 I will just quickly introduce Jonathan Clements who in turn will introduce Charlie. Jonathan was on the last panel. He is a former Wall Street Journal columnist. I will say for me as a young analyst working at Morningstar, he was my favorite part of the journal and really very much influenced my own career path to talk more about personal finance and financial planning and has the humble dollar blog and also was involved in a great book project, a book I just love that has come out over the past year called My Money Journey, which is essays by people about how they found their own financial footing. So Jonathan, if you can come up here and introduce Charlie or do you want to sit tight? Okay, great, thanks Jonathan. Good morning everybody. I moved back to the United States from London in 1986 and I became a reporter at Forbes magazine which meant basically I was a glorified fact checker. I spent the next two years of my life trying to make sure that the senior writers didn't make too many errors in the magazine. But one of the nice things about the job was that you had a certain amount of free time and Forbes also at the time had a great library and that's where I got my personal finance education and going through the stacks down in the second floor library, I came across this book called Investment Policy. Now Charlie, that really wasn't a very catchy title was it? Investment Policy was a book that came out in 1985 but it really grew out of a financial analyst's journal article that appeared a decade earlier in 1975 called The Loser's Game and it was of course written by Charlie Ellis. So Charlie, tell us a little bit about the story behind that essay and how it evolved into what's become a phenomenally selling book winning the Loser's Game. Do you mind if I take just a minute and go in another direction and then come back? You know, you are a difficult individual I know but go ahead. I'm looking out at this really large audience and those of you who I've met obviously have certain characteristics. I'd like you to think just for a minute about Jack Bogle, how he had a nightmare and he had a dream. His nightmare was that he would be forgotten and it really, really mattered to Jack that he not be forgotten. As he told me, the only reason I'm really writing books is so I might not be forgotten at least for a while but I'm really, really worried about being forgotten and if you look at this group or walk the hallway or that lovely sign out front with Jack's picture you realize, well Jack you may be gone but you're certainly not forgotten. The second thing is, Jack was a real tightwad and he made a celebration out of being stingy and cheap and how he would take personal or to save the nickels. He would be thrilled. This is the first time in 50 years that I've been in a public speaking situation with no fee whatsoever. So back to your question. I happen to love tennis as a game. It doesn't take very long to get there. You can play for as long as you feel like and then you've got plenty of time left over for the rest of your day whereas golfers it takes a while to get there and it's a long, long game particularly if the weather's nice. And you don't have much time. I wish I were a really gifted tennis player but I'm not. And so I was attracted to the idea that tennis is an overcoming problems game rather than a doing brilliant things game. Wonderful man named Simon Ramo who more than anyone else invented the American space program as the chief executive officer of TRW, Thompson Ramo Wildridge. He conceptualized what space could be all about and made clear in such a way that Congress and the administration really understood this is something we've got to do in a major way. He was a very talented business executive. Much more important to him, he was a gifted musician. He and three members of the Los Angeles Symphony Orchestra performed in public as a string quartet quite often and took on some very complicated pieces of music. Finally, he was also a terrific athlete and his favorite game was also tennis and he wrote a book called Extraordinary Tennis for the Ordinary Tennis Player. That's me, Ordinary Tennis Player so I bought the book and it was a mind-opening experience for me. The purpose of the game for those of you who are expert is to hit a shot that goes so close to the line that the other person can't quite get it back or is hit so hard that the other person is put a little bit on their back foot or in a series of shots has them running back and forth across the court trying to keep up with you and gradually you get ahead of them and slam it through into the corner. That's what experts do. They win points. The rest of us, the outcome of the game is determined almost entirely by who loses the most and I thought that's my kind of game. I double fault sometimes, I hit it in the net sometimes, I hit it out of bounds sometimes with the least intention. I never wanted to do any of those things but they do happen. And if I could cut back on those mistakes sure enough I'd have a better outcome. One of his recommendations was hit the serve always, first serve and second serve that is about as good as you can do and get in 80% of the time. If you do that you will double fault once or twice in a set and that's all and your second serve will keep the other player back in the court and on defense. It's a magical insight and I tried it and it worked for me and I had a wonderful time. So I realized my god this is a brilliant understanding and it applies entirely to investment management. If we could just eliminate our dumb head mistakes if we could just avoid making I'm terrified I'm getting out of the market at the wrong time or I'm excited as could