John C. Bogle, the outspoken founder of the $180 billion Vanguard Group of Investment Cos., has publicly extolled the virtues of passive over active investment strategies since 1976.
Now his son is building a career on proving him wrong.
John C. Bogle Jr., 36, has chalked up a 28.2% average annual return from his small-capitalization mutual fund's August 1992 inception through Jan. 31 using a highly quantitative, active approach. The Numeric Fund, subadvised for the Quantitative Group in Lincoln, Mass., has handily beaten the 17.1% return of the Russell 2000 index, despite the fund's high expense ratio and turnover.
"We're sort of the antithesis of indexing in our very active, aggressive approach," the younger Mr. Bogle said.
Like the Frank Sinatra song, "he's doing it his way and I'm doing it my way," said his father.
The senior Mr. Bogle said he and his son have a common affection for money management, but have followed very different paths.
"We both have shared, since he was a kid, an interest in investing. I developed my own philosophy, which is perfectly clear and reasonable to him. He has done the same thing."
"He's a computer whiz. What he does with it strikes me as a little short of miraculous," he added.
While Vanguard's clientele is largely conservative retail investors, Numeric Investors L.P. caters mostly to large institutions. John Bogle Jr.'s firm runs $1.7 billion, mainly for institutional investors in long-short strategies. Mutual funds, subadvised for the Quantitative Group, Lincoln, Mass., account for only $130 million.
And while John Bogle Sr. hasn't managed portfolios in decades, his son is very much in the trenches. In fact, his strategy, which looks at revisions in earnings estimates, sometimes requires him to trade at a moment's notice.
"His (John Bogle Jr.'s) career is that of a money manager. Mine has been built on my investment philosophy, implementing it the way Vanguard does it, conservatively and at low cost. I could not have done successfully what he has done," said the senior Mr. Bogle, who has made it a personal mission to promote the virtues of passive investing.
He recently made a $25 wager with investment adviser Robert Markman that Vanguard's Standard & Poor's 500 Stock Index fund will outperform - over the next five years -the fund-of-funds Mr. Markman runs for clients.
He wrote in his Vanguard booklet, "The Triumph of Indexing": "Indexing provides an odds-on bet that an investor can outpace most other funds and a virtual guarantee of never being at the bottom of the pack."
He also wrote the book "Bogle on Mutual Funds," in which he stresses the importance of low-cost investing.
His son acknowledges: "I couldn't refute that the average manager can't beat the market. It's impossible over long periods. I was brought up on that."
But he added: "There are certain inefficiencies within the equity market than can be exploited under a specific set of circumstances.
"It's hard to find investment concepts that will beat the market, but small firms - money managers with small amounts to invest - are more likely to succeed."
That's why John Bogle Jr. closed his Quantitative Numeric small-cap mutual fund when assets reached $100 million. (Quantitative Numeric II, a midcap fund, has $8 million, and will close at $200 million.)
Still, John Bogle Sr.'s recipe for success in active management is quite different from his son's.
In "The Triumph of Indexing," the senior Mr. Bogle said active funds that "levy no sales commissions, maintain low costs (or even moderate costs) and keep portfolio turnover within reason, have, by definition, the best chance of distinctive success."
Numeric does none of the above. Retail shares of Numeric I and II have 1% back-end loads; expense ratios of 1.86% and 2.32%; and turnover of 325% and 225%, respectively. (The Numeric funds' institutional shares have lower expenses and no back-end loads.)
How does the younger Mr. Bogle reconcile his fund's high expense structure with his father's values? "If we grow to $10 billion like Windsor (Vanguard's flagship mutual fund) our fees will be lower," he said.
As for sales charges, John Bogle Jr. said he wouldn't rule out forming a no-load fund. "If I had the choice, I wouldn't want to pay a back- or front-end load. But it discourages churning and market timing (by shareholders), which is counterproductive," he said.
Despite the obvious differences in strategy, the younger Mr. Bogle insists he and his father are not that far apart in their thinking.
"We really don't approach the industry in very different ways. It was my father's guidance way back when that (led me to) pursue quantitative investing," he said.
His father urged him to sign on with State Street Bank & Trust Co.'s credit training program after finishing business school at Vanderbilt University, because he thought it would be good training for a money manager.
It was. Morningstar has awarded Quantitative Numeric five stars.
Quantitative Numeric II, the midcap fund, logged a return of 29.7% from its start in March 1995 through the end of January 1996, vs. 24.4% for the S&P MidCap 400 index. Returns are adjusted for expenses, but not the back-end load.
"We don't disagree in our views on efficient markets," said John Bogle Jr.
But while his father argues that efficient markets limit the odds of outperforming an index, he says efficient markets require him to constantly perfect his computer-driven mousetrap.
"He's (John Bogle Sr.) intimately aware of our investment approach. We've responded to changes in the market and enhanced our investment approach," the younger Mr. Bogle said.
"Once I'm no longer able to beat the market, I'll teach," he added.
He's not giving up yet.
When it became more difficult to earn excess returns using only the earnings estimates momentum model perfected by his firm's president, Langdon Wheeler, the duo developed an additional model. "Instead of chasing hot stocks, we've developed a valuation-based mean reversion model."
The model, based on behavioral economic theory, ferrets out and avoids owning "glamour stocks," hot, sexy growth stories that are bid up too high but are psychologically comfortable for investors to own. Instead, it seeks oversold stocks about which people have become too pessimistic.
Is he becoming a convert to value-oriented approaches, sort of like Vanguard's active strategies?
"We've come to this conclusion on our own. We learn from the markets. I had been brought up with more of a value orientation, but hearing more of the indexing story," Mr. Bogle Jr. said.
Commenting on his son's transaction-heavy strategy, John Bogle Sr. said: "At Vanguard, we like people like John Bogle Jr. He makes it easier for us to carry on transactions. He makes the market more liquid."
Father and son also differ as to their personal style. The younger Mr. Bogle's mutual fund doesn't advertise, although it does get a fair amount of publicity given his name, quantitative approach and track record.
John Bogle Sr., who recently stepped down as chairman of Vanguard, enjoys the spotlight.
John Bogle Jr. does not aspire to be an industry figurehead like his father. "I don't want to get up on a soapbox and trumpet this. I don't think I'll become a spokesman for any subset of the industry."
While his father's public stance may serve the purposes of an index fund manager that benefits from economies of scale, "we don't want to attract competitors and too many investors," Mr. Bogle Jr. said.
"I'm really into managing money. We intend to stay a very small collegial firm that puts research above all else."
John Bogle Jr. expects to apply his strategy to international developed and emerging markets. He also is testing a small-cap value approach. A tactical asset allocation model for institutions - that will allocate among stocks and bonds, not cash - is "just about ready for prime time."
Does Numeric have what it takes to succeed in the frustrating battlefield of active management?
Said John Bogle Sr.: "If one investor does 10% better than the market, another will do 10% worse. There is a necessary regression to the mean ....Does Numeric have the ability to be that plus 10%? My own judgment is ....there's no reason they shouldn't be able to distinguish themselves."
Quipped his son: "Maybe ultimately we'll be competing with Vanguard."