I was lucky enough to attend an intimate conference last week in Hong Kong with some finance “cool kids”: Nobel Laureates Myron Scholes and Robert Merton, and global asset manager Dimensional Fund Advisors founder David Booth (known for his US$300 million donation to The University of Chicago Graduate School of Business in 2008) to name a few.
They told the story of the first index fund, ever. It is pretty incredible to look back at the evolution of investing in the last 50 years.
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.
A quick timeline of events and research (adapted from Chicago Booth Magazine Spring 2012):
- 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) rely
- 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.
- 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
- 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
- Mac and Wells Fargo establish the first index fund, ever, for the Samsonite pension program
- 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 Wallstreet”, explaining the Samuelson and Fama theories to all investors
- Assets in the Wells Fargo and ANB S&P 500 index funds reach $1 billion each
- John Bogle launches Vanguard, making systematic index investing available to retail investors
- David Booth launches Dimensional Fund Advisors, with Mac and Eugene Fama as founding Directors.
Mac was a practitioner that managed to bring science and implementation together. David Booth’s firm Dimensional was born out of this mindset, and has been translating academic research into practical, real world investment solutions since 1981.
“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
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, 100% of Dimensional’s funds still exist today. In the industry, this number is 42%.*
In the last 20 years, 85% of Dimensional’s funds have beaten their benchmarks. In the industry, this number is 17%.*
*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. That is Dimensional investing.
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.
Dimensional funds are available to retail and accredited Singapore-based investors through certain MAS-licensed financial advisors. At Endowus, our advised investment portfolios are built on Dimensional funds and more.