be about this is a really opportunity at the wrong time we would do fine. And so that's the origin of the book. So that was the origin of the book but you wrote the original essay in 1975 and by the way Charlie thanks to Wikipedia I can tell you it's about to turn 86. Next week. Next week. I won't say happy birthday to you but Charlie wrote Winnie the Loser's Game half a century of the original article half a century ago and at the time you had spent a considerable period covering analysts with Donaldson Lufkin Generic and you had seen how well they did the analysts and that gave you an insight into the performance management game and whether it was that and how it was a Loser's Game you talk a little bit about that. But one of the great privileges of being a stock broker is you get to meet a lot of people and if you're in the institutional business you meet a lot of people at major institutions and I was responsible for all of our clients in northern Manhattan and Boston and Chicago and Boston was a hotbed of talented people and one of the things you couldn't help but realize is these guys are all really good at what they're doing they're all smart as the Dickens, they've got terrific good education and boy they're fiercely competitive. The second thing you learned is they're all fighting against each other and they don't realize that they're competing with each other and that's pretty tough competition because they're all really smart and they're all really well educated and they're all highly motivated and they're competing with each other and they're not going to work out all that well for all of them and sooner or later people are going to have real difficulty and that was for me a really opening-minded insight that just they are not trying to compete with the market they're competing with each other the markets you can look at and say ah you know it's just the market but when you're competing with brilliantly talented people with great educations and ferocious ambition to beat you back this is a different game So when you wrote the 1975 piece for the financial analyst journal what sort of reception did they get among people on Wall Street? Oh they loved it They were playing a losers game They loved it I got so many friendly remarks I read your article of course you're wrong but I thought your article was beautifully written or it was fun or your analogy was really terrific but you're wrong I'm going to beat the Dickens out of the market how I'm going to make my living you really are wrong so far the evidence seems to be going the other way the game's not over yet it's a long, long, long, long game but the evidence keeps building that active investment managers as talented as they are and I have to tell you we have never in the world had such a talented group as we have now active management practitioners incredible we have never had as much equipment for them to use the computing power that they carry around in their pockets is way beyond anything that could have been imagined 30, 40, 50 years ago the information flows that go to them from thousands and thousands of analysts and portfolio managers and economic analysts and strategists from all over the world all day, every day, through the internet is unbelievable if you haven't played with the Bloomberg terminals in the last couple of years find an opportunity to go play with the loop terminal they are unbelievably powerful only problem is everybody's got them everybody has a Bloomberg terminal most people have two one at home and one at work a lot of people have three one at home, one at work and one in the car that drives them into work the information is not competitive the computing power is not competitive the talent and education is not competitive it is overwhelming and they are still out there struggling away hoping to find a way to be able to do better than the competition the analogy that comes to my mind is if you are 6'2 and you're 24 and you are a damn good athlete and you've had some experience as a prize fighter and you and I meet each other somewhere out here in the hallway and it's a competition I know who's going to lose it's going to happen for sure but change things a little bit you've got a knife and I've got a knife I might be good with a knife no no you've got a gun well I've got a gun but you might have a killer instinct and I might flinch at the idea of killing somebody with a handgun no you've got a machine gun and I've got a machine gun who gives a damn about you being 6'2 you've got a tank I've got a tank nobody cares about the fact you're 22, 6'2 and you're a prize fighter that's what's happened to the investment management world the power of the tools that are available to the people who are doing the work have gone up and up and up and all of them for the individual are marvelous you should see what I've got in the way of technology you should see what I've got in the way of information only problem is everybody else has it too in exactly the same time so they're equalizers they make all of us more and more and more equal and if you think the market is going to do 7% a year and you've got a 1% fee that's a 15% of returns fee that's going to be really hard to overcome by outsmarting the other people smart as they are, hard working as they are all over the world so just to give you some historical context when Charlie's original essay came out in 1975 that was before Jack opened the S&P 500 fund to investors in 1976 so when you hear Charlie talk about his essay and the reception that it received remember this was radical in the mid-1970s this was stuff that people on Wall Street not only didn't want to believe simply didn't believe they really did believe