How sushi in a subway can explain the art of indexing
12 April 2018 | Topical insights
Commentary by James Chatfield, senior portfolio manager with Vanguard's Equity Index Investment Group in Melbourne, Australia.
"I do the same thing over and over, improving bit by bit. There is always a yearning to achieve more. I'll continue to climb, trying to reach the top, but no one knows where the top is." – Jiro Ono
One of my favourite documentaries is Jiro Dreams of Sushi, Jiro Ono being the 85-year-old owner and sushi master of a tiny 10-seat restaurant located in a Tokyo subway station, serving a tasting menu of 20 individual pieces of sushi with the entire dining experience lasting only 30 minutes (speaking from personal experience).
To the outside observer Jiro lives a simple existence, having dedicated his life to mastering the art of making sushi and maximising the experience for his customers, all while remaining endearingly modest and humble. Jiro admits that "Even at my age, in my work ... I haven't reached perfection", but continuously strives for improvement in his craft, working hard and innovating tirelessly, even after 70 years in the business.
The documentary got me thinking about the "art" of indexing as another example of where "simple" does not mean "easy," and where we at Vanguard, much like Jiro, are continuously looking for ways to evolve and refine our established practices.
Low cost, high quality
Benchmark indices are theoretical constructs, calculated without the frictional costs of transacting in the markets.
In the world of equity trading these frictional costs take two forms: explicit (brokerage commission, fees, and ticket charges) and implicit (market impact, the impact of others, and general market movements).
Now, the reality in life is that some things are cheap for a reason and best avoided on that basis.
As we grow at Vanguard, we're continuing to drive improved performance by leveraging our global size and scale to lower explicit costs, tracking benchmarks with greater precision and strengthening our relationships with trading partners.
We also remain laser-focused on minimising implicit costs (particularly market impact), given they're generally considered to be multiples of their explicit counterparts, albeit harder to quantify, and we seek to equip ourselves with the trading tools necessary to reduce these and achieve best execution for underlying investors.
This means partnering with brokers whose interests most closely align with our own, adopting a "trust but verify" mindset and not merely being seduced by what could be a particularly low headline brokerage commission number, which may increase the likelihood of a broker seeking to monetise our order flow in more covert ways.
Vanguard's Transaction Cost Analysis team, working closely in conjunction with their index investment counterparts, are solely focused on lowering implicit costs, armed with the knowledge that every basis point saved on our funds may translate into millions of pounds remaining in our clients' accounts around the world – exactly where that money belongs.
Our efforts to lower implicit costs also extend to advocating proactively for market microstructure and index methodology improvements which have the potential to benefit all long-term investors. These efforts see us working closely with exchanges, regulators, industry working groups and index providers in an attempt to effect positive change.
We're not standing still
Financial markets continue to evolve, and our work will never be done when it comes to refining the way we trade – the likelihood being what works to reduce costs today may not necessary hold true 12 months from now.
Our stewardship obligation to clients, and the acute responsibility that comes with managing other people's money, demands that we continue to raise the bar. You can rest assured knowing the index fund management professionals at Vanguard are focused on doing just that – much like Japan's famous subway sushi master.
Senior portfolio manager, Vanguard Equity Index Investment Group
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