Beating the markets | Book Review: Trillions: How a band of Wall Street Renegades Invented the Index Fund and Changed Finance For Ever By Robin Wigglesworth

There are several books on economists and their lives, starting with Adam Smith and all the way down to Paul Samuelson. But there are not too many tomes on a series of stock market gurus, especially those focusing on specific kinds of investing. Robin Wigglesworth of Financial Times brings out a rather interesting book called Trillions, which talks of passive investing through the use of index funds. But while explaining the worth of such funds, he takes us through the history of various fund managers and academicians who have made their contributions in this field. Interestingly, the value of funds in such passive investing is around $26 trillion, which is the size of the GDP of USA.

Warren Buffet is known to have wagered on passive investing through index funds and won substantial money on such bets. He had said that over 10 years such an approach would thrash an elite crew of hedge funds picked by Protégé Partners, a Wall Street investment firm. Simply put, if one invests in say the S&P 500 index or the Sensex in India, one can reap superior benefits in terms of rewards over a time horizon of 5-10 years. This also means that all the fund managers who have their techniques in investing in various stocks during this period cannot actually do better than the index. He showed how the free, “dumb” index fund prevailed, returning 126% over the decade, while hedge funds made a more modest 36%.

The interesting facet of such index funds is that they mimic a market benchmark which can be the FTSE 100, the S&P 500 or developing country bonds with low cost. They can also be unmanaged mutual funds or exchange-traded funds (ETFs) that can be bought and sold throughout the day, just like any stock. As the approach to trading is fixed by definition, one only needs technology to execute and no human intervention is required.

This surely is interesting because when one looks at research on the performance of any fund, mutual or hedge, a comparison is always made with the benchmark indices and the conclusion drawn is that passive investing is a more efficient way. The way it works is simple. As the index has certain stocks, the fund manager has no choice but to invest in proportion any new subscriptions to these funds, which automatically keeps the buying pressure up under normal times, leading to prices rising. Hedge fund managers would be indulging in all kinds of strategies to beat the market, which they may succeed in the short run, but not in the medium term. This holds for equities as well as bonds and hence even passive investing in bond funds give better returns. Paul Samuelson, the famous economist, had also believed in this approach.

All this flows from the fact that one cannot predict share movements and they follow a random walk, meaning thereby that the movements tomorrow could be just as good or bad as yesterday and there can be no pattern as such. This means that all kinds of modelling may not work in practical life. The author puts all the pieces together by starting with Markowitz’s portfolio theory followed by Sharpe’s risk-reward matrix to Gene Fama’s efficient markets hypothesis to Bogle’s index funds. The concept of beta (Greek letter to denote performance against benchmark) is explored and the creation of various indices as well as funds that invested in them

Wigglesworth takes us in considerable detail through the history of index funds and how they were formed and the protagonists along the way. These fund managers came together five decades back and contributed to this unique thought process. The first fund came in July 1971 and Wells Fargo became a sort of pioneer with a fund that mimicked the S&P 500. In fact, the first investible index came when Jack Bogle started Vanguard and created the first S&P 500 fund in 1973. Ironically what is the biggest fund today had an indifferent response when launched as it only raised $11 million, which wasn’t even enough to buy all the stocks in the S&P 500.

The ideas presented here are deep and if what has been written is true, then the hype over fund managers and their well thought strategies may not really be superior to the market. Hence, this can lead to the conclusion that one may not be able to beat the market as such. In this tryst the author also takes us through the efficient markets hypothesis as well as the capital asset pricing model (CAPM). It makes interesting reading for sure, though it does reduce the halo we normally attach to the brains that deal with our funds. One may just as well invest in a Sensex or NSE500 fund and sit back and reap the rewards without bothering about the internal stocks.

Along the way there are some insights thrown in by the author on the composition of indices that will be relevant for us in India, especially as there is some degree of excitement on Indian bonds being included in global indices. Essentially getting included in the index will automatically mean that investment made in the indices will percolate to the Indian bonds or any share if it is a stock index. This creates an ever-flowing demand for the security (debt or equity) and hence there is this craze to be included in these global indices.

If one is a stock market buff, then Trillions is the way to go, and the reading will be satisfying.

Madan Sabnavis is an independent economist

Trillions: How a band of Wall Street Renegades Invented the Index Fund and Changed Finance For Ever
Robin Wigglesworth
Penguin Random House
Pp 336, Rs 899