A while back, a colleague recommended that I listen to a podcast on Bloomberg called Masters in Business with Barry Ritholtz. On the podcast, Ritholz interviews luminaries from the investment industry (and a few others) and talks about my favorite topic.
Although I had listened to one featuring AQR co-founder Cliff Asness, I really didn’t take interest because I had seen Ritholtz on CNBC and didn’t think he was particularly interesting or articulate.
That was a mistake. Last week, Cliff Reynolds urged me to give it another try and listen to an interview with Dimensional Fund Advisors (DFA) co-founder David Booth. Since we have a lot of client assets in a number of DFA funds, I felt obligated to listen.
I’ve heard Booth speak before (and even had lunch with him once), but it was a fascinating interview. Hearing him tell the DFA story reminded me how impressive it was that Booth and his co-founder (controversial St. Louisan Rex Sinquefield) started a business from scratch and turned it into the 10th largest asset management firm in the US with more than $400 billion in assets under management.
It’s more than a story of building a successful business, though, because when they started DFA, their philosophy of passive investing was deeply outside of conventional thinking – some people thought it was downright un-American.
Back in 1971, Booth was earning his MBA from the University of Chicago and was working as a research assistant for Gene Fama, the father of the Efficient Market Hypothesis (EMH) and recent recipient of the Nobel Price.
In the interview, Booth said that the ideas that Fama presented seemed obvious and Fama helped him land a job at Wells Fargo where the first index fund was born.
Although Jack Bogle at Vanguard often gets the credit as he was the first person to create an index mutual fund – Wells Fargo did it first for institutional clients (their first was Samsonite’s pension).
In the late 1970s, there was emerging research that suggested that small cap companies outperformed large cap companies (read my primer on small caps here). Back then, the term ‘small cap’ didn’t even exist.
Booth wanted to create a small cap index fund at Wells Fargo, but they weren’t interested, so he and Sinquefield set up shop in Booth’s Brooklyn apartment and created the first mutual fund dedicated to passively managed small cap stocks (actually, they were micro-caps and the fund is alive and well today in your portfolio).
Wisely, Booth recruited a number of academics to serve on his board including Fama, Roger Ibbotson, Merton Miller, Myron Sholes and, later, Ken French. I realize that these aren’t household names, but in our academic finance, it’s an all-star team.
When the fund started, there was no small cap benchmark to compare themselves against, academics weren’t sure whether it would work because small/microcap stocks were so expensive to trade that it might eat up all of the performance and, importantly, small cap stocks suffered their worst relative returns in history (I chronicle the story without naming names here).
Because Booth had preached the diversification benefit of small cap stocks in addition to the higher expected returns and sold the fund to institutional clients, they made it through the lean years.
In the mid-1990s, shortly after Fama and French did their most famous work that added value investing to small caps, DFA launched passively managed value funds and small/value funds.
Although they certainly weren’t the first value investors, they pioneered small cap and value investing in developed and emerging markets – again, long before indexes were created.
The interview with Booth is worth a listen even though it’s an hour and a half. Since then, I’ve listened to another half-dozen interviews and even though I still don’t love Ritholtz, his guests are amazing and I’m a big fan of long-form journalism that doesn’t cut important ideas into nine second sound bites.