that they were better than average so Charlie launched a firm called Greenwich Associates which was a management consultancy firm and in 1976, I think I've got this right he had a fateful lunch with a man by the name of Sandy Getsman and this is the point at which you realize that Charlie is a complete fraud and is in fact a brilliant active investor so tell us about the lunch Charlie Sandy Getsman was the chief executive of a firm called First Manhattan and they had been clients the year before and I've written as we did for each client an analysis of their strengths and weaknesses with a series of 3, 4, 5 specific recommendations as to what they should do differently they had some terrific research for creative investment ideas they did not have institutional or industry coverage they didn't do it that way they were looking for individual stocks rather than wanting to be responsible for all the stocks in the chemical industry or all the stocks in the auto industry or any other industry and I'd explained to them quite carefully that they were working in a way that was counterproductive because brilliance in creative ideas without having the full understanding in context of the total industry they were going to miss the privilege of being listened to carefully by the analysts at the institutions and all the institutions had analysts who covered their industry and they found the best ideas and fed them up to the portfolio managers and as a result they were never going to have access to the portfolio managers and they were going to never be able to build a significant institutional business this is some way to treat a client you're making a terrible mistake and you're really in trouble and I called the next year to see if I could make an appointment to see Sandy and his assistant said well Mr. Goddardman would like very much to see you but he would like very much that you would come for lunch and I thought it's going to be terrific because we just told him he's doing everything wrong and he's decided to upgrade my stature and invite me to come in for lunch this is going to be a guaranteed win so I went in with all the politeness I could set us and Sandy just delighted with this conversation looking forward to it very much he said before we get in the conversation Charlie let me just tell you we're never going to take your service again you told us that we couldn't succeed with what we're doing and we understand that you're right we can't succeed with most institutional investors but that's only part of our business we do a lot of investment management and we do individual stock brokerage for individual people we don't need institutional business that's a small sideline ooh we why would he invite me to come in if that's what he has as a message most people would send a short message you're wrong for us and we don't want anything to do with you or a telephone call or some other but he's invited me in for lunch oh well Sandy we've got this really interesting service for investment management would you like to know how you're doing compared to other investment managers no Charlie we don't really care about that because most people are going after the large pension funds we're going after the small pension funds run by entrepreneurs so we don't really care about that business ooh we this is going to be a difficult situation that's okay Sandy said well let's go up for lunch and as we got in the elevator I realized I had to come up with something to talk about over lunch because he has just shot down the two possibilities I had on the way in as we sat down I said Sandy you're one of the best investors anybody knows would you talk about your favorite all-time investment I said sure I said first what was it still is what is it Berkshire I'm sorry Berkshire Hathaway well I'd heard about Berkshire Hathaway and I'd heard about Warren Buffett and I knew something about the Buffett partnership but I didn't really know very much about it at all so I said Sandy can you do me a big favor would you talk in depth about Berkshire Hathaway started by telling me how long you're going to own it forever I had had a conversation with my partners that we were running a fragile business we were a small firm we couldn't possibly borrow any money from a bank so if we had any trouble financially we were in serious jeopardy probably wiped out and that we ought to put aside a reserve which we could do if we would defer our annual bonus by six months and the other fellows in the partnership said I don't really want to do that because I'm almost hand to mouth but I think that's a really good idea we put it aside so we had a hundred thousand dollars that we had decided would be enough of a safety cushion in case we got in trouble and my partners had said Charlie you know something about investing so why don't we look to you to find how we should invest this and really do it so with that background Sandy started talking about Berkshire Hathaway and laid out a concept of why that was a great long-term investment that was compelling in my mind so I went back to my partners and said I think we should put everything into Berkshire Hathaway what the hell is Berkshire Hathaway I've never heard of it you will hear about it it's a really really well run investment organization and it's in fairly conservative stocks most of the time and it's got some really clever ideas about how to do better well that was a long time ago and the stock was selling a little over a thousand dollars in shares there's nothing like being lucky and today we have Berkshire Hathaway around half a million in the share yeah and do you still own it I'm following Sandy's advice he said forever and I figured why