While the conversation started with pension funds, if you get AQR Capital Management co-founder Cliff Asness and Vanguard Group founder Jack Bogle onstage together it’s inevitable that active management, and the fees that come with it, will come along for the ride.
Explaining why he thinks state pensions are in trouble, Bogle says that we’re looking at about 7% returns from stocks and 3% from bonds in the coming years, giving about 5% returns overall before we start talking about costs, an assessment Cliff Asness mostly agrees with.
“I’m approximately as gloomy,” said Cliff Asness. “I’m not as gloomy about our fees.”
Investment system takes 75% of market returns, says Bogle
From Bogle’s point of view, it’s impossible to really do anything other than own the market. If the market is returning 7%, then an explicit indexer paying 5 basis points for a low cost product will get 6.95% returns. Everyone else gets the same 7% return on average, but now with fees going up to 2%.
“If you look at that differential over an investment lifetime the investment system is taking in round numbers 75% or 80% of the market return,” says Bogle. For him, there’s just no reason to get caught up in figuring out which stock picker has the best track record when low cost products will outperform them in the long run.
Jack’s math has never been wrong, says Cliff Asness
“Jack’s math as he said has never been wrong and never will be wrong, it can’t be,” says Cliff Asness, but it’s the ‘average’ part of Bogle’s view that he takes issue with.
“Let’s say we have this group called active managers,” Cliff Asness explains. “If these people around the market are randomly distributed you should always be with Jack because you’re Jack minus 2% with a random number added to it and no one wants that… But if people make errors than this stuff around Jack won’t be equal.”
For Cliff Asness the sum total of risk assets is the starting point for everyone whether they like it or not, and the only way for one person to come out ahead is to for someone else to fall behind. Indexers accept the situation and focus on keeping costs low, while active manager are supposed to take risks that others can’t and put their knowledge of pricing, behavioral finance, and other disciplines to come out ahead even after taking their fees. Unfortunately that’s not always what happens, and while Asness defends active management in general, he realizes that not everyone earns their fees.
“Do I think the hedge fund world is not doing it in the most attractive package and therefore do I understand CalPERS decision on one percent of their assets? Yes I do,” says Asness.