 A number of years ago, Jack Askevee and Bill Bernstein could have an informal non-political chat as part of the agenda. And we all know that what Jack wants, Jack gets. So it's been so popular it's become a regular part of our conference agenda ever since and it's now affectionately known as the Farside Chat. Jack's companion for this Farside Chat is a retired neurologist who helped co-found efficient frontier advisors. He's written a number of best-selling titles on both finance and economic history. He holds both a PhD in chemistry and an MD. Please welcome one of the smartest guys I know, Dr. Bill Bernstein. Jack and Bill, since the Boglehead community is politics-free group, we respectfully request that you honor and refrain from discussing anything political. Other than that, the floor is yours. Take it away, Bill. Okay. Well, thank you very much. I don't know who you're talking about. The first observation I would like to make is just to thank the moderators of the board. That's the main public forum of this organization. That's the one that almost certainly does the most public good among all the things that the Bogleheads do. And I particularly want to thank the moderators, Susan Ladygeek, Alex Fracht, Jim, who is prudent on the board. Thank you. And Mel moderates the board, too, because we all know what happens to boards very quickly when they are not moderated. I want to make an observation, Jack, which is there's a famous scene which repeats a bit of urban folklore from the big short. It's one of the characters in the movie says to one of the others, don't gloat about your great success in predicting the crisis because for every $3 million that disappears from the economy, there's one excess death. So this is going to kill a lot of people. It's going to hurt a lot of people as well. You quoted a figure, and that's something which is reasonably well accepted, I think, among epidemiologists and healthcare economists. You quoted that just in your most recent talk this morning that Vanguard saves investors $2.5 trillion or has $2.5 trillion in assets so that if you do that computation, it's saving investors somewhere in the vicinity of $25 billion a year. That's just in fees at transactional expenses on top of that. It's maybe $40 billion in fees. If you do that division, $3 million a life, you're saving about 10,000 lives per year. I wondered if you had ever considered that. I'd add one other thing, which you're probably contributing to excess mortality conversely among active managers. I wonder if you've ever thought about that one. Well, the answer is I have not thought about that. You can't think of everything. That's a good question. I didn't quite get the transition from dollars to lives. That's the regression slope of excess mortality on decrease in GDP. In other words, for every $3 million a GDP that's lost, there's one excess mortality in the population. As long as we're having fun with that, I thought I'd segue it to something else, which is, and I don't think this is political, there are certain things in the economy that are best run by the state. Even if you're jumping up and down Libertarian, you admit that defense in the courts and maybe even infrastructure fall within the purview of the state. That conversely, even if you're a socialist, you believe that the private sector should be producing most goods and services. It is a third area of the economy, which is nonprofits, which dominate and rightfully so certain parts of the economy. Education, for example. No one wants to go to San Diego University. Hospitals is there a doctor in this room who would want to be a patient in a poor profit hospital. Vanguard is a nonprofit organization for all practical purposes. What you demonstrated in your talk is it's slowly taking over the industry. Do you think that nonprofit organizations like Vanguard or maybe only Vanguard, maybe that finance is one area that should be run by nonprofits? I wouldn't be in this for a dictate, a law, pass a law to do that because the issue was far too complicated for that. I do think that the one thing people don't quite understand about Vanguard and mutual funds generally is the reason you can mutualize is you need almost no capital. When we started Vanguard, I think our capital was maybe under a million dollars, maybe a million to two million dollars, and the funds had plenty of money, I guess at that point a billion five in assets, but a couple of million dollars is just a rounding error there. You really don't need to have as much capital as we had. You can rent computers, you can rent land, you can rent buildings, and your ongoing costs, employee costs usually about two-thirds of the costs, 65%, 75% of most businesses you pay every month on a capital item, just have to have the revenues to support it. It works, and the more interesting question is why don't more people do it? Why aren't, I mean I've told people often, we started this Vanguard, we call it Vanguard meaning the leader in a new trend back in 1974, and here we are 43 years later, and we have yet to find our first follower, so how can you be a leader if you don't have any followers? It's kind of an existential question, and the reason it's going to take, so you don't need the capital. You can run a company this way, and I don't want to go too far here, but it is mutual, truly mutual, but there are no limits on the amount we can pay people. Our executives are very highly paid, they don't want to disclose it even to me, but it's a different world than when we started a lot of years ago, and there are certain reasons that should be very high, and certain reasons maybe it is