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MIB Live (Replay) with Eugene Fama and David Booth · Masters in Business

0:02
Speaker 1: This is Masters in Business with Barry Ridholts on Boomberg Radio.
0:07
Speaker 1: This week. I was privileged to travel to the University
0:09
Speaker 1: of Chicago to the Booth School of Business, where I
0:12
Speaker 1: got to sit down with Eugene Fama, Nobel Laureate, Chicago
0:16
Speaker 1: Booth School of Business UM, founder of the Efficient Market hypothesis,
0:22
Speaker 1: creator of effectively the three, five and seven UH Fama
0:27
Speaker 1: French factor model, basically the father of modern finance. I
0:32
Speaker 1: don't know how else to describe him, along with his
0:36
Speaker 1: best student, David Booth, co founder of Dimensional Funds, the
0:41
Speaker 1: person that the Booth School of Business is named after.
0:45
Speaker 1: What can I tell you? I flew out to Chicago.
0:48
Speaker 1: UH basically went to the Booth School of Business at
0:52
Speaker 1: the University of Chicago where they were celebrating this relationship
0:57
Speaker 1: that both Fama and Booth have had for literally fifty years.
1:03
Speaker 1: I got to sit down with the two of them
1:05
Speaker 1: for an hour in front of about five people in
1:07
Speaker 1: the audience, including a lot of students from the Boost
1:10
Speaker 1: School as well as other notables who were in attendance.
1:15
Speaker 1: And Fama is notoriously press shy. He does not do
1:19
Speaker 1: a whole lot of UM interviews with the media. This
1:23
Speaker 1: was just a delight. I can't begin to say how
1:27
Speaker 1: just awesome he was. He's a provocateur. He likes to
1:31
Speaker 1: say things that are very much, um contrarian. He's a
1:35
Speaker 1: little bit you know, if Farma was on Twitter, he
1:38
Speaker 1: would be a troll. He loves to tweak people, especially
1:41
Speaker 1: his buddy and fellow Nobel laureate Richard Taylor. Uh. He
1:45
Speaker 1: was busting his jobs about behavioral finance, basically saying it's
1:50
Speaker 1: all just pushed back to the efficient market hypothesis. Uh.
1:54
Speaker 1: David Booth, also very insightful, had a lot of things
1:56
Speaker 1: to say. There's obviously a tremendous amount of respect at
2:00
Speaker 1: between the two of these guys. I could babble about
2:04
Speaker 1: my experience in Chicago for hours, but rather than do that,
2:08
Speaker 1: why not just say my conversation with Eugene Vama and
2:12
Speaker 1: David Booth. There is so much material to cover. We're
2:16
Speaker 1: gonna keep this to about four hours. We'll take a
2:19
Speaker 1: break for dinner, and then we'll finish up before midnight. Um.
2:24
Speaker 1: So I really don't have to introduce either of these gentlemen,
2:28
Speaker 1: but let me just put a little more flesh on
2:30
Speaker 1: the bones of what what the Dean started with. Obviously,
2:35
Speaker 1: Jean is best known for not only the efficient market hypothesis,
2:39
Speaker 1: but his research on portfolio theory, asset pricing, the Fama
2:43
Speaker 1: French factor models. He is recipient of the Nobel Prize
2:49
Speaker 1: in in Economics, and I like the sentence that the
2:53
Speaker 1: Nobel group used quote for stuff for his work showing
2:57
Speaker 1: quote stock price movements are impossible to predict in the
3:01
Speaker 1: short term and that new information effects prices almost immediately,
3:05
Speaker 1: which means markets are efficient. David co founded Dimensional with
3:10
Speaker 1: another University of Chicago alum, Rex Sinquefeld in one The
3:15
Speaker 1: firm now employees four hundred people who helped manage five
3:20
Speaker 1: hundred and seventy nine billion dollars over the twenty years
3:24
Speaker 1: ending in twenty eighteen. Eight of dimensionals equity and fixed
3:29
Speaker 1: income funds beat their benchmark the rest of the industry
3:34
Speaker 1: just seventeen and that's based on much of the work
3:38
Speaker 1: that Professor Fama did. So so let's jump into the
3:43
Speaker 1: history um of both Gene and David and see where
3:46
Speaker 1: it goes. Jeane, during your last I feel weird calling
3:50
Speaker 1: you Gene. It really should be Professor Farma, shouldn't it Um?
3:54
Speaker 1: During your last year toughs. You worked for Professor Harry
3:58
Speaker 1: Ernst who had a light gig running a stock market
4:02
Speaker 1: forecasting service, and you did research for him. What sort
4:07
Speaker 1: of work did you do with this stock forecasting research?
4:12
Speaker 1: I was devising schemes to beat the market, and how
4:16
Speaker 1: did that work out? Worked out fine? And on the
4:20
Speaker 1: data that I fitted to didn't work out fine on
4:23
Speaker 1: the whole load sample never did So that was a
4:26
Speaker 1: lesson that data judging continn of things that aren't really there.
4:31
Speaker 1: And how did that research into forecasting the stock market
4:35
Speaker 1: impact your thinking about whether or not the market could
4:39
Speaker 1: be be well? When I came here to Chicago, uh,
4:44
Speaker 1: research on asset prices had again to get going in
4:49
Speaker 1: really serious way, and many people were interested in the
4:53
Speaker 1: question of how well stock prices adjusted to new information.
4:57
Speaker 1: Put in context, they always say it started because of computers.