not it's forever with me too and now of course it would be stupid to sell and pay the capital gains you'd never recover at my age before you're gone and buried so I'm looking at sort of like a flower bond those of you who are in your early mid 80s will understand flower bonds were the bonds that you could use to pay off your estate taxes and they were bargain and the prices up and stuff like that so I want to move on to another part of Charlie's story career Charlie spent 17 years heading up the investment committee for Yale University I was on the investment committee for 17 years and I was chair for 11 which means that basically Charlie was David Swenson's boss front row seat watching the best talent that any of us have ever ever known of to tell us about David he's a beautiful man he was good looking he was a good athlete he was as nice a guy as you would ever want to meet he was the most disciplined investor there has ever been everything about his activities were worked out and done deliberately his greatest personal strength as an investor was his fascination with risk management most of us think risk will take care of itself not David, he really wanted to manage the risk very very carefully before he got to Yale he had invented the first major derivative transaction $100 million swap between floating rate and fixed rate interest between IBM and the World Bank nobody had ever conceived of doing anything quite like that kind of a transaction he conceived of it and then figured out who would be the right clients to do the transaction with and then of course the fee was pretty attractive on both sides then at Solomon Brothers where he was then employed it was a spell binding experience to see somebody do something created David invented the endowment model concept of investing which is probably the most powerful development of thinking in investment management that anybody has ever done except possibly indexing which I'm devoted to so be careful there's a bias there when he got to Yale New Haven I have to tell you New Haven is somewhere between New York and Boston Boston's a hotbed of talent nobody needs to have some place to live and work that's halfway between the two cities and that's what New Haven was they had no investment community of any kind of distinction or capability there was no way that somebody who was really good was going to leave Peter Boston in order to get a job in New Haven and it was sort of the desert of investment management he was so responsible for the endowment and started place was to create the first really serious minded investment committee that Yale had ever had an interesting challenge you put together one after another after another first rate insights into how you could do one thing after another after another after another if you really want to have a talented investment team fine start with someone who is a gifted teacher David Swenson ask him to create a seminar that the smartest students at Yale will all want to take and Yale has not a very large undergraduate college a little over a thousand students per year but they are really the cat's meow in terms of talent and creativity and ability to learn have a seminar that all of those students are going to want to apply for carefully select the 25 students you will allow into the seminar within the seminar make it an interesting experience of learning and development choose the one or two or three students each year who are really outstanding and offer them a summer internship if someone is in the summer proves that they are really gifted at doing the work offer them a two or three year extended position offer them a chance to stay permanent on the team oh by the way make it fun lots of activities in sports because Yale has got all kinds of sports equipment and facilities and David is a very good athlete have really interesting competitions with other teams be sure that you have group activities that are very close knit bring people together so that they realize this is like a family be sure that they have a chance to learn an enormous amount because they are included in all the most important meetings and they participate in the decision after the meetings pretty soon you can attract particularly a Scuttlebutt network passes the word students pass it on to other students pass it on to other students so it didn't take more than two or three years before everybody at Yale knew the best thing you could possibly do was go to David Swenson's seminar so it attracted quite a large group and then he carefully selected the best of those students to be members of his seminar and then took it from there so in terms of the investment committee overseeing same thing was it like the cop with the presidential motorcade you just waved it through or did you ever second guess David's decisions well first David did the selection he did not just take whatever was offered he was very careful to find a cluster of people a really small number of people but a cluster of people with different backgrounds who would really be committed to helping the Yale endowment and who would be sources of insight and information and perspective judgment that he might be able to incorporate so it was his investment committee without a doubt and then he treated them as though they were gods and they gradually thought themselves as being pretty close to gods with David as their favorite employee the intensity back and forth was quite terrific lots of open discussion only once in 17 years did I see a recommendation from David's team come up and meet a series of skeptical questions from the investment committee at which point David said you know I think what we ought to do is take this back for