can impact social policy

00:52:01.220 | by disinvesting in those companies makes no sense at all.

00:52:04.020 | I mean, it's more likely that those companies

00:52:06.260 | will get out of private and will escape public scrutiny.

00:52:09.300 | I've never understood it as a tool for advocacy.

00:52:18.220 | You know, and then as far as governance goes,

00:52:20.900 | I'm looking at more general concerns

00:52:22.620 | from Anne Bargh's point of view

00:52:24.340 | in terms of societal, you know, just societal,

00:52:28.020 | society and the health of the capitalist system

00:52:32.420 | where we've now evolved a compensation system

00:52:34.860 | that relies heavily on stock options,

00:52:37.700 | which really incentivizes companies

00:52:41.220 | to manipulate their short-term earnings reports

00:52:46.340 | and not to think of long-term.

00:52:48.300 | They don't embrace the Warren Buffett's theory

00:52:51.940 | of long-term readings.

00:52:53.660 | - Yeah, you know, so a couple of, just to add to that.

00:52:57.100 | So I couldn't agree with you more on the, you know,

00:53:00.100 | your observations around the E and the S,

00:53:03.940 | at least historically.

00:53:05.180 | So no question that those, you know,

00:53:08.300 | the companies in the industry as you listed have outperformed.

00:53:12.940 | And again, this is part of why when we talk to people

00:53:15.540 | about doing some of these exclusionary screens,

00:53:18.740 | we really try to remind them

00:53:20.180 | that you are likely giving up return

00:53:22.060 | and just understand that as an investor.

00:53:24.900 | So 100% agreement there.

00:53:28.260 | You know, on the governance side,

00:53:31.240 | one of the really important things we think

00:53:34.900 | is the emergence of Vanguard

00:53:38.940 | and, you know, other index providers

00:53:42.500 | is actually changing some of the dynamic.

00:53:47.380 | And it's actually, I think, positive change.

00:53:49.580 | I think it's still very early innings.

00:53:52.180 | Again, this is something Jack Bowman and I

00:53:54.340 | spoke quite a bit about during the last couple of years

00:53:58.260 | because it was, this is a real sea change.

00:54:03.260 | And here's the heart of the issue.

00:54:07.140 | So we talk, everybody talks about long-termism.

00:54:11.500 | So, you know, you look at a lot of your traditional funds

00:54:14.860 | and traditional managers,

00:54:16.820 | look at the portfolio turnover.

00:54:18.860 | It belies the idea that they're long-term.

00:54:22.260 | Most active funds, on average,

00:54:24.820 | active fund turnover is about 80%.

00:54:27.700 | Even if you factor, if you say,

00:54:29.380 | okay, let's just do name turnover.

00:54:31.180 | Name turnover is over 50%.

00:54:32.700 | So that means the holding period is less than two years.

00:54:35.300 | So when somebody who says I'm really long-term oriented,

00:54:38.660 | they're not, okay?

00:54:40.060 | And that's where a lot of the pressure has come from.

00:54:42.580 | So I agree with your observation there

00:54:45.300 | on the short-termism.

00:54:46.860 | Here's the difference.

00:54:48.020 | For our index holdings, we can't sell a stock

00:54:51.300 | if we don't like what's going on in the company.

00:54:53.580 | We are a permanent shareholder.

00:54:56.580 | And what's interesting is we're now having

00:54:59.140 | those discussions with companies.

00:55:02.020 | And it's a very different set of discussions

00:55:04.740 | than what they're used to.

00:55:06.460 | Because we can't just, if we don't like what we hear,

00:55:10.620 | we just can't go home and say let's just get out of this

00:55:12.580 | and go pick another company in the sector and be happy.

00:55:15.900 | So active engagement with boards and independent directors

00:55:20.100 | has become a big thing.

00:55:22.060 | We'll probably do 1,100 engagements this year,

00:55:25.500 | and that number's just gonna keep growing.

00:55:27.580 | And most of it is around this notion

00:55:29.940 | of what's it mean to be a permanent shareholder,

00:55:33.100 | and how can you, as an organization,

00:55:36.620 | better align yourself with a permanent sense of capital.

00:55:41.620 | And it doesn't mean that short-term actors

00:55:46.340 | have no place in this universe,

00:55:49.980 | but they shouldn't have an outside voice.

00:55:51.980 | They should not have an outside voice.

