There has been a tectonic shift in the world of investment in the past half-century. It has probably passed the average lay person by, but trillions of pounds of investors’ cash has flowed out of so-called ‘active’ funds – ones that are overseen by handsomely rewarded fund managers, who are supposed to use their brain power to choose where clients’ money should be invested – and into much cheaper ‘passive’ funds, which are overseen by computers and clerical staff and spread investors’ cash around so that their investments mirror particular stock market or bond market indices. In Trillions, the Financial Times’s global finance correspondent Robin Wigglesworth tells the story of this quiet revolution, describing it as ‘one of the most profound forces to rip through the finance industry in history’ and as a development that ‘could ultimately help reshape capitalism itself’.
Part investment history, part paean to the godfathers of index tracking, the book opens with the story of a high-stakes bet made in 2007 between the billionaire investor Warren Buffett and a successful hedge fund manager named Ted Seides. Buffett bet that an automated fund would make more money than a group of actively managed hedge funds over ten years. Buffett won. The book then moves back to the early history of investment management, revealing how in 1884 the Connecticut-born journalist Charles Dow invented the world’s first daily stock market index, which he published in an afternoon newsletter (it later became the Wall Street Journal), before creating the Dow Jones Industrial Average in 1896. In 1957, at the height of the Cold War, the bond-rating agency Standard & Poor’s came up with the world’s first semi-computerised stock market index, the S&P 500. This had the advantage that it could be updated throughout the trading day and ushered in finance’s ‘electronic era’.
Wigglesworth describes how, in the late 1960s, the University of Chicago professor Eugene Fama came up with his ‘efficient-markets hypothesis’, which postulated that asset prices reflect all available information, meaning that it should be impossible for fund managers to generate ‘alpha’ (superior) returns consistently. When, subsequently, the Wall Street bank Merrill Lynch commissioned an in-depth study of historical share price performance from the Chicago-based Center for Research in Security Prices, a shocking discovery was made: that net of fees and charges, the average performance of ‘active’ funds was actually worse than that of the index as a whole. This essentially showed that the emperors of fund management – some of whom were still getting away with charging investors outrageously high fees and other costs – were in fact naked. Later research revealed that hyperactive trading in stocks, in which fund managers often engaged, was actually worsening returns, since the costs of trading were so high.
Such findings fired the starting gun on a race to develop the world’s first index fund, one that mirrored the weightings by market value of each firm in, say, the S&P 500. The iconoclasts at Wells Fargo Management Sciences in San Francisco, who benefited from access to some of the best financial thinkers of the day (including Fama), soon broke away from the pack. Wigglesworth describes them as overseeing ‘the Manhattan Project’ of financial economics.
However it was Vanguard, based in Valley Forge, Pennsylvania, and led by the Princeton University economics graduate Jack Bogle, that brought index funds to the masses. Wigglesworth puts Bogle on something of a pedestal as he outlines his crusade to enable ordinary Americans to prosper without being ripped off by Wall Street. When Bogle launched the world’s first index fund for ordinary investors in 1976, it was initially derided as ‘Bogle’s folly’, a ‘sure path to mediocrity’ and even ‘un-American’. Yet it wasn’t long before the fund started to deliver the promised returns and public opinion softened, partly thanks to Bogle’s skills as a self-publicist. Twenty-five years later, the original fund, renamed the Vanguard 500 Index Fund, was the world’s largest mutual fund, with $107.2 billion of assets, and had spawned a host of imitators.
Trillions also covers the birth of exchange-traded funds (ETFs), at which Bogle turned up his nose. These are similar to index-tracking funds, but differ in that they themselves can be traded on the stock market, meaning that their share prices fluctuate throughout the trading day. Since being launched in the USA by the ‘unlikely revolutionary’ and former Second World War submariner Nate Most in 1993, ETFs have grown into a $9 trillion industry, accounting for about a third of all trading on US stock exchanges.
Despite the supposed strengths of the City of London, the British are largely absent from Wigglesworth’s story. It was only after Barclays acquired Wells Fargo’s San Francisco-based index-tracking business in 1995 that the British started to have a look-in. In 2000 Barclays launched a suite of forty ETFs under the iShares brand, promoting them as a flexible, low-cost way for investors to gain exposure to a range of market segments, including fixed-income assets, emerging markets and broad-based indexes. These proved a major hit.
But Barclays got into such financial difficulties during the 2008 financial crisis that it was forced to sell its asset management business, by then called Barclays Global Investors. It was acquired by New York-based BlackRock, led by ex-bond trader Larry Fink, for $13.5 billion. Fink proceeded to transform BlackRock into the world’s largest asset management firm, with nearly $9.5 trillion under management and tremendous power over the fate of corporations. Of this development, Wigglesworth writes, ‘The index fund revolution had finally won. From its modest, iconoclastic roots, it had now finally established itself in the heart of Wall Street … The finance industry may be unpopular, but this has so far been a boon to humankind, with everyone directly or indirectly reaping the benefits through cheaper savings.’
I have only a few criticisms of Trillions. One is that Wigglesworth is perhaps too much of an evangelist for index investing. He does, in his final three chapters, cover some of the downsides of the index-tracking revolution: that ‘passive’ management firms have become so dominant that they increasingly resemble an oligopoly; that their funds are undiscriminating and therefore potentially reward incompetent management; that they have given too much power to the organisations behind financial indices. But he sometimes seems to wish to minimise the risks and undermine the counter-revolutionaries. He fails to mention that some active funds, such as James Anderson’s Scottish Mortgage Investment Trust, have outperformed index funds through canny stock picking, even when charges are taken into account. He also has an annoying habit of using American phrases, such as ‘skunk works’, ‘bleachers’ and ‘silver trucker’, some of which were incomprehensible to this reader.
Overall, however, Wigglesworth has written a fascinating account of an investment revolution. Trillions should be read not just by millionaires, billionaires and trillionaires, but by anyone who has a pension plan, individual savings account or money invested, directly or indirectly, in the stock market.
This book review was published in Literary Review in December 2021