David Booth, chief executive and chief investment officer of Dimensional Fund Advisors Inc., had no idea when he launched his investment company 25 years ago that his work would stand the test of time. Booth began his career at Wells Fargo, where he helped create one of the first index funds to track the performance of small-company stocks. When Booth started Dimensional in 1981 with a fellow graduate student from the University of Chicago, Rex Sinquefield, they based their work on the research of two American academics Eugene Fama at the University of Chicago, and Kenneth French at Dartmouth College. The firm began with one index mutual fund and stuck to a passive investment philosophy. It set out to prove what the academic research had shown that it’s impossible to beat the markets. Over time, the theory goes, bargain-priced “value” stocks consistently outperform fast-growing, glamorous “growth” stocks. Though it got off to a rocky start, Dimensional now manages $98 billion in assets, up from $84 billion a year ago.
In the past few years, Dimensional has expanded globally into Europe, Australia and Latin America, where it is now one of the largest managers of public investment funds in Chile.
Question: How did you first get interested in the stock market?
Answer:
I grew up in a small town in Kansas. There wasn’t a lot of talk about the stock market, though I was always interested in it. So when I went to get my MBA at the University of Chicago, I became intrigued with the theories of one of my professors, Eugene Fama. When I graduated and went to work for Wells Fargo in California, I began thinking of how to offer a specialized product on small companies that didn’t exist.
Q: How hard was it to start the company?
A:
We started with six salesmen in five offices around the country and we had a lot more rejections than clients.
Q: You now manage $98 billion in assets. Break that down.
A:
The market is up 4 percent this year but small cap stocks are up 12 percent or 13 percent, so a lot of money is coming in our direction again. Of course, name me one pundit at the beginning of the year that said small caps were going to outperform the market. We always hear it’s the other way around. Broken down, we get roughly $65 billion that comes in through financial advisors and $33 billion from institutions.
Q: Why is Dimensional one of the few money managers to base its investment philosophy on academic research?
A:
Wall Street research, we don’t think is particularly useful to us, whereas academic research is. A lot of the academic work came out of the University of Chicago. Professors Fama and French, their research is the cornerstone of how we manage money. Fama is the guy that coined the term “efficient markets,” for his equilibrium view of markets. We were all young together in the 1960s at the University of Chicago, then we became middle aged together, and now we’re getting old together. It’s pretty cool that these ideas have borne out the test of time. It’s not like people have concluded that the ideas were silly. In fact more and more people believe it every year. Fama has been right at the forefront of it all along. I was a research assistant to Fama in school.
Q: Why isn’t Wall Street research helpful?
A:
Because it’s oriented toward trying to out-guess the market, which at the end of the day, we don’t think we can do.
Q: How did you decide that you would give academics like Fama a prominent role in the firm and an ownership stake?
A:
When we started the firm, we thought it would be nice to have an academic link that was tested out and made sense. You want to have a different, outside perspective to challenge you. And we wanted people that didn’t have a vested interest. Even back then Fama was a legend.
Q: How would you describe the “efficient markets” theory that Dimensional bases its investing strategy on?
A:
That begs the question does having a view of the market seem to help? Starting about 40 years ago, primarily at the University of Chicago and MIT and a couple of other places, academic research has focused on whether anyone should care about different opinions of the market. These academics got a similar number of hypothetical orangutans to throw darts at the market similar to those that are published in the Wall Street Journal and they compared their outcome to the stock picks of professional money managers. They’ve been doing these studies for 40 years and the evidence always shows pretty much the same thing once fees and taxes are considered, the orangutans seem to be doing a little bit better job than the professionals. From a social point of view, that’s a very good outcome because it says markets are doing their job. It’s very difficult, on a risk-adjusted basis, to out-guess the market.
Q: How is that a good thing?
A:
The reason it’s encouraging is that it would be horrible if the only way to have a good investment return were to make someone else have a bad investment return. Stated differently, if you buy the stock market which you can do as a basket of stocks, for example, through Vanguard funds over the long haul, you’re going to do fine. So why go through all the anxiety of picking stocks, when the evidence says it’s very difficult to outperform the market? If you can have a good investment experience, why put yourself in a position of a lot of anxiety, when there’s not much evidence that it works?
Q: Yet, Dimensional went through some tough times of its own during the dot.com bubble, right?
A:
If you go back to the time when technology stocks had high rates of return in the late 1990s, we’d go to dinner parties and everybody at the table had a hot stock pick. People would ask what I thought of the market and I would always say that we really couldn’t explain it. At that time, the biggest, safest companies were getting the best stock returns, like General Electric. I’m a risk-return kind of guy. I think risk and return are related. I don’t have a story for why the lowest risk companies would have the best stock returns. You just have to enjoy it, because it shouldn’t happen over the long haul.
Q: How did you convince people to invest in a concept that Wall Street and most money managers do not adhere to? In fact, they think quite the opposite.