5:02
Speaker 1: Before really didn't have a serious computer too do data
5:07
Speaker 1: analysis on. And with the coming of computers, statisticians economists
5:11
Speaker 1: were they had a new toy too to play with
5:15
Speaker 1: and stock stock prices were easily available, so that was
5:18
Speaker 1: one of the first things they started to study. And
5:21
Speaker 1: then immediately the economists said, well, how do we expect
5:24
Speaker 1: prices to behave if the world was working properly, in
5:27
Speaker 1: other words, if markets were efficient. They weren't using that term,
5:31
Speaker 1: but that's what they were after, and they were all
5:34
Speaker 1: kinds of theories proposed. They had lots of shortcomings to them,
5:39
Speaker 1: and a little bit of time we came to the
5:42
Speaker 1: efficient market hypothesis. And you were in your senior year Toughs.
5:47
Speaker 1: You had applied here, but you never heard back from
5:50
Speaker 1: the school. Is this an urban legend or is this true?
5:54
Speaker 1: So what happened? I called? I called in uh the
5:59
Speaker 1: Dina students toff at Keff answered, that wouldn't happen today.
6:03
Speaker 1: The school is so much bigger. The dean students doesn't
6:05
Speaker 1: even have a telephone. Way too important for that. So
6:10
Speaker 1: he answered the phone. We chatted for a while and
6:12
Speaker 1: he said, well, I hate to tell you, but we
6:13
Speaker 1: don't have any record of your application. So what kind
6:16
Speaker 1: of grades do you have at Toughs? And I said
6:18
Speaker 1: pretty much a lazy. He said, well, we have a
6:21
Speaker 1: scholarship for someone from Toughs. Do you want it? And
6:25
Speaker 1: then that's how that's how I ended up at the
6:27
Speaker 1: University of Chicago. So so you come here as a
6:31
Speaker 1: student you're you're finishing your work. Eventually, Martin Miller says
6:35
Speaker 1: to you, Hey, do you want to stick around and
6:37
Speaker 1: keep doing the sort of research you're doing? Is that
6:40
Speaker 1: how you became a professor here? Yeah? I was. I
6:45
Speaker 1: had offers that some other places, um, but lots of
6:50
Speaker 1: the places turned me down. They said it was to Chicago.
6:54
Speaker 1: I don't know what that meant actually, but but uh,
7:00
Speaker 1: it was very rare to hire somebody from your ound
7:03
Speaker 1: PhD program onto the faculty. They're only gonna one or
7:07
Speaker 1: two before there. So, David, you had a somewhat different experience.
7:12
Speaker 1: You grow up in Kansas, you get a b a
7:13
Speaker 1: in economics and a master's from the University of Kansas.
7:17
Speaker 1: What made you decide to come to Chicago. Well, I
7:21
Speaker 1: did a little bit of reading um in finance um
7:25
Speaker 1: and um my had a finance professor there that gotten
7:30
Speaker 1: his PhD here, and he said, finances exploding really emerging
7:36
Speaker 1: as an academic discipline. It's really one of the the
7:40
Speaker 1: epicenters is clearly Chicago. And so I thought, well, I, God,
7:44
Speaker 1: I should be fun, maybe be a professor. So I
7:47
Speaker 1: applied here. Uh. Um, Yeah, I started to stay, took
7:52
Speaker 1: jeans class my very first class, and is was the
7:56
Speaker 1: Dean Correct? Was that literally fifty years ago? Fifty years
8:00
Speaker 1: ago this fall? It was. Yeah, it was the first
8:04
Speaker 1: year that Chicago had a football team in thirty four years.
8:09
Speaker 1: And you had written about your experience taking a class
8:13
Speaker 1: with Gene. You called it um life changing and transformative.
8:19
Speaker 1: In what ways was it life changing? Well? Life changing
8:24
Speaker 1: led to a career. I mean, I can't have much
8:26
Speaker 1: of a bigger change than that, but it's um life changing.
8:30
Speaker 1: And then I think everybody here probably UM, I would
8:35
Speaker 1: like to think of themselves UM having a public purpose.
8:39
Speaker 1: At the end of it all, when you get to
8:40
Speaker 1: be my age, you want to look back and I
8:43
Speaker 1: think somehow the world was better off for your having
8:46
Speaker 1: been here. And so these ideas that were coming out,
8:51
Speaker 1: you know, the essence of efficient markets, it was already
8:55
Speaker 1: well developed. He had already coined the term UM. And
8:59
Speaker 1: you just said, this is enormously useful. If you look
9:01
Speaker 1: at the way money was managed fifty years ago, people
9:05
Speaker 1: are getting ripped off. I mean, fees were way too high.
9:08
Speaker 1: You know, the commissions were fixed by the government, uh
9:11
Speaker 1: at about ten times what they are today, and uh
9:14
Speaker 1: we forth it's free today. So it's a lot more
9:19
Speaker 1: than ten x yeah. Yeah, yeah, So it's um. I
9:23
Speaker 1: think there was a spirit of that we can improve
9:27
Speaker 1: people's lives, you know, a real purpose to all of this.
9:31
Speaker 1: Gene um more on the research side, and I've thought
9:37
Speaker 1: my role in all this would be more on the
9:40
Speaker 1: application of the ideas. So you become Jane's teaching assistant.
9:44
Speaker 1: How did that come about? I always I always picked
9:48
Speaker 1: the student in the class in the previous year to
9:52
Speaker 1: be the teachers good student. It's the best of the class.
