Leveraging Chicago Ideas
Snyder: Could you talk about Dimensional’s core strategy and
how it has leveraged Chicago ideas?
Booth: We view ourselves as evolving in a process, a feedback
loop. There are models that are cause and effect, and then there’s
a feedback loop system, where you can start in any number of
places. Let’s begin with academic research. That leads to ideas
about how to invest money. If you have ideas, then you acquire clients for the strategies you develop based on those ideas.
Next is implementation, which is our strength. After you
implement, you review your results, which leads to a dialogue,
which leads to questions, which requires more research, which
leads to more strategies, clients, implementation, evaluation, and
attribution analysis, more dialogue—and then more research.
That’s the feedback loop. One of the key components is
research. It’s a luxury to build a business knowing that when
you need serious research, you have access to the highest quality.
That’s something as a firm we couldn’t hope to monopolize.
But all the finance professors in the world work for us,
they just don’t know it.
Snyder: You’re reading the research?
Booth: Fama, Ken French, and our other board members are
reading it. They pass along the research they think is relevant so
I don’t have to read it all. That way, we can focus on the parts
where we have direct control, which is the implementation.
Ideas are great, but somebody has to engineer them, package
and present them to clients, and execute them. We have access
to the great minds, and hope we provide a great service for our
clients in terms of value added. From the academic viewpoint,
the firm can apply these ideas and make things come alive. It’s
a good partnership.
It’s intriguing because we build a firm around the view of the
efficient markets, as Fama calls it, or equilibrium markets, but
taken to an extreme, it can’t really be right. This idea of efficient
markets breaks down at some level, but that depends on your
vantage point. From the vantage point of our clients and firm,
we accept the idea that markets are efficient, because on a costbenefit
basis, it doesn’t pay to behave any other way.
That’s a pretty subtle argument to say we build a firm around
this set of ideas, and this is how we choose to behave, what we
choose to believe—when in reality we know that there’s got to
be somebody out there who can pick stocks. But the cost of identifying
and giving them the money is one difficulty. Secondly, all
economists must agree that if there is anything in scarce supply,
it’s that ability to outguess the market. If there are people out
there that have it, why would they share it with anybody else?
The academics are really focused on the question, are markets
efficient. As a businessman, that’s only part of the question. We
ask, are markets efficient and will our clients get any of it?
Snyder: The extras.
Booth: Right. We believe totally in this notion of market efficiency,
but you can have a have a career talking about this issue
in a way where reasonable people can have differences of opinion
about the answer. One thing we’ve been able to document
clearly is you don’t have to believe that you can outguess the
market in order to have a good investment experience. And our
message to clients is that there’s a fair return that everybody is
entitled to over the long haul.
Snyder: In marketing the firm, you operate in a very competitive
space. Obviously, Dimensional has done amazing things for
people who’ve invested over the long term. Your track record of
outperforming the relevant indices is phenomenal, but in terms
of the marketing message it seems like you’re trying to get people
to understand the approach. Is the marketing of Dimensional
about wanting your clients to understand performance?
Booth: Yes. I’ve told Fama that the difference between teaching
at the business school and selling this set of ideas is that, in
essence, all of our “students” have to get As. If they don’t understand
well enough to get an A, we don’t get the business.
One of the things that’s shocked us is how important these
ideas are, how valuable they are in the marketplace. When I was
in business school there was a term, the “ivory tower.” I don’t
hear that much anymore, but everything you teach is theory
and analysis. Some people think they want to study something
more practical, but what we’ve been able to demonstrate is that you
can take a set of ideas and make it relevant for people and devise
something that provides a very good investment experience.
Chicago is a bit like our firm in that you also have competitors
who imitate parts of what you do. Our first investment strategy
was a small cap fund. I won’t go into detail, but research started to
become available beginning with Michael Jensen’s PhD dissertation.
He examined a mutual fund’s performance on data from
1946 through 1965. He set in motion an industry of analyzing
professional money management returns in public markets.
They’d been doing these studies with increasing sophistication
over the years, but they always show the same thing—trying
to outguess the market is not a cost-benefit effective thing to
do. When people started reading that research, the conclusion
was: if we can’t outguess the market, then you can buy the market
through an index fund. Sure enough, the three decades in
existence—the ’70s, the ’80s, and the ’90s—have the simple S&P
500 Index Fund as ranked in the top quartile when compared to
professional money managers in each of those decades.
I counter that here’s where behavioral finance might be of
some use. When you talk to MBA students at Chicago Booth, you know
they see that data, but they interpret it slightly differently. But
it’s true that when you compare professional money managers
to a similar number of hypothetical orangutans throwing hypothetical
darts at the stock listings in the Wall Street Journal, the
distribution outcomes look pretty much the same. And you
know that one orangutan in a thousand will outperform the
market every year ten years in a row. It’s actually not quite that
much for the professional money managers.
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