not, and it should not be. So that's a kind of pressure that the typical non-profit, National Constitution Center, has done the face, but so I would not pass a law, but at some point competition has the rear, it's ugly head, and it's amazing that at this stage of the industry's development, despite someone's asked me yesterday, maybe the last evening, I think maybe you did the last evening, Bill, and asked me how do these mutual fund companies survive with assets shrinking? The assets haven't shrunk at all, because they've had net liquidations pretty much year after year for 12 years or so, more money going out than coming in, a lot more going out, but the market's been going up, and so the assets of mutual funds are actually larger, quite sure about this, larger than it was 12 years ago. So a bull market is going to keep people from making the necessary changes. A bear market will make consumers much more sensitive to performance, much more sensitive to cost, much more sensitive to the industry as a whole, to even investing in stocks, that's what bad markets do, very perverse. So I think it's going to gradually happen, and once it happens, it will be like a little rolling stone that gathers a lot of moss on the way down. Sort of remind, sort of analogous to Warren Buffett's face, name a statement that you don't know who's been swimming naked until the tide goes out. All right, well let's talk segue to the composition of the market portfolio now. Everybody, not people in this group of course, but everybody else is talking about the Fang stocks, F-A-A-N-G, what, Facebook, Amazon, Apple, Netflix, Google, and they're something on the order of what, 15 or 18% of market cap? Not unusual if you look at market history for five or six stocks to the top five or six stops to occupy that much market cap. What is unusual is that they're all tech companies that are selling for high valuations, it's one thing when Exxon, Mobile, and Proctor, and Gamble are the biggest stocks in the index, it's another when there are companies that could easily vaporize over the next 10 or 15 years. And I'm wondering if you have any thoughts about that. Well of course that's a lot about it, and we've done a little research on it, it's not so easy to do, but the reality is that let me use your number of 16 or 17% of the index funds assets are in these tech stocks or just market disruptive companies, whatever you want to call it, but the same amount about 16 or 17% is in those stocks held by active managers. There's finally no way around this because you can if a certain set of stocks are 17% of the industry and there's index funds that own, let's say a third of it, and that the remaining two thirds of the assets have to be invested in the same stocks because they're there, I mean somebody has to own them. And we took it even a little bit further than that, Mike did some good work, Mike Nolan did some good work for me on this, and tried to isolate out the mutual fund industry as compared to all other investors. And it turns out that the concentration is almost identical in the mutual fund field. So if the market goes to, is this political now? If I ask what the market does, but if the market were to go way down, other funds will go down just like the index funds, other funds as a group will go down just like the index funds do. There is a certain risk, I'm editorializing a little bit here, Bill, a certain risk that will all this money coming into the index fund at very high prices with people having an awful lot of shareholders never having experienced a bear market that the index fund could be hit more heavily with redemptions from disappointed investors. They shouldn't be because if they've been listening to me, all I did was ever promise them their fair share of market returns, good or bad. And sometimes I think they only hear good, you know the way the world is. So it does not worry me, maybe it should, but it does not. Okay, let me ask another somewhat related question. I'm sure you're aware, Jack, of, I think it's still a working paper, but it's gone viral by these three authors, Azar, Schmaltz and Tessu. And for those of you who aren't familiar, the title of the article is the Anti-Competitive Effects of Corporate Ownership. And basically one of the hints is that one of the propositions that these professors put forward is that mutual funds in general and index funds in particular are bad for competition. Okay, the concentration of ownership means that they really don't care about how companies compete. In fact, the best thing is for them to collude, to increase their profits. And this is bad for society in general because it distributes wealth away from consumers who are paying for the higher profits and towards the owners of capital. So I'm sure you've thought about it, and I thought I'd open it up for your comments. Yeah, I have thought about it, and I actually, like everything in my life, there's an anecdote about it. And the anecdote is that for a whole lot of reason, one of the Pine Prize winner at Princeton, most outstanding student, a young woman, was engaged to a young man. They were both graduating the same year, and he was the valedictorian. And when you get the Pine Prize winner married to the valedictorian, no one wonders what that holds for the future generations. It's kind of awesome. And Glenn Weil is the valedictorian's name, and he is part of the group with Eric Posner and one other Gal from Yale, Fiona from somebody, I can't remember the last name off hand. And they are big in the same thing. They've written papers about it. They had an op-ed published in The Times, and The Times wouldn't