Billions: How a Gang of Wall Street Renegades Invented the Index Fund and Changed Finance Forever. 2021. Robin Wigglesworth. Wallet.
About 50 years ago, the index fund revolution began in the financial markets. Like many revolutions, it unfolded quietly, with little fanfare. When he began to gain attention, many of his ideas were frowned upon by the establishment. But the revolution was kept alive by a number of smart and passionate outsiders looking for a way to apply the academic research they studied to real-world investing. Today, index funds have gone from being a fringe investment idea to becoming the establishment.
In Billions: How a Gang of Wall Street Renegades Invented the Index Fund and Changed Finance ForeverRobin Wigglesworth, the Financial Times global finance correspondent, has written an illuminating history of the index fund industry. With his gifted writing style, Wigglesworth has taken what could be a dry and boring account of the financial markets and woven a compelling story of the characters who created one of the greatest financial revolutions of the last 50 years.
The book is very much like a good novel, with interesting characters that we meet along the way. Wigglesworth begins by introducing the major players with brief summaries of their backgrounds. Everyone will be familiar with Warren Buffett and John Bogle as far as professionals go, and finance students will know Harry Markowitz, William Sharpe and Eugene Fama. Many of the founders of the indexing revolution, however, are less well known, even to those well versed in academic finance. Some may not know that the intellectual development of indexing began not with the aforementioned scholars, but with Louis Bachelier, a French mathematician whose early 20th-century work on the random walk laid the groundwork for people like Fame more than half a century later. . Unfortunately, Bachelier was in the wrong field and ahead of his time, so his work languished in obscurity for many decades.
billions it tells how several academics created the theoretical basis for indexing and how their disciples established an industry based on these principles, but it is also a story of several random events that led to the indexing revolution. Readers wonder what the path of finance would have been without some of these fortuitous developments. If the mathematician Jimmie Savage had not discovered Bachelier’s work, would Paul Samuelson and others have studied the random nature of stock prices? If Markowitz hadn’t had a chance conversation with a stockbroker outside his advisor’s office, would modern portfolio theory have begun in the 1950s? Without the background provided by Markowitz, would Sharpe have been attracted to funding, or might he have returned to the research he conducted at Rand on a smog tax? If Fama had chosen to attend Harvard instead of calling the University of Chicago to inquire about his application, would Harvard now be the home of market efficiency? And what about the students Fama inspired in Chicago, like David Booth and Rex Sinquefield?
Indexing is believed to have begun with Bogle’s introduction of Vanguard’s 500 index fund in 1976. Passive investing actually originated several years earlier with Wells Fargo Investment Advisors’ management of a from the pension fund of luggage manufacturer Samsonite.
The early days of passive investing met with considerable resistance and extremely limited acceptance. By the end of 1976, Vanguard had managed to raise just $14 million for its first fund offering, an S&P 500 tracker. Today, Vanguard manages more than $5 trillion.
This dramatic growth reflects how time has proven the validity of the concept. Wigglesworth tells the now-legendary story of Buffett’s bet with investment management firm Protégé Partners. Buffett bet that a fund that tracked the U.S. stock market would beat any group of hedge fund managers in the decade ending in 2018. Protégé Partners picked five funds of funds, Buffett, the Vanguard 500 Index Trust. Ten years later, the Vanguard 500 Index Trust had toppled funds of hedge funds, 125.8% to 36.3%. None of the funds outperformed the S&P 500.
The author continues the history of indexing through the development of Standard & Poor’s Depository Receipts (SPDRs) and exchange traded funds. Although exchange-traded funds (ETFs) have gained prominence in the financial markets, their origins and creators are not as well known as those of indexing. The idea for ETFs came from Nate Most, the head of product development at the American stock exchange. Well familiar with the concept of traders buying and selling warehouse receipts rather than physical products, most applied it to a basket of stocks. Like index mutual funds before them, ETFs met with outspoken critics, including from Vanguard founder Bogle.
Wigglesworth notes several distinctions between ETFs and traditional indexing. Unlike index mutual funds, the rapidly proliferating ETFs straddle and, in some cases, straddle the line between passive and active investing by adjusting indices in various directions. For example, Robert Netzly’s Christian Wealth Management has designed ETFs to align with Christian values. Among the many other ETFs that move away from the notion of passive is HACK, which buys shares in computer security companies.
No book on indexing would be complete without a discussion of the indexes that funds track. Wigglesworth reminds us that the composition of an index is not magically transmitted from the sky. Rather, it is the construction of a committee that decides which companies are included in the index and even determines how companies are ranked for purposes of allocation to the various indexes. For example, the tech industry has come under political fire from both the left and the right for a variety of reasons, but some of the most criticized companies don’t classify themselves as tech. The index builders assign Amazon to the retail category, while Google and Facebook are considered communications companies. On the other hand, financial payment companies, such as Mastercard and Visa, are classified as technology securities. Index committees have additional market power due to the price impact felt when a stock is added to or removed from an index.
The indexing revolution has likely saved investors billions of dollars in fees and shaken up the investment industry. These changes have not been without cost, however. They have squeezed the revenues of a financial industry that does not exist just to line the pockets of analysts and portfolio managers, but supports an entire ecosystem. This includes functions such as providing research reports to active managers and executing trades, all of which are necessary for the indexing industry to survive.
Wigglesworth also raises provocative points about the downsides of indexing, notably the inability of indexed funds to adapt to new economic or social conditions. The February 14, 2018, shootings at Marjory Stoneman Douglas High School are a case in point. In the wake of that deadly incident, index fund providers such as Vanguard and BlackRock were unable to divest stocks of the weapons makers, prompting calls to boycott them. Similarly, index funds that are not expressly designed for this purpose cannot divest from stocks that do not meet the standards of the environmental, social and governance (ESG) movement.
Additional challenges facing index funds stem from their own success. The explosive growth of the industry has endowed the major providers of index funds with substantial percentages of shareholder votes. As a result, they can end up exerting disproportionate influence on government policy, facing criticism from both sides of every issue.
with Billions: How a Gang of Wall Street Renegades Invented the Index Fund and Changed Finance Forever, Wigglesworth has produced a historical, entertaining and thought-provoking book. It’s one that both finance professionals and interested laypeople will enjoy.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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