00:55:53.020 | If somebody owns 1% of a company

00:55:56.060 | and wants them to spin this division,

00:55:58.540 | merge this thing and do this and do this

00:56:00.580 | to jack up the stock price for the quarter,

00:56:03.940 | if that's detrimental to our long-term,

00:56:06.580 | the long-term value of the company,

00:56:08.420 | we're actually gonna stand against that

00:56:10.740 | from a government standpoint.

00:56:13.660 | And we're beginning to have a much,

00:56:17.500 | I would say there's a much more,

00:56:19.820 | there's a much larger voice.

00:56:21.900 | Now it's really, the challenge, of course,

00:56:24.300 | is as you can well imagine,

00:56:26.460 | everybody wants to politicize that voice

00:56:28.180 | as quickly as they can and push social agenda

00:56:33.060 | and political issues as opposed to economic issues.

00:56:35.940 | And so the way we deal with that

00:56:38.020 | is when somebody, let's say somebody on the S,

00:56:41.540 | an activist, a social activist,

00:56:44.140 | comes to us with an idea,

00:56:46.420 | our first question is,

00:56:47.700 | show us the link to long-term value creation,

00:56:50.420 | and we'll have a discussion.

00:56:52.340 | So if you're writing a proposal to a board

00:56:54.700 | to be considered for the shareholders,

00:56:56.020 | we wanna see the link to long-term value creation

00:56:58.140 | and if there's a link, we're gonna listen.

00:57:00.020 | We may disagree, but we're at least gonna listen.

00:57:02.180 | If there's no link,

00:57:03.060 | we're not gonna really spend a lot of time on it.

00:57:04.700 | So that's kind of how we're trying to handle this, Bill,

00:57:07.940 | and again, it's very new territory.

00:57:11.140 | You can imagine these are tricky issues to deal with.

00:57:13.740 | The fundamental underlying principle, though,

00:57:18.420 | is what's in the interest of our long-term investors,

00:57:21.700 | because again, as I started by saying,

00:57:24.340 | we have investors who tend to stay with us

00:57:27.900 | for a very long period of time,

00:57:30.060 | and therefore, and then in our index funds in particular,

00:57:33.780 | but also many of our active funds

00:57:35.100 | have very low turnover relative to their peers.

00:57:37.940 | We are, by definition, a long-term shareholder,

00:57:41.420 | if not a permanent shareholder,

00:57:42.620 | and we need to reflect that

00:57:43.980 | and we need to reflect those values.

00:57:47.700 | - Do you or can you even speak to

00:57:49.700 | how well you coordinate with BlackRock?

00:57:52.180 | - So we don't coordinate with BlackRock.

00:57:55.020 | To be blunt, we can't.

00:57:57.820 | We deal with all kinds of antitrust issues,

00:57:59.460 | and frankly, I shouldn't say this, but I will,

00:58:02.740 | 'cause you guys are friends.

00:58:04.300 | (audience laughs)

00:58:05.860 | What BlackRock says and what BlackRock does

00:58:07.460 | are sometimes very different.

00:58:09.380 | We try to do what we actually say.

00:58:11.140 | (audience laughs)

00:58:13.980 | And again, I pay a lot of attention to what they say,

00:58:17.700 | because they actually say some important things,

00:58:20.380 | and they're very influential.

00:58:22.100 | But I think how you, if you look at, for example,

00:58:26.140 | how we compensate active managers.

00:58:29.100 | So I've spent most of the time talking on index.

00:58:31.220 | I think all of you know,

00:58:32.540 | 'cause we get notes from you all the time,

00:58:35.780 | that all of our active managers

00:58:39.380 | are under incentive contracts

00:58:40.900 | where it's longer-term performance

00:58:43.580 | that's rewarded, not short-term performance.

00:58:45.820 | And by the way, it's perfectly symmetrical.

00:58:49.020 | If they underperform, they get paid less.

00:58:50.580 | If they outperform, they get paid more.

00:58:52.660 | And what that does is it sets them to think longer-term.

00:58:57.020 | Most of them are on a three-year,

00:58:58.460 | I would like to see it go to five.

00:59:00.340 | We have a couple, I think, we've managed to do that.

00:59:02.980 | That's very different than anybody else in the industry.

00:59:06.980 | So people will talk about long-term, long-term, long-term,

00:59:09.020 | and then you look at how they incentivize

00:59:10.460 | portfolio managers, and you look at how they act,

00:59:13.060 | how they actually act, it's quite different.