9:57
Speaker 1: You don't have to laugh at that. I mean, so
10:02
Speaker 1: best student, professor Farmers teaching assistant. Why not a career
10:07
Speaker 1: in academia. Well, first off, I realized I could never
10:11
Speaker 1: compete with gene I mean when you're at the top
10:14
Speaker 1: of the mountain. Um. But it's really something. It caused
10:19
Speaker 1: me to reflect and you know, really internally and what
10:22
Speaker 1: what am I about? What do I enjoy? And I
10:27
Speaker 1: I just saw this as a great opportunity to go
10:29
Speaker 1: out to apply all these ideas people were developing. Every
10:32
Speaker 1: new paper coming out was a landmark paper. It was
10:35
Speaker 1: it was all brand new stuff, and uh, none of
10:38
Speaker 1: them was being applied. So we're gonna come back to
10:41
Speaker 1: the application very shortly. But you mentioned that all these
10:45
Speaker 1: new ground baking, groundbreaking papers were coming out. Professor Farmer,
10:50
Speaker 1: your doctoral thesis in four was the behavior of stock
10:55
Speaker 1: market prices, And this sentence jumps right off the page
11:00
Speaker 1: quote chart reading, though perhaps an interesting pastime, is of
11:04
Speaker 1: no real value to the stock market investor. So this
11:08
Speaker 1: gets published in the Journal of Business in nine. What
11:12
Speaker 1: sort of pushback do you get to the general concept
11:15
Speaker 1: that UM charts are of no use past market walk
11:21
Speaker 1: is of no future predictability to what happens going forward.
11:25
Speaker 1: You got a lot of a lot of pushback from
11:27
Speaker 1: the professionals. The academics looked at the data, looked at
11:31
Speaker 1: what people were saying, what they were showing, and adopted
11:35
Speaker 1: it right away. I mean, there was no prospect among
11:37
Speaker 1: the academics. Really, it's really the beginning of I mean,
11:40
Speaker 1: if you had to summarize really impact of all this
11:44
Speaker 1: is UM what was going on in Chicago then really
11:48
Speaker 1: changed the way people think about investing. And that's really
11:53
Speaker 1: been the theme, and Jen has changed the way people
11:56
Speaker 1: think about investing more than that's that's the pre and
11:59
Speaker 1: post law line, pre FAMA and post Fauma there's a
12:03
Speaker 1: ce change. I don't like the postframa business meaning meaning
12:12
Speaker 1: post publication of your way. So we not only have
12:18
Speaker 1: your doctoral thesis, we have the efficient market paper. We
12:22
Speaker 1: have the FAMA French three factor paper. There are a
12:25
Speaker 1: number of very very influential papers that David, if I'm
12:30
Speaker 1: hearing you correctly, you're saying that changed the firmaments of
12:34
Speaker 1: finance forever, changing it forever and for the better. I mean,
12:38
Speaker 1: I get particularly, and there's among students there's this kind
12:44
Speaker 1: of antipathy towards finance and economics, you know, and they
12:49
Speaker 1: don't realize how much UH finance has changed for the better.
12:54
Speaker 1: People's lives have been improved by these ideas in this research,
12:58
Speaker 1: lower fees, better of risk control, and so forth. So
13:03
Speaker 1: so let's let's compare then and now a little more specifically,
13:08
Speaker 1: and we'll start by talking efficient markets. Back in the
13:11
Speaker 1: days when active managers were dominant, inefficiencies could still be
13:16
Speaker 1: easily found, as could to percent fees. Professionals didn't believe
13:21
Speaker 1: markets were efficient. They thought they were kind of sort
13:24
Speaker 1: of eventually efficient. I doubt many of them would say
13:28
Speaker 1: that today, what do you think has changed to bring
13:32
Speaker 1: so many people over to the efficient market theory, well,
13:37
Speaker 1: the accumulation of of performance evidence. So back then there
13:42
Speaker 1: wasn't there was no real evidence on how these people did. Uh.
13:46
Speaker 1: And one of the first papers was like Jensen's thesis,
13:49
Speaker 1: which studied new toral funds for the previous twenty five
13:54
Speaker 1: years and so that basically they weren't beating the market. Uh.
13:59
Speaker 1: And now we know on hindsight that in fact that
14:03
Speaker 1: has to be true that active management is a zero
14:07
Speaker 1: sum game before cost because they don't they can't win
14:11
Speaker 1: from the passive managers because the passive people hold cap
14:14
Speaker 1: weight portfolios. They don't, they don't overweight and underweight in
14:18
Speaker 1: response to what the active people do. So if there's
14:21
Speaker 1: anybody underweighting and overweighting, there has to be another active
14:24
Speaker 1: manager on the other side doing the opposite, which means
14:28
Speaker 1: if one wins, the other loses some of those is
14:31
Speaker 1: zero before costs arithmetic of active management. He calls it
14:40
Speaker 1: the arithmetic because it is arithmetic. It's not a proposition.
14:43
Speaker 1: It has to be true for everyone, or there's an
14:45
Speaker 1: offsetting loose. So what about technology, how does that impact
14:51
Speaker 1: how fast information makes its way into prices? It should
14:56
Speaker 1: make it better, Uh, but you know, truth is, prices
15:01
Speaker 1: are so volatile. Markets have always looked really efficient. They
15:06
Speaker 1: don't look anymore efficient than they and they ever have
15:09
Speaker 1: with the introduction of all the technology. So if information
15:13
Speaker 1: is spread much more quickly now than it was fifty
15:17
Speaker 1: years ago because you have so many sources and they're
15:20
Speaker 1: so quick, but you can't really see in the data
15:23
Speaker 1: that that's had a quantum effect on the adjustment of
15:27
Speaker 1: crisis to information. So we may not be able to
15:31
Speaker 1: see it explicitly in the data. But when we look
15:34
Speaker 1: at things like hedge fund performance, they did very well
15:38
Speaker 1: before the financial crisis, since then not as well. We
15:42
Speaker 1: look at the money flows away from expensive active towards
15:47
Speaker 1: inexpensive passive, it sounds like lots of investors are voting
15:52
Speaker 1: with their dollars that, hey, the market is efficient and
15:55
Speaker 1: we can't beat it. Doesn't it seem like technology is
15:59
Speaker 1: dry having some of that Because there used to be
16:03
Speaker 1: information asymmetries. There used to be inefficiencies that a savvy
16:08
Speaker 1: manager might have been able to find. It sounds like
16:10
Speaker 1: it's even harder to find those inefficiencies today than thirty
16:15
Speaker 1: years ago. Um, Hey, you have better information than I
16:18
Speaker 1: do because you're saying, so it's always looked, it's always
16:23
Speaker 1: been that, it's always been zero sum game. I've been
16:27
Speaker 1: in the business now almost fifty years, and every year
16:30
Speaker 1: people say, next year is gonna be the stockpickers stockpickers market?
