Acquired
01:23:31 · Ben Gilbert, David Rosenthal
[01:23:31] S0: reliably identify the winners in advance, especially when your goal is to stay invested for decades, the expected value of active management with fees as a whole is a negative expected value compared to an index fund without fees. [01:23:45] S1: Yep. So back to 1975, 1976, and Jack and his merry crew And they do indeed call all employees at Vanguard crew members for many, many years because of the ship and the nautical theme, etcetera. It's perfect. Jack assigns one of the first employees, a guy named Jan Twardoski, to go write the software to do this, to create the first retail index fund. He goes off, writes it in the APL programming language on a time sharing computer in Philadelphia. Jack, meanwhile, goes off to Standard and Poor's headquarters and negotiates a licensing fee with them for the rights to use the S and P 500 index as the basis for this first index fund. There's a great story that Jack tells on a podcast interview about this. He was negotiating with whoever the head of the department that ran the 500 was at S and P. And, the guy was, basically, I don't know. Gosh. Should should you be paying us? Should we be paying you? This is gonna be great marketing for us. They eventually land on Vanguard paying S and P $25,000 per year that they sort of pull out of thin air as the transaction value for this, which is absolutely hilarious because now index fund licensing is basically the entire business of indices around the world, and it is extremely high margin.
01:25:12 · Ben Gilbert, David Rosenthal
[01:25:12] S0: I've got the numbers on this. People estimate that Vanguard pays S and P Global something like 3 to $400,000,000 per year and is their single largest licensing client. And the licensing segment of their business as a whole does $1,850,000,000 a year. And to your point, David, that is essentially all profit. Right. I mean, the whole world has agreed the S and P 500 is the standard brand for the market, and so they just get to take a rent of a $1,850,000,000 a year for anybody who wants to make an index fund. [01:25:48] S1: Great work if you can get it. Yep. Vanguard, BlackRock, Fidelity, State Street, all paying them a lot of money. [01:25:55] S0: And it's charged on a basis points of assets under management or AUM It's a management fee. Or trading volume basis. And so it scales depending on how valuable it is to you as a client. [01:26:09] S1: I did not know that. That is so deeply ironic. [01:26:11] S0: And I started looking too. Like, why doesn't Vanguard push their total market one stronger, or why doesn't someone come up with a sort of synthetic thing that looks a lot like the S and P 500 but isn't the S and P 500? Fidelity tried that. There is a 500 stock Fidelity fund that is not quite the S and P 500 or at least doesn't license the name, but people just don't flock to it. People want the standard. [01:26:37] S1: They want the brand. [01:26:38] S0: It's a good business if you can get it.
01:26:38 · Ben Gilbert, David Rosenthal
[01:26:38] S0: It's a good business if you can get it. [01:26:39] S1: It's the Intel Inside, the ingredient brand. Yep. Well, regardless, in 1976, Vanguard launches the first index investment trust fund. Terrible name. Which today has been renamed to the much better titled Vanguard five hundred index fund. Ticker, VFIAX, the first retail index fund available to the public. Today, the second largest individual fund in the entire world with 1 and a half trillion dollars in assets, and second only to its own sister fund that you mentioned, Ben, the Vanguard Total Stock Market Index Fund, which has $2,100,000,000,000 in assets, $3,600,000,000,000 between these two funds today. [01:27:34] S0: Which are effectively the same thing. [01:27:35] S1: Effectively the same thing. [01:27:36] S0: If you own the S and P 500 or you own the entire US stock market, in the long run, they're gonna be nearly identical returns. [01:27:43] S1: And they they both have, you know, their roots in this fund that Vanguard launches in 1976 with a broken IPO that raises $11,000,000.
01:27:43 · David Rosenthal, Ben Gilbert
[01:27:43] S1: And they they both have, you know, their roots in this fund that Vanguard launches in 1976 with a broken IPO that raises $11,000,000. [01:27:54] S0: Well, to the point we were talking about earlier, why would anyone wanna buy the average? Yeah. That's a terrible sales pitch. I wanna outperform. Don't pitch me on this. And by the way, we talked about sort of the far future where Vanguard's fees have come down so dramatically. I own the ETF, the VOO one. Yep. I looked this morning. It's a three basis point management fee that is a point o 3% management fee. It's near zero. You know, them and all their competitors are near zero. When this thing debuts, it actually has a significant management fee. Yeah. It's not as bad as the rest of the industry with a percent or percent and a half or two percent, but it's still, like, point six something. [01:28:30] S1: Point six five or something like that. [01:28:32] S0: So the pitch as a subscale index fund is, do you want to be average but actually with a significant drag from fees? Yes. It's a bad pitch.
01:28:32 · Ben Gilbert, David Rosenthal
[01:28:32] S0: So the pitch as a subscale index fund is, do you want to be average but actually with a significant drag from fees? Yes. It's a bad pitch. [01:28:42] S1: Well and and and worse than that. So remember we talked about the three things that a management company does and what the Vanguard fund board the Wellington fund board allowed Jack to do. They said, hey. We'll let you just do administration, but investment advice and distribution still have to live with Wellington. Well, distribution is still through the stockbroker network with Right. Sales loads. So the only way that Jack and Vanguard can get around the distribution prohibition for this new fund, they figure out, is to do an IPO of it. So I said IPO. This is why there's an IPO. So they rustle up a group of Wall Street banks, and I guess technically doing a one time event of an IPO of the fund did not count as distribution and marketing. Uh-huh. So Vanguard was allowed to do it. And they think that they can raise and that they're gonna need about a $150,000,000 of initial fund holder capital in this fund to make it work, and they can't get the demand. They raise $11,300,000. It is so bad that they don't have enough One fourteenth of their target. Right. Right. Right. They don't have enough capital to go buy even 100 share lots of the entire S and P. [01:30:05] S0: So don't they go buy, like, the S and P 220 or something? [01:30:09] S1: Well, this I don't know how they got away with this. They buy 280 stocks, but they had to choose which 280. So they are doing active management in
01:30:09 · David Rosenthal, Ben Gilbert
[01:30:09] S1: Well, this I don't know how they got away with this. They buy 280 stocks, but they had to choose which 280. So they are doing active management in [01:30:18] S0: the bar. It's something like they picked the 200 largest, and then with the remaining 80, they tried to create a representative sample that was mathematically equivalent to owning the 500, but that was an academic hypothesis, not completely proven yet. [01:30:32] S1: I mean, it's still requiring significant judgment in there. You might even say investment advisory. You might even say. You might even say. There's an amazing story on this. Did you find it? No. So Vanguard, a, didn't have a lot of resources, and b, didn't wanna go do anything that looked like hiring a professional investment adviser, investment manager to manage this program. So they hire a young woman part time to work nights and weekends. Really? And basically, like, choose these 80 extra stocks and then manage and track everything. She worked full time during the day at her husband's furniture store in Wilmington, Delaware. Woah. And by nights and weekends, she was the portfolio manager for, you know, what today is the second largest fund in the world, together with its sister fund, by far the largest fund in the world. How incredible is that? [01:31:27] S0: Okay. So they've got this completely broken IPO. They didn't raise enough capital. The pitch is bad.