00:59:14.940 | So for me, so we don't coordinate with them.

00:59:19.940 | We certainly pay attention to what they say.

00:59:22.340 | We pay attention to what State Street says.

00:59:23.900 | We pay attention to what Tia Krupp says.

00:59:26.100 | All of these organizations have intelligent,

00:59:29.140 | thoughtful, constructive things to say on this topic.

00:59:31.820 | So you've gotta be a student of what they say.

00:59:34.580 | But we're trying to carve our own way here.

00:59:39.180 | Frankly, again, with all humility,

00:59:41.220 | the guy who runs this for us, Glenn Warren,

00:59:43.100 | is considered by most people in the industry to be the best.

00:59:47.100 | So frankly, people pay a lot of attention

00:59:48.980 | to what Glenn says and what he does.

00:59:51.940 | And I think we're actually able to effect change

00:59:55.260 | a little bit more greatly than even our direct influence

00:59:59.660 | because of Glenn's thoughtfulness here.

01:00:02.140 | - On a lighter note, did you happen to see

01:00:05.540 | Michael Burry's interview with Bloomberg?

01:00:08.180 | Okay, just as a, Michael Burry was the hero of The Big Short.

01:00:13.180 | This autistic ex-neurologist who called

01:00:18.940 | the financial crisis by, was he, he loved reading

01:00:22.900 | corporate bond offering statements.

01:00:25.460 | And he went on record as saying that

01:00:27.900 | markets have grown terribly inefficient

01:00:31.620 | because of indexing and he thought that there was

01:00:34.340 | an outsized play and undervalued small value stocks

01:00:37.740 | and Japanese stocks and these hundred dollar bills

01:00:40.420 | lying in the ground and he was gonna be describing

01:00:42.500 | how he was gonna be picking them up.

01:00:44.380 | I wonder how you responded to that.

01:00:46.940 | - With a chuckle, you know, look, he's,

01:00:51.940 | you know, I think he's becoming an active manager.

01:00:55.100 | So, you know, it's a story.

01:00:57.740 | So I would say two things.

01:00:59.340 | One, you know, so let's like look at the practical part.

01:01:03.180 | Is indexing the bubble?

01:01:04.180 | I don't think so at all.

01:01:06.060 | You know, the difference between the financial crisis

01:01:08.500 | that he, you know, didn't talk quite eloquently about

01:01:11.860 | in his own way was, you know, one of the most

01:01:15.460 | important elements of that was massive, massive,

01:01:17.980 | massive amounts of leverage, right?

01:01:20.140 | So the leverage was a critical component there.

01:01:22.540 | There's no leverage in investing, right?

01:01:26.380 | In what we do at the index side where we're purely agents.

01:01:29.540 | So the fact that there's no leverage

01:01:32.380 | actually removes a lot of risk.

01:01:34.620 | And frankly, if you think about it,

01:01:37.260 | because we're not a proprietary investor,

01:01:39.060 | we're an agency, you're the ones who bear all risk.

01:01:43.080 | Like, you know, index goes up, you do well.

01:01:46.020 | Index goes down, you don't do as well.

01:01:48.020 | That's very different than what was going on

01:01:50.220 | during the financial crisis where proprietary positions

01:01:53.300 | were really what was driving so much of what went on.

01:01:56.700 | So I think the analogy is very weak.

01:02:00.360 | Now, to his observations that value stocks

01:02:05.360 | may be actually really valuable today,

01:02:09.420 | I'm much more agnostic about, you know,

01:02:12.460 | I think there has been a massive premium put on growth.

01:02:17.200 | You know, we are at the longest period in history

01:02:20.380 | of value underperformance.

01:02:22.440 | And, you know, if you look at sort of value versus growth,

01:02:26.220 | you see these tremendous waves over time

01:02:30.480 | where one outperforms usually for much longer

01:02:34.500 | than one expects, but they usually cross.

01:02:38.540 | This is the longest period

01:02:39.660 | where we've seen growth outperform.

01:02:42.100 | I would argue, and again, I'd be really interested

01:02:44.540 | because you've written a lot about factors

01:02:47.180 | and you've thought about this probably more deeply

01:02:50.300 | than I have, but I think when you look

01:02:53.220 | at macroeconomic policy and its impact

01:02:56.380 | on the capital markets, it's actually really reinforced

01:03:01.380 | the importance of growth.

