Charles Ellis was once described as a “legend among index fund investors”. It was Ellis who, in an article written in 1975 called The Loser’s Game, became the first industry insider to proclaim publicly that most active fund managers fail to outperform the index and that the ordinary investor is therefore better off investing in low-cost index funds.
Educated at Yale and Harvard, Ellis studied for a PhD at New York University, and worked briefly in public radio before entering the investment industry. Based in Connecticut, he has written 14 books and more than 100 articles and has an international reputation as a public speaker and investment consultant.
SITV caught up with him on a visit to the UK and found that, nearly 40 years on, Ellis is more convinced than ever before that most people spend far too much on investment advice and services, and that lower costs lead to higher returns. And no, he doesn’t like smart beta.
SITV: Charles, you’re over here mainly to give a presentation on the effect of emotions on investor behaviour. How big a part do emotions play in people’s investment decisions?
Charles Ellis: Too big. We are human beings. Emotions do have a very powerful force - particularly at extremes. It’s at extremes that we really ought to be most rational and calm and steady, but because we’re human beings, that’s not the way we do things. We get scared - really scared - and we act in an unfortunate way. When we get excited - really excited - we act in an unfortunate way. And the result is that we tend to buy at high prices and we tend to sell at low prices, and that does grievous harm to our long-term results. If we were totally rational we would be much better off, and to the extent we can oblige ourselves to be rational, that’s for the good.
SITV: So is one of the main rôles of a financial adviser to persuade the client to keep their emotions in check?
Charles Ellis: There are two main rôles for an adviser. One is to help individuals understand themselves and what their real financial purposes are, and what their anxieties would be, so they can lay out a sensible, long-term investment programme. And the second is to hold the client’s hand and encourage them to stay in it for the long term, because the long term can be very positive - if only we can stay with it through thick and thin, through the exciting positives and the terrifying negatives that cause most of us to make mistakes.
Ben Graham spoke about Mr Market and Mr Value. Mr Value does all the work and Mr Market has all the fun. Mr Market is out there trying to tempt you, tempt you, tempt you every day. He wants you to do something, do something, do something. And he’s really good at tempting you when everything’s positive and everyone’s excited and it looks like a winning situation to be a buyer. But that’s at the highs. He really tempts you to be a seller when everyone says it’s very difficult and the future’s not at all promising, and you can see things going down and down and down. Mr Market is out there, ready to trade whenever you like, and he’s going to tempt you. And if you can ignore him and stay instead with the dull plodder Mr Value, you’ll be much better off.
SITV: In our documentary Passive Investing: The Evidence, you said every investor should read a little market history. What’s the best way to do that?
Charles Ellis: The best way is to read newspapers at times of ebullient markets and at times of dreadfully sad markets. Look at what people are saying. “It’s been going down and down and will probably keep going down and down for ever”… That’s about what you get at the very bottom of the market. “It’s been going up very handsomely, and it’s going to keep going up, maybe for infinity”… That’s the kind of thing you get at the tops of markets. And once you see what people are saying you can work out the trends, and look at history as history rather than the daily papers.
SITV: You once said the short-term ups and downs of the market are like the weather, but that what we should focus on is the climate. What do you mean by that?
Charles Ellis: Weather is what’s going to happen today, and climate is what’s going to happen this year, next year and the year after that. Anyone who’s had a wedding scheduled for months on end, and the day comes and it pours down with rain, will never forget it. But that’s weather; it’s not climate. We should choose a climate that we would like to live in and not worry about the unusual weather that sometimes comes along. In the same way we ought to think about investing in the longer term and not get so excited about what happens day-to-day.
SITV: The strength of the bull market since 2009 has taken many of the so-called experts by surprise. Do you think that in itself is a validation of the indexing approach?
Charles Ellis: No, it’s neither a validation nor disconfirmation. It’s the way markets are. People rush to buy and people rush to sell, and that creates ups and downs in the market. The really important thing for investors is, how long are you going to be invested? If you’re going to be invested for a long time - and if the average age at death is 85, you’ve still got 20 years to run when you’re 65 - you should think long-term instead of day-to-day-to-day. Then you’ll find that the easiest way to invest is through indexing.
SITV: Here in the UK, passive investing is nowhere near as popular as it is in the US. Can you see that changing?
Charles Ellis: It would be good if we could change the name from passive, because very few people like to be called passive. It’s got a negative connotation for all of us. “Why don’t you do something?" is a much stronger admonition than, “Why don’t you just stand there?” Settling for average is hard for people. Passive is not something that anybody wants in a spouse or a friend or a job, and certainly none of us wants to be described by our friends as passive. But the reality is that indexing - or passive investing, as it’s still often called - is a much wiser way of investing today. 50 years ago, active had a great rôle to play. Even 20 years ago it had a good future. But so many talented people have been attracted into it that, after all the effort they put in and all the talent they represent, there’s not much left over. And so active managers, because so many of them are very good, continue to underperform index funds.
SITV: You’ve always advocated traditional indexing, but everyone seems to be talking nowadays about smart beta - or fundamental indexing, or factor investing, depending on what they prefer to call it. What’s your view of smart beta?
Charles Ellis: Not very much. With many of these seemingly amazing discoveries, it’s torturing the data that creates the discovery at about the time when it’s most likely to be ‘proven’, and most likely to be no longer valid. So I’m very sceptical about smart beta.