further consideration of course it never came up again once in 17 years and if you look at the Yale endowment it had over 100 different investment managers most of whom none of us would recognize by name there was no well known investment management firm that ever made the cut in David Swenson's array of investment management because he was reaching for people who were so talented but so new that nobody knew about them or would feel comfortable hiring them he was the first client for a very large number of quite successful later on investments he was very good at it and that helped but he caught people at just the right time and then the interesting thing to me was even though I would not have recognized four out of five of those managers I've got a reasonably wide exposure in the investment management world I just didn't know of them at all the average duration of the relationships was 17 years imagine that the average duration of the investment manager relationship turnover was what, 6% it's just phenomenal so when I hurriedly sketching notes for today's conversation with Charlie I knew that he had been a friend of John Neff and I was going to ask him about that for those of you who've been long term investors in the Vanguard Windsor Fund you'll of course know John's name I was also going to ask Charlie about Burt Malkiel Charlie's also good friends with Burt Malkiel they go on vacation together they did a book together probably the second most famous book that Charlie's written, the Elements of Investing and of course Burt and Charlie sat on the board of directors of Vanguard together for a while but I'm going to leave that aside because we're going to run out of time and I have one last topic that I want to talk about one last series of stories which of course is Jack Bovell so Charlie you're a management consultant you look at Jack's tenure as the chairman and chief executive of Vanguard how would you appraise him as an executive? Terrible Would you like to elaborate? If you'd asked as a leader then I might not have said terrible I would have said compelling exhilarating inspiring and capable of causing people to reconsider what they wanted to do with their lives and why they wanted to do it you heard earlier observations about the service ethic that's deeply rooted in the people who work at Vanguard candidly serving as a consultant and then as a director of Vanguard I was backstage all the time and I saw all kinds of opportunities to observe they were a bunch and are today a bunch of Boy Scouts and Girl Scouts they are decently nice people to each other ferocious in their drive to reduce cost who got that going? That was Jack he was ferocious at what reducing cost and it makes a terrific difference when a large group of people can have a purpose as specific as reducing cost and they work away at it all the time all the time and it was great effect second thing is Jack was determined to have real value delivered and everybody who's at Vanguard has to drink the Kool-Aid if you don't understand we're here we serve with higher and higher value the owner, shareholders of Vanguard and the owner part is something they care serious about and they mean it because investors in the Vanguard funds are the owners because the funds own Vanguard and a little bit of a skittishness on taking risk because they as a group know that many of us have got this terrible temptation after things have done well to get excited rather than when things look pretty grim but might do well so if you said in terms of leader or founder or inspiration then I think you'd have to rank him exceptionally high the day after Jack died this was the man that was afraid of people not paying attention the New York Stock Exchange had 50 photographs of Jack's displayed all over the floor of the New York Stock Exchange because they had such a high regard for what he had done and what he had done was leadership but management he was terrible he really never ever understood computers as a cost saving device he looked at the cost of a computer the price tag and said that's just too damn much I'm not gonna pay that instead of realizing if he would do that he would be able to bring the cost levels down he really got way behind the curve on computerization in all kinds of technology he made dreadful mistakes he had the chance of a lifetime to seize and make a real success out of ETFs I'm not gonna do that ETFs are speculative you don't understand ETFs are a cheap way for people to own stocks no no no they're speculative because you can trade them anytime you want to yes Jack most people don't trade them the hedge funds trade them all over the place that's where the turnover comes from you don't have to worry about individuals they would buy and sell them when they need to but they will not go trade I'm not gonna buy them we're not gonna have anything to do with ETFs they're speculative that lasted for a decade dead wrong dead wrong strategy decisions in several cases were also dead wrong he decided for reasons that were totally inappropriate that he was gonna do something and he badgered the board of directors to give him permission to do it and finally they said Jack it's never gonna amount to anything and you're all determined once you go ahead and try it when you fail and come back we're not gonna hurt your feelings and we're certainly not gonna penalize you but you're really really wrong I'm gonna do it okay so he went out and organized a new investment service idea and he went to Wall Street and said I've got a great idea you guys are gonna love it you're really really gonna love it I'm gonna raise money and we're gonna do something that's innovative and creative and you're gonna be