01:03:04.020 | And so I think growth stocks have been bid up as a result

01:03:06.780 | because, you know, we've lived

01:03:07.780 | in this very low growth economic time.

01:03:11.620 | So investors have put a huge premium on finding growth,

01:03:15.900 | you know, some level of growth.

01:03:17.700 | And what that's done is it's really driven the price

01:03:20.180 | of growth stocks to a level, or the gap between growth stocks

01:03:25.180 | and value stocks to a level we've not seen.

01:03:27.380 | Usually those sorts of things

01:03:30.660 | do eventually reverse themselves.

01:03:32.500 | So that's where, you know, again,

01:03:34.300 | I look at what Barry's saying on that front

01:03:37.220 | and it's somewhat interesting when and how that all happens.

01:03:41.300 | I don't know, you know, we are in unprecedented territory

01:03:44.180 | in terms of central bank intervention

01:03:46.340 | and that shows no signs of abatement.

01:03:49.820 | And I think that's actually distorted the markets

01:03:53.820 | to a large degree.

01:03:55.420 | This is a personal opinion,

01:03:56.340 | not necessarily a Baker opinion,

01:03:57.740 | but I think what's gone on both at the Fed

01:04:01.860 | and in central banks in terms of monetary policies

01:04:06.540 | is so unprecedented, we've not gotten back to normal.

01:04:10.180 | And, you know, there is a sense among the central banks

01:04:14.100 | that they can make economies more recession proof

01:04:18.780 | than their predecessors could.

01:04:20.540 | I'm not even sure that's a good thing, by the way,

01:04:22.220 | 'cause I think recessions are actually important,

01:04:23.940 | go back to Schumpeter.

01:04:25.180 | But we're living in a period

01:04:29.820 | that we've never seen this kind of intervention

01:04:32.340 | and it is definitely having distortion effects

01:04:34.580 | on the capital markets, no question in my mind.

01:04:37.860 | - Yeah, I mean, with regard to future value premiums,

01:04:40.980 | my late mother used to say, "From your lips to God's ears."

01:04:44.420 | You know, and I do see the same thing that you're seeing

01:04:50.940 | in terms of the overvaluation of the growth stocks,

01:04:55.500 | simply as being a function of low inflation

01:05:00.220 | and low interest rates, which gets to my,

01:05:02.500 | I think it's going to be my last question,

01:05:05.100 | yeah, my last question, which is,

01:05:08.060 | you know, do you see the equity risk premium

01:05:13.060 | and the risk-free rate, the two components of returns,

01:05:18.060 | risk-free rate for fixed income and the sum of that

01:05:21.740 | and the equity risk premium as historically shifted

01:05:25.780 | to lower values over the past 20 or 30 years?

01:05:29.540 | You know, until, you know, 30 or 35 years ago,

01:05:34.900 | those existed within fairly narrow bounds

01:05:37.820 | and we seem to have jumped the shark

01:05:41.180 | in terms of lowering both of those values.

01:05:43.340 | Now, how many of you think that's permanent or not?

01:05:45.900 | (mimics explosion)

01:05:47.860 | Sorry, two of you.

01:05:49.020 | - Yeah. (audience laughs)

01:05:50.940 | So, look, the short answer is I don't know

01:05:53.460 | because, again, you know, the policy changes

01:05:58.460 | are so profound, it's hard to see it reversing

01:06:02.900 | anytime soon, the low risk-free rate feels to me

01:06:07.900 | like a even longer term thing that we're going to live with.

01:06:15.460 | I think the equity risk premium,

01:06:18.300 | that one I'm not sure about.

01:06:19.940 | You know, I think there's a possibility

01:06:21.740 | that we'll see a return to norms there,

01:06:26.180 | but I don't know when, it's certainly a long ways out.

01:06:30.540 | But, you know, that question Bill does bring up,

01:06:32.980 | I think a really, really important notion.

01:06:35.780 | And, you know, again, you're going to have people

01:06:38.060 | far, far smarter than I am to talk about this,

01:06:41.020 | but I know if Jack were here, he'd want to remind people

01:06:44.780 | of his little formula for predicting future returns,

01:06:48.660 | which happens to correlate very closely

01:06:51.380 | with our own multivariable capital markets model,

01:06:55.380 | which has got like quantum computing going on or whatever.