publish my rebuttal. But Eric got his PhD in, I'm sorry, Glenn got his PhD five months after he graduated from Princeton. He's a little smarter than I am. And he is one of those, and we are having violent philosophical arguments about this. And the first thing is, I mean, there are a number of levels of which I can respond to this on. One involves Pascal's wager, whether God exists or God does not exist. And the conclusion is, you probably all know this, but the conclusion is, consequences must always outweigh probabilities. So they're saying, in effect, that the probabilities are that we're destroying this concentration of ownership. We're limiting competition and reducing competition. And we ought to not be allowed to own more than one stock in a given industry. And they always use the airline industry as the example. We probably own eight airline stocks. Let me take a guess. That would be all there are. And so I mean, I wish they'd give us another example. But that argument ignores the fact that we would then have, and I'm trying to get this number out of them. And they can't give it to me because I haven't done their work. And that is, how big would the S&P 500 fund, how many stocks would it hold, if you couldn't own any competing stocks? And they say, well, it's very difficult to do that because we don't know what an industry is. What industry is Amazon in? Well, if you don't know that, what is the point of saying that you can only hold one stock in an industry? I mean, it just makes no sense at all. And it would destroy the index business because you would have that. And that's the consequence of this possibility, I hesitate to call it a probability, the possibility that there's an anti-competitive effect to destroy an industry. Just think about the capital gains that funds would throw on their shareholders, for example, if they had to divest all the companies in the industry but one. And then think about Vanguard by bets on, let me say Google. And Fidelity in their index fund decide not to bet on Google in that category, but to bet on, let's say Apple, I'm not sure how these categories are not exact. So then Apple does better in Google. And so we got some people at Vanguard say, we got to get out of this Google and into Apple. It's a managed fund. And that's the way it would work. So it would destroy a great idea. That's the number one thing. And is it worth it to do it for that? OK, that's one level. And the second level is, what is happening about there? Where is this pressure, as it's generally stated, pressure on companies to reduce wages and increase prices coming from? Well, first it comes from a system where capitalism is trying to reward its owners. I'm not sure that's good, but it doesn't have anything to do with index funds as such. That's the way capitalism works. And the Glenn Weil, Eric Posner thing, is really a socialist kind of thing. They don't like that. They don't want capitalism to work that way. And they think indexing is abetting it. And that may actually be. But we're not doing anything. This is the point. And Vanguard under Glenn Borum has about, I think, 40 analysts who look at corporate proxies and that kind of thing. And a little postscript here that we put on a lovely booklet on full disclosure, which I've been asking for for years, of exactly how we do our proxy voting every year just came out. And you should go to our website, all of you, or any of you that are interested, and see how we do the voting. But it doesn't have anything to do with calling ahead of United Airlines, or American Airlines, and saying, we really want you to raise your prices and to reduce your wages. We don't get into that with these companies. The essence of governance from an index point of view is to make sure that the company is run in the interest of shareholders. And if that means some bad things for the system, favoring capital against income, well, that's the way capitalism has worked forever. And I don't need to defend capitalism. Everybody knows these two things about it. It's the best economic system, the best system for allocating resources ever designed. And it distributes those benefits very, very disproportionately. And that's why we have this large gap between the wealthiest 1-tenth of 1%, or even 100th of 1%. It's kind of scary. And the rest of the people and the rest of the income earners in the country. So there are a lot of repairs we need, but none of them have anything to do with changing the S&P 500 into the S&P 411 or 382. They won't give me the answer. Someday they're going to find it. They claim they can figure it out. But if they can't even adequately define industry, how are they going to answer my question? But this is not a specious attack. This is an attack that can be regarded as possibly even winning, because the Clayton Act, 1914, is designed to protect competition. And even the suspicion of anti-competitive actions or structures puts the burden on you to prove that you're not doing it and not in the government to prove you're doing it. So it's complicated. It is threatening. I don't know how this exactly happened, but I've been kind of the lead person at Vanguard, even though I'm not technically in Vanguard, on responding to these authors. And we're going to have at it. And one more good fight. You get the blood boiling and the heart pounding. I love it. But it is a real threat. To which I would add that the data are very fragmentary. They've really only looked at one industry, which is, as you pointed out, is the airline industry. And also, I just don't imagine how the managers of Vanguard's and BlackRock's index funds get together with