Burton Malkiel was born on 28 August 1932 and is author of the classic A Random Walk Down Wall Street, now in its 10th edition since 1973, and eight other books on investing. He has long held a professorship at Princeton University and is a former Dean of the Yale School of Management. Recently, at the splendid age of 81, he became Chief Investment Officer for a new online investment adviser, Wealthfront.
It’s important to understand Malkiel’s basic views before reading the interview. A ‘random walk’ as defined by Malkiel when it applies to the stock market “ … means that short-run changes in stock prices cannot be predicted.” Malkiel is a leading supporter of the efficient market hypothesis, which argues that the prices of publicly-traded assets reflect all the publicly-available information.
But Malkiel also accepts that some markets are inefficient, and while he strongly supports buying using index funds as the most effective portfolio management strategy, he does think it is viable to actively manage ‘around the edges’.
In his book, he gives four determinants affecting the value of shares. He argues a rational investor should be willing to pay a higher price for a share, other things being equal:
Rule 1: … the larger the growth rate of dividends
Rule 2: … the larger the proportion of a company’s earnings that is paid out in cash dividends
Rule 3: … the less risky the company’s stock
Rule 4: … the lower are interest rates.
With two caveats:
Caveat 1: Expectations about the future cannot be proven in the present
Caveat 2: Precise figures cannot be calculated from undetermined data.
He summarises in his book: Thus, when all is said and done, it appears there is a yardstick for value, but one that is a most flexible and undependable instrument.
Before my interview, Malkiel made some comments in a ‘fireside chat’ with Harry Markowitz and John West of Research Affiliates.
“If someone's gone up more than average, someone else must be holding the securities that went down more than average. The beauty of indexing which I still take as almost a religion is that you are investing with minimal fees and competition has driven the ETF fees down almost to zero.
We need to be very modest about what we know and don't know about investing. The only thing that I'm absolutely sure about is that the lower the fees paid to managers, the more there will be left for me.
What you also find within active managers is that it is hard to pick the winners. Morningstar has run a study to see whether the stars they were giving to mutual funds were good predictors of future mutual fund performance. What they found is the best way to predict performance is to simply look at the fees. And there are all kinds of problems with high turnover, especially if you're a taxpayer.
I think markets are reasonably efficient. I don't mean prices are necessarily right, in fact, I think prices are always wrong, it’s just nobody knows for sure whether they’re too high or too low. But if there's some inefficiency in the market, it's the amount paid to investment managers. The finance sector has gone from 4% of GDP to 8% and about one third of that is asset management fees. There ought to be economies of scale, it only costs a tiny bit more to run $200 million as $100 million but active fees as a percentage of assets have if anything gone up. Fees have been stable overall but that’s because index fund fees have fallen.
So why do people pay those kinds of active fees? My colleague at Princeton, Danny Kahneman, would say that it's over optimism. People are convinced against overwhelming evidence that they will outperform. It's like a positively sloping demand curve, they really think that by paying more they're getting a better product. And the mutual fund industry is this enormous advertising machine to convince people to use the professionals.
What David Swenson, the CIO of Yale who has an enviable long-term track record, told me was that when he's investing in securities which a lot of people follow, and are heavily traded, he indexes. Where he makes his extra money is in private placements.”
Malkiel is also Chief Investment Officer of Wealthfront, which not surprisingly makes heavy use of ETFs in its solutions, using online investment advice focussed on the Silicon Valley community. It has a minimum account size of $5,000 and manages the first $10,000 for free, and 0.25% thereafter (this is the advice fee, separate from the management fee cost of the fund). It achieves the low cost using its online solution and the principles of modern portfolio theory as the basis for asset allocation. Malkiel believes this is the way to deliver professional advice to retail investors who cannot justify, or who do not want, a full fee relationship.
Here is Malkiel's latest research paper on asset management fees, and a review of his work from Harvard Business Review.
Click here for Burton Malkiel on "Asset Management Fees and the Growth of Finance"
Click here for Harvard Business Review on "Just How Useless Is the Asset Management Industry?"