16:34
Speaker 1: Well Gene saying is it's arithmetically impossible. So so let's
16:39
Speaker 1: talk a little bit about index funds. Gene. You introduced
16:43
Speaker 1: David when he is finishing his NBA and wants to
16:47
Speaker 1: go out into the world of work, to John McGowan
16:50
Speaker 1: over at Wells Fargo, where they were developing as an
16:54
Speaker 1: institutional product, the first index fund. What made you think
16:59
Speaker 1: that that was a good fit for for David mac mcclown,
17:05
Speaker 1: who was in charge of the Wells Fargo unit, came
17:07
Speaker 1: to well the seminars we did here for business people,
17:10
Speaker 1: we didn't twice a year, the Center for Research and
17:12
Speaker 1: Security Prices were in seminars for interested business people and
17:16
Speaker 1: Mac came to all of them and he seemed very
17:22
Speaker 1: you know, into the new stuff. And so when it
17:26
Speaker 1: came down the David said, I see what you do,
17:27
Speaker 1: but I don't want to do it as an academic.
17:32
Speaker 1: So I called Mac and said, I have a really
17:34
Speaker 1: good student here if you've got a place him and
17:36
Speaker 1: he did. So what was your experience like it? Wells
17:40
Speaker 1: Fargo working on that index one, Well, there was a
17:42
Speaker 1: terrific experience, great exposure. I learned the importance of a
17:49
Speaker 1: client work. I mean investment businesses part technology or investment science,
17:55
Speaker 1: and it's part client work. And as I've told Jean,
18:00
Speaker 1: you know, I studied finance for two years, I've been
18:03
Speaker 1: studying client work at the last you know. And that
18:09
Speaker 1: was we uh, we were so naive about dealing with
18:15
Speaker 1: clients and what they would be interested in, and we
18:18
Speaker 1: were so pumped up, jazzed up about the ideas. Somehow, um,
18:24
Speaker 1: we missed the mark and actually my group got it
18:28
Speaker 1: was unsuccessful, we got shut down, but they were um,
18:32
Speaker 1: the other parts of the bank kept it going. And
18:34
Speaker 1: now that little project we started end up as through
18:39
Speaker 1: various hands, is now a big part of black Rock.
18:43
Speaker 1: So so let's that's right. It eventually ended up going
18:45
Speaker 1: to Barclays and then black Rock bis them and now
18:48
Speaker 1: I shares I think they're coming up on six or
18:51
Speaker 1: seven trillion dollars not to not too shabby. Um, but
18:55
Speaker 1: let's talk about the application of genes theories to the
19:00
Speaker 1: practice of working with clients post Wells far ago. You
19:05
Speaker 1: decide to open the small microcap fund out of your
19:09
Speaker 1: second bedroom in an apartment in Brooklyn. Tell us how
19:13
Speaker 1: you applied Professor Farmers research to that microcap fund. Well,
19:18
Speaker 1: the first thing is, UM, we decided UM not to
19:22
Speaker 1: have UH around the portfolio like an index fund, even
19:26
Speaker 1: though at first we call it an index fund because
19:29
Speaker 1: it's very similar to indexing. With the final step being
19:33
Speaker 1: UM that we don't trade UH market on clothes like
19:38
Speaker 1: many index funds do. UM. And what that means is
19:42
Speaker 1: we were we would be trading stocks throughout the day. Well,
19:45
Speaker 1: that created a lot of skepticism, particularly among academics, because
19:49
Speaker 1: you're going to the marketplace. You know, you don't have
19:52
Speaker 1: any undiscounted information. People on the other side of your trade,
19:56
Speaker 1: largely institutions, think they know a lot about the stock.
20:00
Speaker 1: You know, why won't they just rip your eyes out
20:02
Speaker 1: when you're trading. That's a that's a quite legitimate question. Uh. Well,
20:07
Speaker 1: I mean that the answer is there a lot of
20:09
Speaker 1: things you can do to use the energy of markets
20:11
Speaker 1: and the power of markets to your advantage. It turns out,
20:15
Speaker 1: for example, if we want to buy a stock. Let's say, um,
20:20
Speaker 1: they have an institution wants to sell it. Their anxiety
20:23
Speaker 1: is greater than ours, so we can use that their
20:27
Speaker 1: interest in trying to do a quick trade to our
20:30
Speaker 1: advantage and protect ourselves. And there's you know, plenty of
20:35
Speaker 1: information now floating out about the stock that you can
20:38
Speaker 1: use to protect yourself. But that wasn't known back then.