A:
From a marketing standpoint, it was a horrible way to proceed. Our evidence showed that it was crazy for people to pay high fees when there’s no evidence that picking individual stocks actually works. Therefore, let’s just buy index funds. I tried to make subtle changes to the argument, more along the lines of you can have a good investment experience this way so why not take the anxiety out of it. When we first started Dimensional, the first inquiry by leading academics and all the leading business schools in the world was: Can the pros beat the orangutans? The second line of inquiry is: What seems to make a difference?
Q: I understand the name Dimensional has significance?
A:
We call our name Dimensional because we think of investing in terms of risk and return, which have several dimensions. Of our assets under management, we’re about 90 percent equity and 10 percent fixed income. On the fixed income, the dimensions typically followed are maturity and quality, so most of the research is on the equity side. Equities have two dimensions: large versus small, and then the price dimension is, low-priced stocks versus high-priced stocks. And low-priced stocks, which typically are called value, have a tendency to have higher average returns than high-priced stocks, which are typically called growth.
Q: Last year, your partner, Rex Sinquefield, retired from the firm. How big a change is that?
A:
It’s actually been a pretty easy transition because Rex stayed on the board and kept his shares. Last week, we had a few board level issues that I ran by him. He still goes out and meets with clients. He’s still joined at the hip. We were lucky. Rex always loved being with clients and traveling a lot, so he wasn’t around here much anyway. What he’s doing now is fascinating. He’s creating a think tank in Missouri to work on public policy issues. One of his main issues is to get rid of the state income tax. Rex is still pretty much a scholar and he comes up with a point of view based on empirical evidence though I don’t know what that has to do with politics at all. He thinks he can still make a difference. (Laughs)
Q: Has your daily life changed in the last few years?
A:
My daily life has changed a lot in the past few years because we’ve grown so much. And next month is our 25th anniversary. The first 10 or 15 years, you’re basically surviving and getting an organization together. We’re now at a certain size where we have a human resources department and a compliance department. I think we waited too long on those issues, though. If a problem comes along, now I can just say, ‘Go talk to HR.’ And one of the key things we’re doing now is developing a lot of younger people, you know, people in their 40s, kids who are now running things.
Q: Who are your clients?
A:
It’s primarily institutions. For us, institutions mean public pension funds and corporate pension funds. The other types of clients come to us indirectly, through a fee-only financial advisor who is getting paid by the client and charges a cash fee. We don’t have any relationship with these advisors because we want them to work for their clients. Typically, CPAs are the fastest-growing group of advisors.
When people first hear the evidence that the orangutans seem to do well, they think, well, I don’t hire the average orangutans, so that doesn’t bother me, because I’m only going to hire the good managers. Obviously, they don’t realize that everyone is out there trying to pick the winning manager.
Q: Can you apply the risk-return theory to something like politics?
A:
No, not unless you believe politics has something to do with economics. The market has a good way of sorting things out in a nice sort of way. That’s the essence of the investment story because markets sort through risk and return in ways that we don’t understand. In a similar fashion, the whole Communist experiment was that central planning could allocate resources better than market prices. But that didn’t work. It goes back to the Middle Ages and the whole concept of “juste prix,” or a just price. There was a time in the Middle Ages when no one could charge interest rates and that’s probably one of the reasons we had the Middle Ages in the first place because you couldn’t get a fair return on your money.
Q: What advice would you offer people about investing?
A:
One of the key elements of investing is saving a lot. If you invest over the long haul, the magic of compounding will bear you out. The evidence is, if you invest the way we invest and your neighbor tries to pick winners, it’s highly likely that you’ll end of with more money than your neighbor.
Q: Tell me about your involvement in the arts.
A:
My wife, Suzanne, is an art restorer and our own personal curator, since we have a large contemporary art collection and some Renaissance paintings. I became a member of the board of trustees of the American Academy in Rome and a couple of years ago we lived in Rome for a year. Rome is a great city for kids. Our daughter was going into the sixth grade, and we just made a spontaneous decision to do it. Some cities aren’t like L.A. you can get your kids into school in Rome, since they’ve had a couple thousand years to get it right. I’m also on the paintings conservation council of the J. Paul Getty Trust. I attend an annual meeting and have helped fund some projects there. It’s basically enough involvement for a nice dinner when all is said and done.
Q: You’re a big fan of UCLA and the coaching strategies of John Wooden. Why?
A:
Wooden is a guy that had principles. That’s why I believe you have to tell people what you can do, what your philosophy is, and let them decide. The best story about Wooden is the one that Bill Walton tells all of the time. One of the rules Wooden had was none of his players could have facial hair. And Walton came in with a beard and he sat down with Wooden and told him that facial hair is really important to him. Wooden says, that’s fine, if it’s really important to you, I wouldn’t want to change your view, so good luck wherever you end up playing basketball