01:06:59.860 | We actually, on an absolute basis,

01:07:03.580 | are expecting lower equity returns over the next decade.

01:07:08.340 | Nothing is ever a sure thing,

01:07:13.060 | but it's close to a sure thing in my view,

01:07:15.580 | just where valuations are today.

01:07:17.740 | And it's not going to be a straight line.

01:07:19.620 | So the combination of lower equity returns

01:07:24.420 | and perhaps even normal volatility,

01:07:27.460 | that's not a good combination for investors.

01:07:30.100 | Normally when we see real volatility,

01:07:32.100 | at least people are like,

01:07:32.940 | well, you know, hope that they're rewarded

01:07:35.420 | for that in the long run.

01:07:37.580 | I'm not convinced of that right now.

01:07:38.980 | Again, Bill, I don't know what your own work suggests there,

01:07:42.100 | but we think, you know,

01:07:45.220 | even if you took the equity risk premium

01:07:48.220 | as sort of what it's been historically,

01:07:51.500 | and you look at where the risk-free rate is today,

01:07:55.820 | you put those together, you get a much lower return

01:07:58.500 | than what we've seen historically.

01:08:01.020 | If it stays a little bit compressed, as you suggest,

01:08:05.460 | that's just the worst news, if you will.

01:08:07.700 | And again, I hate to be Debbie Downer on that,

01:08:10.180 | but I think as investors,

01:08:11.620 | we all have to be thinking about,

01:08:13.740 | from a portfolio allocation standpoint,

01:08:15.540 | what the implications of tenure returns are

01:08:19.540 | in terms of how we draw down when we're in retirement,

01:08:23.260 | how much we need to save

01:08:24.260 | when we're in the accumulation phase and so forth.

01:08:26.540 | I think it's actually a really, really important point.

01:08:29.340 | - Yeah, I mean, you know, it certainly feels

01:08:33.180 | as if the risk-free rate,

01:08:35.260 | the rate on fixed income assets in general,

01:08:38.020 | it's gonna be low from now out to the horizon

01:08:41.460 | and come up with any number of narratives

01:08:43.660 | of why that should be.

01:08:44.500 | But I've learned over the years not to trust narratives,

01:08:46.780 | and I also can remember 35 years ago, 40 years ago,

01:08:50.660 | when it seemed like we were going to be

01:08:52.260 | in an inflationary environment forever,

01:08:55.260 | and it was never going to end.

01:08:57.340 | So.

01:08:58.700 | - Yeah, I think, you know, I think just to--

01:09:00.260 | - It's hard to tell.

01:09:01.100 | - Yeah, I couldn't agree with you more.

01:09:03.660 | We all grew up in that inflationary period,

01:09:05.740 | and again, I remember that it was never gonna change.

01:09:10.660 | I think a lot of what, you know, I talked about,

01:09:13.020 | I sounded pretty critical of central banks,

01:09:14.780 | and look, I get what they're doing

01:09:17.340 | in the sense that the thing that they fear the most

01:09:20.580 | is deflation, because as bad as inflation can be,

01:09:23.660 | deflation, once you get into a deflationary spiral,

01:09:27.100 | it is just the death of the economy.

01:09:30.420 | And I think they've been obsessed with that.

01:09:32.340 | And when you look at the demographic factors in particular,

01:09:36.780 | you can see why people are pushing

01:09:39.980 | against doing everything possible

01:09:42.620 | to prevent deflation from setting in broadly.

01:09:45.900 | And again, I'm not enough of a demographer,

01:09:49.420 | but as you sort of look at what the data suggests,

01:09:52.180 | there's gonna be a lot of downward pressure

01:09:54.900 | because of the aging of the population and so forth globally.

01:09:58.820 | This is not a US phenomenon, it is a global phenomenon.

01:10:02.300 | And I do think that you're right, Bill,

01:10:04.660 | that that could shape the narrative for a long time now.

01:10:07.460 | - Thank you.

01:10:09.420 | - Bill and Bill, thank you so much.

01:10:11.060 | (audience applauds)

01:10:14.060 | At this time, we're gonna take a 20-minute break,

01:10:21.460 | thank you so much.

01:10:22.900 | (audience applauds)

01:10:25.900 | (upbeat music)

01:10:28.500 | [BLANK_AUDIO]

Bogleheads® Conference 2019 - Bill McNabb & Bill Bernstein Fireside Chat

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