20:41
Speaker 1: It was just we had a belief in markets, belief
20:44
Speaker 1: and and how they work based on what we studied
20:47
Speaker 1: here and said, look, we think we can go out
20:50
Speaker 1: and trade these stocks and not uh not get killed
20:55
Speaker 1: that there were two pieces done here and it's most
20:59
Speaker 1: stuck turns and most of the academics said, well, it
21:03
Speaker 1: looks good in terms of the crisp historical data, but
21:07
Speaker 1: in fact, if you try to trade it, you're going
21:09
Speaker 1: to get swamped by trading costs. Uh. And that was
21:13
Speaker 1: the so called market micro struct just stuff. And then
21:16
Speaker 1: we figured out what we found out what dimensional was, No,
21:20
Speaker 1: he really didn't have to pay those big bit ast
21:22
Speaker 1: spreads that you were seeing. You could go fewer, was
21:25
Speaker 1: patient trader. You could do better with the prices, so
21:28
Speaker 1: we could deliver this small stuff premium. But previous to that,
21:33
Speaker 1: people weren't believes what the academics learned was the market
21:38
Speaker 1: micro structure stuff was garbage. Basically they didn't really understand. Interesting. Um,
21:45
Speaker 1: what we learned about clients along the way, which was
21:48
Speaker 1: seeing in our initial clients were all large, largest pension funds,
21:54
Speaker 1: essentially insurance companies around the world, and they weren't hopening
21:58
Speaker 1: the stocks of small companies. So really the pitch we
22:02
Speaker 1: got into all this stuff, but we hadn't even easier argument,
22:05
Speaker 1: which was, look, you ought to hold stocks of large
22:08
Speaker 1: companies and small, and you're not holding small, so we'll
22:11
Speaker 1: get you access to small. So that was the really
22:14
Speaker 1: the sales pitch that put us on the map. And
22:17
Speaker 1: so that sales pitch starts to take off and dimensional
22:20
Speaker 1: operating out of your apartment gets bigger. There's kind of
22:23
Speaker 1: an urgent urban legend that you called New York Telephone
22:27
Speaker 1: to have them add six phone lines and they refused.
22:30
Speaker 1: They thought you were running a bookie joy. Is that
22:33
Speaker 1: remotely true? Yeah, this was about the kind of at
22:36
Speaker 1: the bottom of Brooklyn Heights, uh, bottom of its history.
22:40
Speaker 1: It's so we started on a shoe string and we
22:46
Speaker 1: ran the portfolio. Was the first portfolio manager running out
22:49
Speaker 1: of my spare bedroom. So I knew we needed more
22:51
Speaker 1: phone lights. So I called up New York Telephone, which
22:56
Speaker 1: was a telephone company at the time. So the need,
23:00
Speaker 1: you know, uh some telephone lines and I know six
23:03
Speaker 1: or eight or whatever, and they thought it was a bookie,
23:06
Speaker 1: so they wouldn't give me the lines. So I had
23:08
Speaker 1: to call up the Treasure of New York tell say,
23:10
Speaker 1: can you send some people down here and give me
23:12
Speaker 1: some telephone lines. And they went around the whole block
23:16
Speaker 1: and found that there were six lines available available and
23:20
Speaker 1: the whole block that based on their equipment, and they said, okay,
23:24
Speaker 1: you can have those six lines. And that's how we
23:26
Speaker 1: got started. And the punch line is he becomes a client. Yeah, yeah, right,
23:31
Speaker 1: New York that was a clickly became a clie down.
23:34
Speaker 1: So so from from day one, Gene is a board
23:38
Speaker 1: member of Dimensional Funds. From the day it launches, well
23:42
Speaker 1: even before I mean, we have the idea to start
23:45
Speaker 1: the firm. Uh uh. My first call it was to
23:50
Speaker 1: Gene say, look, you know, it's been ten years since
23:53
Speaker 1: I was in school. We uh, there's been a lot
23:57
Speaker 1: of research, you know, we we needed we needed to
24:00
Speaker 1: have access to you know, new research and thinking. And
24:04
Speaker 1: would you be on the you know, one of the
24:06
Speaker 1: founders and and uh and and be our list you know,
24:10
Speaker 1: our our eyes in terms of research. And he agreed
24:13
Speaker 1: to do that right away. Who else did you recruit
24:16
Speaker 1: from GSP? Well, eventually we found out we had to
24:20
Speaker 1: have We wanted to create a mutual fund, and a
24:23
Speaker 1: mutual fund has to have an independent board of directors.
24:27
Speaker 1: So Rex and I went over the Business School, walked
24:30
Speaker 1: into Martin Miller's office. They still teach mollarble deiply on
24:33
Speaker 1: the theaters, don't take Yeah, okay, Uh. So Martin was there.
24:38
Speaker 1: We said to you know, he added a YadA small
24:40
Speaker 1: company fund need independent directors and um and said, oh sure.
24:44
Speaker 1: And I walked out the door and down the hall
24:47
Speaker 1: and Myron Schulz was coming out of his office. I
24:49
Speaker 1: gol Myron, he had the YadA. See Gene's point. Business
24:56
Speaker 1: school was a lot smaller then, and having been to
24:59
Speaker 1: the pH d program, I got to know the faculty
25:01
Speaker 1: pretty well. So Myron uh agreed to join, and so
25:06
Speaker 1: on and so forth. So in fact, until recently, all
25:09
Speaker 1: the independent directors of the mutual fund, our mutual fund
25:13
Speaker 1: be Uh have taught at Chicago, so his his business partner,
25:18
Speaker 1: Reck Singfield, was in my class as well. He was
25:21
Speaker 1: really the first one to put out an index one,
25:24
Speaker 1: wasn't he? No, No, it was but but Rex. Actually
25:31
Speaker 1: that was when I was his teaching consistent. He took
25:34
Speaker 1: uh jeans class. And Rex was always uh one of
25:38
Speaker 1: these pain in the neck as a teaching consistant students
25:41
Speaker 1: because he was interested in everything you know. I'm so Jean.
25:46
Speaker 1: You moved pretty easily back and forth between academic theory
25:51
Speaker 1: and real world application of theories. Not a lot of
25:57
Speaker 1: people were able to bridge that gap between academics. Well
26:00
Speaker 1: I hadn't. I hadn't been able to bridge it either
26:02
Speaker 1: until Dimentcino came along. But here it is. It's forty
26:06
Speaker 1: years later, and you seem to continue to be right
26:09
Speaker 1: because he Uh. The reason they couldn't just because one,
26:13
Speaker 1: it's hard to shut me up. I don't take a
26:14
Speaker 1: party line too too too easily. And he didn't. Ever,
26:20
Speaker 1: He and Rex never said would you please do this?
