Chicago Booth Magazine
The Conversation: The Power of Ideas
Snyder: They start to think that they’re smart, whereas the orangutans just keep throwing.
Booth: Right. So in top business schools, bright students see the data and they conclude that they’re in the tail of a distribution. In reality the people in the right tail of distribution are the same numbers you would expect from a distribution of orangutans. So Chicago training led us down a different path than other people looking at the research. Most people looking at the research said well, if we can’t beat the market, then we can create an index fund. We can buy the market and that strategy has worked very well.
Booth: One of the good things about the business school is the people. One fellow student, Rex Sinquefield, ’72, and I became friends and eventually partners—he retired a couple years ago. We worked together for 24 years with a shared view of markets and how to create a business. By 1981, when we started the firm, all the index funds that were available were index funds invested in stocks of larger companies. So we decided to create a fund that would invest in stocks of smaller companies. The first problem that arises when you start to think about smaller companies, rather than larger companies, is the cost of execution, the friction cost. Maybe if you put the institutional quantities of money into working small companies, it’s easy to move prices around. So we decided not to try to slavishly track the performance of an index. We decided to do the best job of execution that we knew how to do, which involved reducing trading costs and protecting ourselves against adverse selection.
If you’re an efficient markets person you realize that you can’t outguess the market, but there is undiscounted information out there and you just have to protect yourself against the adverse selection. So we went down a different path.
Snyder: That immediately gets you away from the pure model.
Booth: Right. We said there’s a cost to tracking. It isn’t free. For example, in the small cap area, the way small cap index funds came to be traded was by trading baskets of stock at the closing price. You call up a broker and say I want the closing price on this basket of stocks. And it occurred to us that maybe if you want that guarantee of a closing price, that might be fairly expensive. So we uniquely went to a different path. Even after 27 years, there’s still some degree of difficulty in labeling because people say, if you don’t think you can outguess the market, then you won’t. But, nevertheless, approaching markets in a sensible sort of way and having a healthy regard for markets, we were able to add significant value, which is why we have a business and why we we’re able to give gifts to the business school.
Snyder: It’s such a great story.
Booth: Yeah. It just turned out to be very useful, very valuable, and it ties to the idea of research and why you want a research university, where you explore things, you know, but if it hadn’t been working we would have had to go in a different direction. We’re empiricists. We look at the data. It took 10 years to persuade ourselves that we were actually adding value—at first we thought it was random good luck. Then we realized it was too much value added. And it took us about 20 years to develop a story around it.
Snyder: I’d like to mention one other thing: I can’t think of a better person to name the school. It’s the perfect gift in terms of endowment and flexibility. It’s affirmation. It gives us an opportunity to work on the brand name gap we have versus our toughest competitors.
Chicago has a great brand, and we’ve had a lot of improvements in our brand name capital and a lot of momentum. I believe that if you perform well, recognition and support follow—and I think the performance of the school is really strong. But the fact is that our brand is uneven in terms of sector and geography, and this is a great opportunity for us to make a major push forward on that dimension.
I appreciate how you frame this gift. Some people would want to make this sound like the biggest deal of all time, but you join me in saying it’s a step, and inviting others to join in. So, together we devise a matching process where other people say, I’ll be able to get a named endowment at the University of Chicago Booth School of Business and take advantage of your gift to do that, that will help us further leverage your gift toward the overall objective of the school and get more people on this winning team.
Booth: I don’t want to step on your line there, but I’m chuckling because it gives me a chance to use the following phrase: I think a gift is necessary, but not sufficient, as they used to say in the business school.
Snyder: I agree.