Eleven Point Three Million

In 1960 an employee of Wellington Management published an article in the Financial Analysts Journal arguing that an unmanaged fund which simply bought the market average had, in his words, a number of weaknesses, and that the idea was destined to fail. He wrote it under the name John B. Armstrong, which was his grandfather's. His own name was John Bogle, and sixteen years later he launched one.

That is the first thing the story of the index fund gets wrong about itself. The second is bigger.

What Samuelson asked for

In the autumn of 1974 Paul Samuelson used the first issue of the Journal of Portfolio Management to tell the profession that picking stock pickers was a mug's game. He was not gentle about it. "A respect for evidence," he wrote, "compels me to incline toward the hypothesis that most portfolio managers should go out of business, take up plumbing, teach Greek, or help produce the annual GNP by serving as corporate executives."

His practical suggestion was modest: somebody with money, a large foundation perhaps, should set up an in-house portfolio that tracked the index, if only so that the in-house gunslingers had something honest to be measured against.

Bogle read it. Samuelson then took to telephoning him with advice while he worked the idea up. "He became in many respects my mentor," Bogle said later. "I would put the phone on speaker so I could write down his ideas as he rattled them off."

The fund that already existed

While Samuelson was writing that, the thing he was asking for had been running for three years in San Francisco.

John McQuown, known as Mac, had trained as a mechanical engineer at Northwestern and taken an MBA at Harvard in 1961. As a young analyst at Smith Barney in Manhattan he spent his weekends renting time on an IBM 7090, a mainframe that filled a room in the basement of the Time-Life Building, trying to find out whether share prices could be predicted. He built a database, wrote his programs, and slept next to the machine while it chewed through them. He did not find a way to predict prices. That failure is the whole of what followed.

By 1970 he was running the management sciences research division at Wells Fargo, with the bank's president Ransom Cook behind him and a stream of academics from Chicago passing through. Then the Samsonite Corporation, the luggage manufacturer, came to him wanting to put six million dollars of its pension money into something that would simply track the market.

The fund launched in 1971. It held every stock on the New York Stock Exchange in equal amounts rather than in proportion to company size, which meant constant rebalancing, and in an era of manual data collection and adding machines that was punishing. "This was fresh earth we were breaking," McQuown said. They worked out soon enough that holding stocks in proportion to their size was far easier, and later versions tracked the S&P 500.

Wells Fargo was not alone. Batterymarch Financial Management and American National Bank in Chicago were building index funds at the same time, using samples rather than every stock. By June 1975 American National was running about three hundred million dollars in several of them.

Why nobody has heard of it

Wells Fargo intended to sell this to the public. It had a product ready, the Stagecoach Fund, to be offered through its branches.

In 1971 the Supreme Court decided Investment Company Institute v. Camp, holding that the Glass-Steagall Act stopped commercial banks from offering what were then called collective investment funds. The Stagecoach Fund could not be sold. Indexing stayed where it was, in the pension accounts of large institutions, available to anybody with six million dollars and no use to anybody without it.

Aware of what Bogle was trying to do, Wells Fargo shared a good deal of its research with him.

Eleven point three

Vanguard's First Index Investment Trust opened for business on 31 August 1976. Bogle had hoped the underwriting would raise 150 million dollars. It raised 11.3 million.

The investment banks handling it were so embarrassed by the number that they proposed giving the money back to investors and abandoning the launch. "I said, 'Hell no,'" Bogle recalled.

The reception was not warm. Critics called the idea un-American and a guaranteed route to mediocrity, which in the aftermath of the go-go years, when several funds had returned over 100 per cent in 1968 alone, was a view with some recent evidence behind it. Vanguard's own directors approved the fund, Bogle said, mainly because they were tired of the trouble he was giving them about it. One of them voted in favour and then declined to sit on its board, on the grounds that it was going to fail.

What happened slowly

It did not take off. From 11 million dollars in 1976, index funds reached 511 million by 1985. That is nine years to grow by half a billion, across the whole category.

Then the market did the work. An extraordinary bull run from August 1982 to March 2000 returned something like 18 per cent a year, and indexing delivered all of it minus almost nothing in fees. Index funds held 55 billion dollars by 1995 and 868 billion by 2005. By 2016 the Vanguard 500 alone held more than 252 billion, and index mutual funds and exchange traded funds together held close to five trillion.

The share kept climbing. Indexed money was about 8 per cent of combined mutual fund and ETF assets in 2000, 19 per cent in 2010 and roughly 40 per cent at the end of 2020. Actively managed funds have seen money leave every year since 2014.

The other half of McQuown's legacy is less discussed. The Wells Fargo division he ran eventually became Barclays Global Investors, which launched the iShares range of exchange traded funds in 2000 and was bought by BlackRock in 2009, which is how the largest asset manager in the world got the business it is largest in.

Bogle became the public face of all of it and deserved to. But the first one was built by an engineer who had spent his weekends failing to beat the market on a borrowed mainframe, and who concluded from that failure that nobody else could either.

Sources

• Jason Zweig, "Birth of the Index Mutual Fund: 'Bogle's Folly' Turns 40" (the First Index Investment Trust opening on 31 August 1976 with 11.3 million dollars against a 150 million dollar target; the underwriters wanting to return the money and Bogle's answer; the critics calling the fund un-American; the go-go funds returning over 100 per cent in 1968; the Vanguard director who voted for it and refused to join its board; Samuelson's 1974 article and the passage about plumbing and Greek; Samuelson telephoning Bogle and becoming his mentor; the 1971 Wells Fargo indexed portfolio of six million dollars for the Samsonite pension fund and McQuown's remark about breaking fresh earth; American National Bank running about three hundred million dollars by June 1975 on Rex Sinquefield's account; the bull market from August 1982 to March 2000; and index fund assets of 511 million in 1985, 55 billion in 1995 and 868 billion in 2005, with the Vanguard 500 above 252 billion and the category near five trillion by 2016).
• CFA Institute, "A Pillar of Modern Finance Turns 50" (the 1960 Financial Analysts Journal article published under the pseudonym John B. Armstrong arguing that an unmanaged fund had a number of weaknesses; McQuown's engineering degree from Northwestern, his Harvard MBA and his recruitment to Wells Fargo; the Chicago academics engaged by the bank; Samsonite approaching the team around 1970 with six million dollars; the fund tracking all New York Stock Exchange stocks equal weighted and the rebalancing burden; the later move to the S&P 500; Batterymarch and American National Bank developing index funds using sampling; and the indexed share of combined mutual fund and ETF assets rising from 8 per cent in 2000 to 19 per cent in 2010 and 40 per cent at the end of 2020, with active funds in outflow every year since 2014).
• Bloomberg, "'Mac' McQuown, Banker Behind First Index Fund, Dies at 90" (McQuown leading the team that created the first equity portfolio tracking an index at Wells Fargo in 1971; the weekends spent renting an IBM 7090 in the basement of the Time-Life Building and sleeping beside it; his failure to predict share prices; the management sciences research division and the support of the bank's president Ransom Cook; the Stagecoach Fund and the 1971 Supreme Court ruling in Investment Company Institute v. Camp preventing commercial banks from offering collective investment funds; Wells Fargo sharing its research with Bogle; and the division becoming Barclays Global Investors, launching iShares in 2000 and being bought by BlackRock in 2009).
• CFA Institute, "Financial Analysts Journal" (the journal in which the 1960 article appeared under the Armstrong name).