26:23
Speaker 1: What they said was, you do what you do and
26:25
Speaker 1: we'll figure out if we can use any of it.
26:28
Speaker 1: And that fits in with the way I work so
26:33
Speaker 1: frequently he would come in and say, look, get get
26:36
Speaker 1: ready to make a presentation for our clients. They go,
26:39
Speaker 1: you know, I don't know what your clients are gonna
26:40
Speaker 1: want to hear this. I go, look, Jane, you know,
26:42
Speaker 1: say what's on your mind. It's been controls my department,
26:45
Speaker 1: you know. And that seems to have worked out. So
26:49
Speaker 1: what was your involvement with the investment committee in the
26:52
Speaker 1: early days of dimensional um? Were you participating actively in it?
26:57
Speaker 1: Were you managing it? What were you doing? Well? I
27:01
Speaker 1: was doing this back and forth with the research stuff.
27:04
Speaker 1: But then they started a fixed income fund based on
27:09
Speaker 1: fixed income research they had done in the seventies, and
27:13
Speaker 1: they said, do you want to come in and trade
27:15
Speaker 1: it for a day? And I said, sure, I remember
27:17
Speaker 1: traded anything. So I went in. I know how much
27:21
Speaker 1: money did we? Here were ten million dollars from somebody
27:24
Speaker 1: and I managed to buy twenty million dollars of bonds
27:27
Speaker 1: and that was a big problem. Actually, so waitwa, Gene
27:32
Speaker 1: Fama day trader. I just want to make sure that
27:37
Speaker 1: that was the last day. But I couldn't see the problem,
27:46
Speaker 1: that's right. Um, So you introduce the Fama French paper
27:51
Speaker 1: on value dimensional funds, introduce as a US large value
27:57
Speaker 1: and you are small value. In ninety three on another
28:00
Speaker 1: farm of French paper leads to international value coming out
28:04
Speaker 1: in that paper won a Graham and Dot Award of Excellence.
28:09
Speaker 1: Was there anyone else trying to apply this sort of
28:12
Speaker 1: academic research to either investing theory or the creation of
28:17
Speaker 1: investable products on the market? There they're always kind of um.
28:23
Speaker 1: Departments of big banks and people were kind of playing
28:25
Speaker 1: around with it. But we were the only ones willing
28:28
Speaker 1: to stand up and say, um, this is what we
28:31
Speaker 1: believe and this is what we think you ought to do. Um.
28:35
Speaker 1: Now they're we have all the quant managers out there.
28:39
Speaker 1: We got tons of people uh uh out there, you know,
28:43
Speaker 1: trying to apply the same data. And back then we
28:45
Speaker 1: basically were at In fact, I often go around and
28:48
Speaker 1: show people thirty year track record on the various funds
28:51
Speaker 1: UM and I go, you know, we had a lot
28:55
Speaker 1: of competition back then, but they don't seem nobody seems
28:58
Speaker 1: to have a thirty year track record. They did not
29:02
Speaker 1: survive long enough to So let me fast forward, um
29:07
Speaker 1: a couple of decades to the mid two thousand's. In
29:10
Speaker 1: two thousand and eight, David Booth made the largest donation
29:14
Speaker 1: ever given to a business school, which has been called
29:17
Speaker 1: a transformational gift. Tell us about your thinking. What made
29:22
Speaker 1: you decide in the middle of the financial crisis to say,
29:27
Speaker 1: I know, I want to make a donation to my
29:29
Speaker 1: alma mater. Well, it was I'm kind of ties into
29:33
Speaker 1: the story I was talking about earlier. I mean, what, Uh,
29:36
Speaker 1: it got to be the stage where it was time
29:37
Speaker 1: to pay back, and um, I mean I wouldn't been
29:43
Speaker 1: anywhere without Chicago. So I said, I wanted to give
29:47
Speaker 1: a big chunk of what I have and uh, um,
29:52
Speaker 1: this was a mix of stocks and cash, Is that correct?
29:55
Speaker 1: And it was actually, Um, I didn't have a lot
29:59
Speaker 1: of cash at that time. It was because we just
30:04
Speaker 1: recently started to accumulate the money big enough to but
30:08
Speaker 1: I had stock in the firm, and so I gave
30:11
Speaker 1: him basically ownership of a big chunk of the of
30:15
Speaker 1: the stock that I had, and they were willing to
30:18
Speaker 1: take a bit on that. And it turned up to
30:21
Speaker 1: be a convet and that that comes with a dividend
30:24
Speaker 1: which continues to pay its way to uh to booth.
30:29
Speaker 1: Were you at all concerned that you were right in
30:32
Speaker 1: the middle of a financial crisis giving ownership of a
30:35
Speaker 1: financial firm. A lot of firms did not make it
30:39
Speaker 1: through the financial crisis. Yeah, maybe it ties in with
30:41
Speaker 1: the earlier question about what I learned from here about
30:44
Speaker 1: markets and how they work, and you have to kind
30:47
Speaker 1: of keep in the depth of the financial crisis. It
30:50
Speaker 1: kind of had to keep reminding people. You know, markets
30:53
Speaker 1: are where buyers and sellers come together and in a
30:55
Speaker 1: voluntary transaction, both sides of a trade have to feel
30:58
Speaker 1: like they have a good they got a deal, or
31:00
Speaker 1: they don't trade. They don't trade. So you know, there's
31:03
Speaker 1: a lot of trading volume activity and a lot of
31:05
Speaker 1: well known investors investing, and it's just you know, one
31:09
Speaker 1: of those UM. It was comfortable those markets were functioning
31:12
Speaker 1: the way they ought to function. Sometimes they go up,
31:15
Speaker 1: sometimes they go down. Gene, how did David's gift impact
31:19
Speaker 1: the Graduate School of Business? Huh, it was. It was
31:25
Speaker 1: a big lot of cash flow that was not there beforehand,
31:28
Speaker 1: so it gave rise to lots of research centers. I
31:34
Speaker 1: think you made everybody feel as if the future is
31:38
Speaker 1: more or less assured. UM and the university also got
31:42
Speaker 1: a pretty good take out of itself, as they always do,
31:48
Speaker 1: so David, you tell a charming story about sitting with
31:52
Speaker 1: the dean and you It wasn't your intention for this
31:55
Speaker 1: originally to be a naming gift. They seem to have
31:58
Speaker 1: brought that up to you. Can you you right know?