the leaders in all these industries and say, hey, why don't you guys get together and just have a quiet little chat about pricing and labor costs so that you can collude against consumers? It just doesn't make sense. It reeks of a certain amount of power and oil, I think. Let me add, if I may, Bill, one editorial thing. And that is, when you get big and successful, there are going to be a lot of problems that are raised in the competitive markets and by governments all over the world, not just the US, because the ETFs and so on are growing at every bit as fast outside of the US. TIF's not at all. TIF means traditional index funds, have you all got that yet? So those threats are going to be there when you get large. It's inevitable. And there will be tough threats. I mean, it's pretty clear that there's an oligopoly. I mentioned that in my remarks earlier, between among Vanguard, number one, BlackRock, number two, and states three to week number three. But that's about it. And you can't really see somebody else coming into the business to try and tackle that oligopoly. We have, I guess, three trillion technically indexed, purely indexed assets. And BlackRock probably has two trillion. Well, outside of their ETFs, they have more assets than we do. And so we compete. But other people can never ascribe or achieve those economies of scale that those three firms have been able to do. States are a little bit different issue, because it's almost all institutional kind of business, one institution trading with another. What a great business. I don't even care for it. But it seems useless. So you get that threat. You get governmental threat. You get competitive threat. But nobody wants to jump into the water, because they would have to spend years and millions of dollars in losses to get anything like the economies of scale that we deliver to investors. But if you deliver them to investors, you're not delivering them to managers. This is a very perverse business. Because really run, to be blunt about it, run more for the managers than for the shareholders. And so that's what makes our stock and trade so high. Yeah, I mean, again, without trying to get Mel to break into a sweat here, Tomah Piketty, when he wrote Capital in the 21st Century about inequality, missed really one essential point, which is that if you look at how income inequality has grown in the United States, 70% of its growth has been basically compensation to corporate managers. That's really where it's all coming from. And you could say that corporate managers are basically looting the system. But I don't want to get into that too much. All right, well, there's a school of thought, Jack, that says that persistently and artificially low interest rates, very expansive Fed policy, has contributed to the slowdown in economic growth and has also made the system more unstable. It's slowed down economic growth because it misallocates capital when interest rates are so low, people put it into unproductive projects, particularly real estate, which is not at all productive, and away from things that are productive. So not only does it slow down the economy, but by inflating asset class bubbles and producing very high asset class prices, it also makes the system more unstable as well. It's the classic Austrian point of view. And I'm wondering if that worries you at all. Well, honestly, only the extent that everything worries me. And when you get into totally uncharted waters, where we are on the interest rates and the Fed balance sheet, I think predicting is that, I wouldn't know who to lean on to say, tell me what's going to happen and have any confidence in their answers. Nobody has been in this situation before. A lot depends on how quickly they take that balance sheet down. I think the Fed balance sheet went from a trillion to around four or five trillion, something like that. And no one knows the impact of it coming back down. Then you've got the fact that China owns, I think, 26% or 16% maybe, a very large portion. Don't hold me to the number of US treasuries. And if they were ever to sell, those rates would go up so quickly you couldn't even find it. So just honestly, for me, and I'm not the brightest bulb in the ground, unpredictable. And you kind of hope that we will muddle through. And we muddled through before because the system works in a supply and demand sense. Usually works pretty well, whether it will in this case, I don't know. But of course it worries me. You know, for those of you who aren't familiar with the name Hyman Minsky, he produced the instability hypothesis that basically says that stability produces instability, and instability produces stability. And you go round and round in these cycles that last about 10 years or so. And the moment when it all falls apart is called the Minsky moment. September 15, 2008. There was a rather very important person who used that phrase this morning. And that was the head of the Chinese central bank. Just something I picked up from the headlines. All right. Well, let's shift gears again. You have that graph, one of the graphs you showed, that just points ever, ever upward, the percentage of assets that are actively managed. So my wife keeps telling me I either need new jokes or new audience. And so I think I have kind of a new audience here. So I'll ask a question, which I've asked you in pretty much the same form every year. And maybe put a little bit of editorializing on it too before I ask it, which is that it is said that if too many people index that active managers will succeed. But we both know that can't possibly be true. Because even if 99% of assets are indexed, that 