The idea of the first index fund
Everything brilliant our species has come up with usually starts with an idea, subsequently backed by science, that might bring us closer to the truth.
This idea brings us back to 1963, New York City, and traces the story of a curious Harvard MBA and mechanical engineer named John "Mac" McQuown, a 'very slow' IBM mainframe computer, and a pile of academic research that started pointing to a similar conclusion: human investors seldom beat the market, and that market prices have information worth harvesting.
These guys didn't know it yet, but it was the beginning of a big data experiment that would change finance forever, earn more than a handful of Nobel prizes, and create an enormous amount of wealth and understanding for humans.
These guys didn't know it yet, but it was the beginning of a big data experiment that would change finance forever, earn more than a handful of Nobel prizes, and create an enormous amount of wealth and understanding for humans.
A brief timeline of events and research of the first index fund (adapted from Chicago Booth Magazine Spring 2012):
1963
- Lawrence Fisher and James Lorie do research and present preliminary results on the returns of stocks to Merrill Lynch executives with Mac in the audience. This eventually leads to the funding to start collecting market pricing and company characteristic data in the form of the Center for Security Prices (CRSP) database, upon which research on systematic and quantitative strategies (such as index investing) is relied on.
1964
- William Sharpe (Nobel Laureate) establishes the capital asset pricing model, a basic explanation of the relationship between risk and expected return
- Mac joins Wells Fargo as head of Management Sciences Division, tasked with "Investment Decision Making" with computers. This is the birth of quant trading.
1965
- Paul Samuelson (Nobel Laureate) shows that prices follow a "random walk", explaining that security prices move randomly and cannot be predicted
- Eugene Fama (Nobel Laureate) comes up with the efficient market hypothesis
- Michael Jensen studies returns of actively managed funds versus the market, and shockingly sees that only 26/115 actively managed funds beat the market. Research ever since then paints a similar picture
1969
- Myron Scholes (Nobel Laureate), Fisher Black, and Michael Jensen look into characteristics of companies and their expected returns, determining that certain characteristics of companies can have higher expected returns
1971
- Mac and Wells Fargo establish the first index fund, ever, for the Samsonite pension program
1973
- Mac launches a Wells Fargo fund indexing the S&P 500 and American National Bank (ANB) launches a competing fund for institutional investors
- Burton Malkiel releases his famous book "A Random Walk Down Wall Street", explaining the Samuelson and Fama theories to all investors
1975
- Assets in the Wells Fargo and ANB S&P 500 index funds reach $1 billion each
1976
- John Bogle launches Vanguard, making systematic index investing available to retail investors and as a result is widely credited to be the “Father of Passive Index Investing”
1981
- David Booth launches Dimensional Fund Advisors, with Mac and Eugene Fama as founding Directors.
Dimensional Fund Advisors (DFA): Putting financial science to work
John “Mac” McQuown was a practitioner that managed to bring science and implementation together and worked with Dimensional co-founder David Booth to develop the first institutional index funds at Wells Fargo in the early 1970s.
Since its founding in 1981, Dimensional was born out of this mindset and continues until today, in translating academic research into practical, real world investment solutions for investors.
By harnessing the wisdom of the greatest minds in finance and following a disciplined and rigorous implementation process, DFA has built an impressive track record of outperforming both benchmarks and peers. As of year-end 2023, Dimensional’s assets under management stood at $677 billion, making it one of the largest (and fastest growing) fund companies globally.
Nobel Laureates such as Eugene Fama, Myron Scholes sit on the firm’s Board of Directors, as well as several other notable academics including John McQuown.
"Mac was in on the ground floor of the movement to bring academic rigor to finance, a pursuit that remains at the heart of Dimensional to this day."
—— David Booth, Co-founder of Dimensional Fund Advisors
What impresses me most about Dimensional is their ability to block out the noise and "what's hot" and stay focused on long-term, cost-efficient, intelligent investing for its clients. This is no easy feat in a fund management industry full of high flyers, big busts, new research and firms every day.
In the last 20 years, all Dimensional's funds still exist today (100%). In the industry, fewer than half (42%) of funds are able to last for 20 years.*
In the last 20 years, 85% of Dimensional's funds have outperformed their benchmarks. In the industry, only 17% of funds are able to achieve this goal.*
*US-domiciled mutual funds of all strategies, including non-US strategies, for the 20 year period ending Dec 31, 2018. Past performance is no guarantee of future results.
Guided by a strong belief in markets, the firm builds and implements strategies to help clients pursue higher expected returns. Imagine a fund that invests in the entire world (10,000+ securities), and continuously and systematically pursues the proven risk premiums of small cap, value, and profitability at a low cost (<0.45% total expense ratio), with minimal market impact and turnover.
To me, it is as if we have witnessed the evolution from horse-drawn carriages (speculative investing), to diesel cars (index investing) to the mag-lev train (systematic investing) in a short time. Costs have also dramatically decreased, and the boundaries to access these strategies have been knocked down.
You can think of the birth of index investing and what Dimensional continues doing today as just a part of the investing evolution, as curious scientists and practitioners continue to pursue the truth in the hope of a better future.
Accessing Dimensional's investment strategies through Endowus
Reasons why Dimensional might still be unknown to many retail investors is because their products are only sold through selected financial advisors, which in turn have to go through a lengthy approval process. And to keep costs low for end investors, DFA does not pay trailer commissions or “kickbacks” to distributors who recommend their funds.
We are delighted to share that retail investors can now access the Dimensionals’ investment strategies through our newly launched discretionary managed Endowus Flagship Portfolios. The Endowus Flagship Portfolios are curated by our Endowus Investment Office with the aim to provide clients globally diversified exposure with Best-in-Class funds at low and fair fees.
Professional Investors can also access Dimensionals’ investment strategies as individual strategies or use them as building blocks to build your own portfolios.
Click here to get started on your wealth journey on Endowus Hong Kong or schedule a free 1-on-1 consultation with our SFC licensed advisors today.
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