32:00
Speaker 1: I said I wanted for the reasons I outlined, I
32:03
Speaker 1: wanted to make a gift a big part of what
32:05
Speaker 1: I have, um, and so this is what I want
32:08
Speaker 1: to do. And the Dean, Ted Snyder at the time,
32:12
Speaker 1: said we were looking to have a naming gift from
32:15
Speaker 1: the business School. This is a lot better deal than
32:17
Speaker 1: that what we're looking for, So we'll name the school
32:20
Speaker 1: after you. Okay, whatever you know. So since then the
32:29
Speaker 1: school has continued to grow in in both reputation and
32:33
Speaker 1: number of students and the offerings here. Um. And then
32:37
Speaker 1: fast forward, uh, five years after that, Jane gets a
32:41
Speaker 1: phone call from Sweden. Let's talk a little bit about that.
32:45
Speaker 1: What was your experience like, Uh, did the phone call
32:49
Speaker 1: manage to reach you? Tell us? Tell us what that
32:51
Speaker 1: was like? Well, they think they call it early the
32:55
Speaker 1: morning Stockholm time, which is really really in the in here.
33:00
Speaker 1: It thinks about five or six o'clock. So I don't know.
33:03
Speaker 1: You never expect to get it, because a lot of
33:05
Speaker 1: people could qualify to to get it when you get it. Somehow,
33:09
Speaker 1: Pete they the people he somehow had I guess or whatever.
33:13
Speaker 1: I don't know why, because they were newspaper people at
33:16
Speaker 1: my door ten minutes later after after the call and
33:21
Speaker 1: they wanted to come in my house. I said, no way,
33:27
Speaker 1: you're class. Well, I had a class that morning, and
33:31
Speaker 1: you don't. You don't get a special dispensation when you could.
33:36
Speaker 1: But I had never missed the class in all the
33:37
Speaker 1: years I've been teaching in fifty years. Yeah, I wasn't
33:40
Speaker 1: gonna start now, so when I wasn't gonna let anybody
33:43
Speaker 1: in because the kids in the class were paying a
33:45
Speaker 1: lot of money to take that course, So no way
33:49
Speaker 1: I wanted people from the outside disturbing it. So, David,
33:52
Speaker 1: you ended up going to Stockholme with Jeane. What what
33:56
Speaker 1: was that experience like? Um, well, of course, being Chicago trained,
34:01
Speaker 1: I've been to the ceremony before with when when Myron
34:05
Speaker 1: and Bob Martin got there Nobel, So you know it's
34:08
Speaker 1: you're kind of used to this of you so third
34:12
Speaker 1: times of charm. Yeah, so the uh so, I I
34:17
Speaker 1: said to Jane, give me a night, uh to organize
34:21
Speaker 1: something special. So I talked to Abba has a museum
34:26
Speaker 1: in Stockholm that they just opened, and I talked them
34:29
Speaker 1: into running me out the museum for the evening. So Jeane,
34:34
Speaker 1: you know, he has four kids and that time about
34:35
Speaker 1: eight grandkids and they're all u big music fans and
34:40
Speaker 1: so the Abbe Museum has a lot of u um
34:44
Speaker 1: um things you can do to have fun and um.
34:47
Speaker 1: One of them is a big stage with a scrim
34:49
Speaker 1: on it and with four Abba musicians singing with a
34:53
Speaker 1: microphone right in the middle, and so you it looks
34:56
Speaker 1: like you're singing with them. And so I looked, so
34:58
Speaker 1: this went on. They were the kids, The kids went wild.
35:00
Speaker 1: I looked over Jeane like and Sally, and I could
35:03
Speaker 1: see that they were they were having fun. So it
35:06
Speaker 1: made it special for me. So the whole thing some
35:09
Speaker 1: people have described as surreal. What was your the day
35:14
Speaker 1: of the day after So they had a big event
35:16
Speaker 1: here of the school, really big event, I mean news
35:20
Speaker 1: and everything. The circles around the building, we're all full
35:25
Speaker 1: of students um. And the next day the Nobel people
35:30
Speaker 1: have a camera committee there following me across the Harper Center,
35:36
Speaker 1: the big hum in the middle, and students are working
35:39
Speaker 1: on on the sides, and we worked down the middle.
35:42
Speaker 1: Nobody looks up. So we get to the other side,
35:47
Speaker 1: and the television guy says, nobody looked up when I said,
35:50
Speaker 1: this is the University of Chicago. If they had to
35:52
Speaker 1: look up every time I nobil fries when I walked right,
35:54
Speaker 1: get nothing done. And and to show you how true
36:00
Speaker 1: that is, David Booth and Gene and I get an
36:04
Speaker 1: elevator on four to come down here, and a student
36:07
Speaker 1: gets in wearing headphones, turns around, doesn't say a word
36:11
Speaker 1: to either of you, and the four of us wrote
36:13
Speaker 1: down in silence. He was completely oblivious to who was
36:16
Speaker 1: in the elevator with him. So I'm always fascinated by
36:20
Speaker 1: that sort of stuff. So so let's let's talk a
36:24
Speaker 1: little bit about um some other things that you've written about,
36:28
Speaker 1: and the two of you have applied. One of the
36:31
Speaker 1: quotes of Professor Farmers that I enjoy is quote, why
36:35
Speaker 1: is anyone even reading Wall Street Research? Unquote? So I
36:39
Speaker 1: have to ask you, why do people read Wall Street Research?
