Vanguard Fund outgrew Magellan for the first time on April 4, 2000. An historic market collapse ensued. Why? Because the great scam artist, John Bogle, had more zombies hanging on his non-stop televised lectures about index funds outperforming active managers, than Big Brother. But is how active managers, holding the same stocks in the same year, performed relative to index funds, really a relevant measure or valid prediction of how index investors would have done if they had instead invested in actively managed stocks? Obviously not. Because the index investors and the active investors would have both invested in a different portfolio had some of those index investors chosen instead to stock-pick.The objective of active managers is to choose a different portfolio of companies from the ones chosen by Standard & Poors. Put more simply, would the same portfolio of productive capacity come into existence if people were actively steering that portfolio, as compared to if it were merely sequence of random states, as a function of the portfolio in the previous period? Probably not. Nobody in an index or otherwise, can ever be smarter than the average person. But an S&P 500 composed of stocks A, B, and C, obviously will perform differently from an S&P 500 composed of stocks X, Y, and Z. The purpose of active managers is to make everbody smarter, in effect, by finding the best combination. The more people are doing the more research about which industries to capitalize, the more novel and diverse the set of investment opportunities which can be discovered. Specifically, the objective of active as compared to index managers, is not simply to rotate funds in and out of the most highly capitalized subset at a higher rate, but to select and capitalize the emerging subset sooner. Index investors had no choice but to hold the same 500 companies as the S&P went from 1500 to 800. With more active management, that subset would have been sold down and replaced sooner. But for some nitwit who assumes a static pool of investments since the dawn of time under arbitrage pricing theory, this process is invisible.Let's suppose that, for every investor that switches $100 from an index fund to an active fund, returns on the S&P 500 go up by .000001%. So by switching to actively managed, that investor increases his returns .000001%, and increases his management fees by 1%. In other words, everybody makes more money, but one individual bears the cost. The problem then, obviously, is a lack of payment flowing to the people who mine, create, and extract information and insights, and flowing from the people who enjoy the benefits of an efficient stock market. The problem is the lack of a payment structure, to prop up a supply chain to increase the pool of "all known information" which is reflected in stock prices.The solution, for obvious reasons, is less disclosure - which will produce more information. And what makes that solution obvious, you ask? Easy. Markets are extremely efficient. For a large inefficiency to be sitting there like an elephant in the living room, just waiting to be overcome, people would have to be blinded to it by an enormous cloud of superstition. Find the most intuitive, most seducitve, most widespread superstition, and you will find the area where people can be distracted from the path of efficiency for the longest time, in spite of all costs. In reality, when nobody is required by law to tell anybody anything, is when people will have to pay for - and make a profit paying for - what they want to know.The job of a mutual fund manager is not to take the same information everyone else has, and make a better prediction based on it. We do not need 10,000 people predicting the weather. The job of a mutual fund manager must be to extract and manufacture new information which no on else has - private information. Who does better in blackjack, a smarter person, or a person who has seen a few more cards come off the deck? Between thinking really hard, and getting new information, it is obvious which pursuit pays better returns. The mutual fund manager then must get paid for that information by investors who otherwise would not have any access to it.Ultimately, the comparison is, do investors do better investing in an index collective, or hiring managers such as Warren Buffet to develop inside relationships, and manufacture asymmetric information? People in a collective always do better for themselves, the less work they do - once you are in a collective. But people in a collective also always do worse, for having entered into a collective in the first place. The problem investors face, is not one of choosing between existing investments, but one of inventing the new pool of investment opportunities each day. This problem is best solved not by investing in yesterday's best capitalized company, but by paying for people who invent secrets.

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Why wouldn't you invest with an index fund? Every report I've seen states that the average active manager has negative alpha. What the hell are you paying them for? And, no the reason why active managers can't beat gthe market isn't that they have higher fee structures, it's because they are the bozos, not Bogle. At least Bogle is honest: he gives you exactly what he says he going to. That's more than I can say for the average active manager who seems to come with every conceivable reason why they can't generate positive alpha or IC. I guess investors must be paying them for excuses, because that's all they seem to be generating.T

QuoteOriginally posted by: TrevorEvery report I've seen states that the average active manager has negative alpha. What the hell are you paying them for?The active managers are picking which stocks the index funds will hold. If indexes have any alpha, it is a result of investment selection by active managers. No index has EVER bought a stock which wasn't invented and built by an active manager.

