Time for some Bogleisms

I have been a big fan of John Bogle as he shows the other side of developments in financial markets (read my earlier post here). He shows how costly and greedy this sector has become. His recent speech is on similar lines but looks at the recent buzzword- speculation.

He actually calls it a triumph of speculation over investment.

We’ll begin by talking about the difference between investment and speculation. Investing, to me, is all about the long-term ownership of businesses, focused on the gradual accretion in intrinsic value that is derived from the ability of our corporations to produce the goods and services…..

Speculation is just the opposite. It represents the short-term—not long-term—holding of instruments—not business—focused (usually) on the belief that their prices—as distinct from intrinsic values—will rise

Over a long-term you should expect both returns to be identical. But we don’t see that happening as we have transaction costs. Hence, speculation will give lower returns than investments. So, we should expect people to invest their monies as an investment, and investment strategies to gain over speculation. However, we see the opposite:

 Consider that during most of my first 15 years in this industry (through about 1966), it was not that way. Fund turnover averaged about 16 percent per year—let’s call that “investing,” a six-year average holding period—and never varied significantly from that norm. But turnover moved steadily upward, and in the past decade, has averaged nearly 100 percent per year—let’s call that “speculation,” a one-year average holding period—exactly the opposite of my expectations when I joined this industry all those years ago.

Actually, Bogle assumes people are rational and invest over a long-term. But actually people are irrational and moreover predictably irrational.  People usually look to others and rely on professional advice, advertisements etc for investing.  The speculation has increased on both the sides- investors (demand) and financial firms (supply). Former speculate as they see better returns in some fund/stock (which have been achieved in the past) and latter to earn some extra return (alpha) to justify their fees, jobs etc.

However, all this shows doesn’t mean Bogle’s concern is overstated, but actually it is understated. If people are irrational , financial sector has to become  more responsible while selling the various products and services. There are huge costs and he should be aware of the returns ex-costs. In the last section Bogle touches on these aspects and questions the various financial innovations which in his words

The incredible rise—and fall—of so many derivative instruments in the present era should raise a red flag of caution regarding the value of financial innovation to investors. The flood of complexity—and its attendant high costs—seems to have overwhelmed simplicity—with its attendant low costs. One example: Collateralized debt obligation (CDOs) have wreaked havoc among our commercial banks and our investment banks, and credit default swaps (CDS) now total an astonishing $600 trillion—speculative derivatives of credit instruments that themselves total less than $20 trillion—an amount of speculation 25 times (!) that modest amount of (risky) underlying investment. We know almost nothing about the counterparties to this boatload of CDS that embody the excesses of our financial system—innovation designed to benefit those who create these instruments rather than those who own them.

(Emphasis is mine)

Another very good speech from Bogle. Worth a read.

Ending the post with his wonderful story:

There’s a wonderful story about an investment banker addressing his colleagues: “the bad news is that we’ve lost an enormous amount of money. The good news is that none of its ours.


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