1% that is left for active managers to invest in is still the market. And they're going to get the market return minus their expenses. But some weird stuff is going to happen if we get to that point. So the question is threefold. One, will it happen? Two, at what point does it happen? And three, if it does happen, what weird stuff is going to happen? Do I answer all three? Not necessarily. You can cut it short by saying it'll never happen. And then I've got to go on to the next question. When you get to 99% or something like that, God knows what would happen. I mean, that's so close to 100% that I'm not sure the market would, in fact, function very well. But would it function well at 50%? Indexing is now said to be, you know it's 41% of the mutual fund business. But overall in the US, at least, it's probably, say, 26%, 27%. It's got a long way to go. And a precipitous kind of ride up and down. And a bear market would slow down indexing, whether it would slow down other people by a greater amount. We just don't know, given the fact, as I mentioned, that a lot of money is coming into the index funds at a high level. And so I don't worry about it. It's going to take a long, it'll be diminishing returns. If indexing is going from 20% to 40% in the mutual fund industry, to go to 80% would require, I guess, 100 years or something like that, to me, anyway. So indexing will continue to do OK. But there are other challenges, in particular, the money coming into the high point, which I mentioned. And then I want to get to your third point, but I can't remember it. What weird stuff happens if we ever get there? OK, well, that gives me a chance to comment on one of the great canards of all this. And the active managers say, or their representatives say, if all these people are indexing, the market will be less efficient, and it'll be easier for managers to win. Well, of course it will. There's no argument about that, the less efficient the market, the easier it is for managers to systematically win, which managers I don't know. But it's also easier by the same amount for active managers to lose. Because you can't have all the active managers winning when they own as a group the index. So it'll be easier to lose and easier to win. What else is new? So I don't worry about the market becoming so efficient that a certain cadre of active managers will start to outperform for the first time. They're really locked into a system, something very little, if anything, has been written about. But the industry is totally dominated by very, very big firms, I think more so than in the past. I don't see a reasonable little money manager in Minnesota or something can't do perfectly well in this system, which probably can't beat the market. But he can keep a business going and be happy in good markets. So the dominance of the big managers means they're really at their peril in getting an indexing, because they're looking for the big profit stream. And the simple fact of the matter is that the easy entry into the index market is the TIF. I don't know when the last, it's the ETF. I don't know when the last traditional index fund was started. Maybe it was 1974. And that was a very slow thing at the beginning. And now ETFs, they come and go at a rapid rate. But that's the means of entry. So that's good if you're distributing your shares through stock brokers, because the great thing, I'll put great in quotation marks with a big question mark next to it, is the way to do distribution through broker dealers. And I got out of that system deliberately in 1977 and we went no load. But we're now much bigger in the broker-dealer system than we ever were then, in terms of percentage of our assets that are distributed by brokers. So anything that gives the middleman strength, the broker's strength in this case, cost money. And anything that involves more trading costs money. And trading is the investor's enemy, because all these traders together get the market return unless the cost doesn't. None of this is very complicated. So I don't see a real challenge from within the industry, because I think the ETF is a step too far. And the TIF is just an awkward way to get into the business, let alone in your own internal frame philosophy in your firm. You've been condemning indexing for all these years. And now you say, we're going to do this. I'll tell you a little anecdote if I have a minute here. And that is, I was walking out in the hall one afternoon at Vanguard. And there was a man, not Vanguard person, looking around like this. And I said, can I give you a hand? He's looking for something. He said, yeah, I'm looking for the men's room. And I said, it's right over there. There's a great big sign that says men. So I said, this guy may not be the brightest bull either. And I said, what brings you down here? And he said, well, I'm marketing the Eaton Howard, I guess it is. It's Eaton Howard that has this new way of trading funds. Eaton Vance, Eaton Vance. I'm back in the old name. And they had a way of trying to compete with regular mutual funds, but have them traded in the stock market. One of the worst ideas ever in going nowhere. Is that called next? Next. Next shares. So I said, he said, I'm down here, right? He said, well, I said, you know, I don't think we're going to run this place, but I don't think we're going to be very interested. And I said, what did you do before that? He said, oh, I was the manager of the index fund, the marketing manager for the index funds at Fidelity. And I said, well, at least you made a step up. Thank you, Jack and Bill. It's time for a break. And we'll take 20 minutes and come right back.