What are you talking about, active managers inventing stocks? How do they got about inventing stocks: mix two parts vermouth, with one part vodka? What do you mean, invent? I've never heard of active managers inventing stocks. Nobody invents stocks, they are issued.And, no index funds don't generate alpha: they're not supposed to, and investors don't pay them for it. But they do pay active managers for alpha, because they certainly aren't paying them for beta. Because if they do want beta, they can pay an index fund a lot cheaper for that.T

QuoteOriginally posted by: TrevorWhat are you talking about, active managers inventing stocks? How do they got about inventing stocks: mix two parts vermouth, with one part vodka? What do you mean, invent? I've never heard of active managers inventing stocks. Nobody invents stocks, they are issued.You may be right. If I write a letter to the SEC, I can get my wheelbarrow on the pink sheets. And with no stock to borrow, I'll be the offer at $22,000,000. Do you suppose Bogle will buy a share?

That must be a pretty impressive wheelbarrow, can I borrow it to wheel you to the local pub: I think you need a drink.You don't active managers to invest in OTCBB stocks, you can let the mob handle that for you.T

QuoteOriginally posted by: TrevorHow do they got about inventing stocks: mix two parts vermouth, with one part vodka? What do you mean, invent? Nobody invents stocks, they are issued.You could also say "nobody invents inventions, they are built." But your recipe metaphor fired up a synapse that has been dormant since 1999:QuoteThe new growth theory puts human imagination and innovation at the core of the New Economy. Paul Romer, a Stanford economist, describes the economy as a well-stocked kitchen. What it lacks is a brilliant chef capable of using old ingredients to create new recipes. Here is Romer's metaphor, as described by Michael Lewis in his book about Silicon Valley:QuoteOnly a very few people who wander into the kitchen find entirely new ways to combine old ingredients into delightfully tasty recipes. These people were the wealth creators. Their recipes were wealth. Electricity. The transistor. The microprocessor. The personal computer. The Internet.I guess great minds - Trevor and Paul Romer - think alike!

QuoteOriginally posted by: TrevorYou don't active managers to invest in OTCBB stocks, you can let the mob handle that for you.So you would argue that a sea of clock-punchers and slot-machine addicts will, by their own stupidity, turn a BB stock into an S&P 500 stock; at which point Bogle will buy it from them?Is there any selection between a stock being issued, and Bogle buying it?I guess that might explain the outperformance by small caps...

Well this is just fine and dandy. Never heard of Paul Romer before, but if you say he's a great mind, okay.You still haven't answered my question though. How do active managers "invent" stocks? Elucidate me on that one, please.T

QuoteSo you would argue that a sea of clock-punchers and slot-machine addicts will, by their own stupidity, turn a BB stock into an S&P 500 stock; at which point Bogle will buy it from them?Really, all stocks when they are issued are OTCBB stocks? Didn't know that one. And I do believe that they have Small Cap index funds. Right?T

QuoteOriginally posted by: TrevorHow do active managers "invent" stocks?By choosing to finance, directly or indirectly, a company which no other company in existence looks exactly like. And by choosing which, among an infinite possible variety of designs, will be the one pursued by management.Whether or not a stock is issued, or a business plan mailed out, a business does not exist until the bank account rises above zero. And it is brought into existence - invented - by the investors. If it were in the capacity of the entrepreneur to invent a business, I would invent 10 a day without so much as needing an email address...

By you definition, a company wouldn't exist until an outside investor "invented"/invested in it. What economy are you describing. You know of couse that the majority of businesses in the US are small, private LLC/LLP's with I dare say, have no outside investors. Maybe a LOC from the bank, but no outside investors. By your definition, they don't exist.And no, investors don't create a company: an entrepreneur, customers and a product do. The investors come along after the company has been created. Or are you suggesting that when someone starts a company, they have to take their business plan to an active manager/investor to create them? Most companies just go to the bank and get a LOC, that's what banks are for.T

QuoteOriginally posted by: TrevorYou know of couse that the majority of businesses in the US are small, private LLC/LLP's with I dare say, have no outside investors.And how many of these does John Bogle invest in?Anyway, every small business owner has a loan of some type. And it would be rididulous of you to suggest that banks do not discriminate between various types of collateral, business plans, geographic regions...QuoteOriginally posted by: TrevorAnd no, investors don't create a company: an entrepreneur, customers and a product do.A product creates a company? That's an interesting sort of animism. So my wheelbarrow might start a small business someday?Anyway, let's say that the portfolio of manufacturing operations available for lenders to discriminate between was at no point shaped by a conscious human thought (i.e. not "invented"). You nevertheless must concede that some force selected that pattern over an infinite variety of alternatives, and that that force did not manifest in the form of the Vanguard index fund or its investors.

QuoteOriginally posted by: TrevorAnd no, investors don't create a company: an entrepreneur, customers and a product do.So Vanguard verifies all these to be adequate before buying? Here's a quote from a 2001 news story about Lucent:QuoteLucent said it expected overall industry spending to decline 15% to 20% in 2002, while its targeted larger customers' budgets would shrink 10% or more.Do you suppose that loss of customers alone was enough to get Bogle to sell his shares in Lucent?Or if everybody took Bogle's advice, would LU still be trading at 80 or 100 or 160? When would he ever sell?