able to be a participant sounds interesting Jack what is it index funds Jack index funds there's some experimental work being done at the Wells Fargo bank with index funds but that's just not that's not an attractive proposition people want to beat the market they don't want to buy the market they want to beat the market they want to run and load on this index fund so they're gonna drop back 8% at the very beginning and the way you're matching it they'll never ever catch up because they're gonna stay at best at the market rate of return at 8% behind 8% behind Jack don't you get it this is a guaranteed failure I'm gonna do it and gradually his aspirations went from a substantial $250 million offering to $100 million offering to $50 million offering to $15 million offering finally he squeezed it out into the marketplace and it went nowhere because everybody could see by this you lose on the date of purchase and you will never recover and then he thought if we drop the load maybe that would help it didn't make any difference by that time everybody knew not to touch it okay I'm losing money operating this fund and the fund itself is losing money and we've got a front-end load we've got rid of the front-end load I need volume so he merged it with the closed-end fund that was also being managed were distributed by Wellington that gave him enough to break even and after nearly a decade indexing started to catch hold catch hold and went on and on all four being ahead of your times but being that far ahead of your times I'm not so sure so we only have a few minutes left if there are any questions Christine's Christine already has them alright we'll try and rattle through these as quickly as possible you need to be a little less loquacious Charlie okay coming back to David Swenson should investors make room for alternative assets in their portfolio no would you like to elaborate well you told me not to be realistic about markets if I were running an alternative investment fund I know where I want to go where big money makes relatively quick decisions and sticks with them for the long long time that has nothing to do with individual investors I wouldn't dream of talking to individual investors I'd concentrate entirely on endowment funds and you would never be able to shake me loose from that however if I were running I've got to make money somehow enterprise and I couldn't compete successfully with institutions for institutional money I might very well find a way to create an access for individual investors nobody's mother would ever say go ahead go ahead and deal with that guy and anybody's father would say don't touch the son of a bitch and I think they'd be right it's a fair market out there but that doesn't mean that all the players are fair to you and if you don't belong there you're going to be treated unfairly I don't belong there to individual people don't come near belonging there all right second question for you are there any market segments where investors use actively managed funds no not emerging markets certainly let me just be fair if you are fluent in Chinese and are resident in China so that you can access a lot of the information that might be available because the Chinese market is still overwhelmingly dominated by individual investors you could if you were a logical hardworking person gather information that would give you comparative advantage and then if you were very disciplined in your investing activities you could probably do better than the Chinese market I have two grandsons who are half Chinese half American they are fluent in Chinese they might be candidates for this these two kids are really super bright 16 and they could do it but if they came to me and said that's grandpa that's what we think they call me Charlie we think we do we are going to go to China and make our life there investing in Chinese stocks I would plead with them to do something else because they've got quite a lot of talent and they could do something that's a hell of a lot more interesting than buying and selling stocks alright so final question this one is for me what's your favorite Jack Bogle story you can give us two no pressure Jonathan you should have given me a pre-warning that that's what you were going to ask alright so it was a warm up for Charlie well the Colk's turn in the early 1990s I was covering mutual funds at the journal that was my first job at the journal and my counterpart at Barron's was Leslie E and Leslie wrote a piece for Barron's where she referred to Jack as the ever self-righteous Jack Bogle the day the piece of pity is her phone rings she picks it up and on the other end this is the ever self-righteous Jack Bogle he loved it that was Jack it was an article that had Jack and Warren Buffett and Jack was pissed off because Warren was mentioned eight times and he was only mentioned twice it's one of the great mysteries of all time which is you go to the campus you will see a statue of Jack Bogle a substantial statue more than life size and you may be the person who for the first time in world history figures out who ordered that damn statue to be put up in that complex I know the directors were not part of that decision I know that the management wasn't part of that decision and the only person that I can imagine is a certain commudian that wanted not to be forgotten and wanted to be wanted desperately desperately to be a hero to ordinary investors and so it came to pass or as one of Jack's assistants from many years ago Kevin Loughlin used to say there are only two groups of people in the world who walked the office every day and passed a statue of their boss the people of North Korea and me thank you Charlie for your time