36:43
Speaker 1: I don't know. It's it's businessman's pornography, basically business based pornography.
36:51
Speaker 1: It's not the real thing. It's not the real thing. Okay. Um,
37:02
Speaker 1: so let's talk a little bit about value. I'm gonna
37:05
Speaker 1: try and realist. Let's talk about value and growth. Value
37:11
Speaker 1: has a tendency to go through these longer periods where
37:14
Speaker 1: growth is beating it. And over the past decade it's
37:17
Speaker 1: been if you weren't in big cap us growth, um,
37:22
Speaker 1: you were underperforming. Everything has been um the SMP five hundred.
37:27
Speaker 1: When we look at emerging markets, we look at small cap,
37:29
Speaker 1: we look at value. Heaven forbid, you're an emerging market
37:32
Speaker 1: small cap value. It's been terrible. What sort of lessons
37:37
Speaker 1: should investors take from this extended period of growth growth
37:41
Speaker 1: beating value? Well, the question they want to ask is
37:45
Speaker 1: as value dead? Okay, let's Kennan. I actually were reading
37:51
Speaker 1: a paper on this at the moment. But the bottom
37:54
Speaker 1: line is there's so much volatility in these premiums that
37:57
Speaker 1: you can't tell if the premium is teamed or not.
38:01
Speaker 1: It may have changed, it may not. You just can't
38:03
Speaker 1: tell us. Let's see a wholl within the range of
38:05
Speaker 1: chance experience that the poor return experiences well within the
38:10
Speaker 1: range of chance over the time that's that it's occurred.
38:13
Speaker 1: So you really can't say anything. So so there have
38:18
Speaker 1: been other periods of time where value is done poorly.
38:21
Speaker 1: I remember hearing in this value investor was washed up,
38:26
Speaker 1: this guy named Warren Buffett. He doesn't know what he's doing.
38:29
Speaker 1: And typically when you hear that, it's usually at the ends,
38:33
Speaker 1: towards the end of that period of underperformance. Um, you're
38:37
Speaker 1: suggesting we won't know for some period of time if
38:40
Speaker 1: the value premium is gone or if it's just a
38:43
Speaker 1: regular cyclical underperformance. I don't think there are real cycles
38:47
Speaker 1: to it. I think it's just kind of random that
38:50
Speaker 1: go through good in bed periods, and you know, you
38:54
Speaker 1: can't recognize them except that from the fact you can't
38:57
Speaker 1: really predict them. Uh, we've we've tried tests, we've tried
39:01
Speaker 1: predictive tests, and they have marginal nothing worth even focusing
39:08
Speaker 1: focusing on. So basically is stuck with the volatility of
39:12
Speaker 1: equity returns. They don't allow to say very much about
39:16
Speaker 1: what's happened to expected returns going forward. And and David,
39:21
Speaker 1: what we've seen a huge proliferation of various factor funds,
39:25
Speaker 1: not just the three factor, of the five factor, of
39:27
Speaker 1: the seven factor model. They're now hundreds identified. What does
39:31
Speaker 1: this mean for investors? Has has the proliferation of all
39:36
Speaker 1: these new factors been good for investors or is it
39:38
Speaker 1: a non event? Well, I mean I think on balance
39:43
Speaker 1: um UM has been overstated and whatever whatever it is
39:47
Speaker 1: the you know, I think UM researchers identified, you know,
39:54
Speaker 1: factors that seem to explain differences in average returns. But
39:58
Speaker 1: there can't be hundreds of factor I mean, they got it,
40:00
Speaker 1: They're probably at the end of the day, they're probably
40:03
Speaker 1: a few factors. Uh and Gene and ken. One of
40:05
Speaker 1: the things they try to do is instead of trying
40:08
Speaker 1: to identify more and more factors, just take the researchers
40:10
Speaker 1: out there and can shrink it down to simpler, you know,
40:14
Speaker 1: more factors that matter, factors that matter, well, lots of
40:17
Speaker 1: lots of these things that just different manifestations of the
40:20
Speaker 1: same thing. Give us an example. So value can be
40:22
Speaker 1: very measured in many different ways. I can use the
40:25
Speaker 1: book to market ratio you need to catch full at
40:28
Speaker 1: the price. They can use lots of different variables, so
40:30
Speaker 1: I identify what is basically this same thing. Uh. And
40:36
Speaker 1: there are thousands of finance professors out there who all
40:40
Speaker 1: want to get ten here um they have the publish
40:43
Speaker 1: to do that. So they're all just kind of searching
40:46
Speaker 1: through the data finding stuff that maybe there only on
40:50
Speaker 1: a chance basis that won't be there out of sample.
40:54
Speaker 1: So there's lots of work being done and it remains
40:57
Speaker 1: to be done on what we call robust this. How
41:00
Speaker 1: does this stand up when I have new data? So
41:03
Speaker 1: we we've always been into robustness in the sense that
41:06
Speaker 1: when we found it in the ninety two paper, we
41:09
Speaker 1: went back and collected the data back to that data
41:12
Speaker 1: started in the sixty three We then went back and
41:15
Speaker 1: collected the data back to to look out a sample,
41:19
Speaker 1: and then we looked at the international leader to look
41:21
Speaker 1: at a sample, and so pretty much the same thing everywhere. Um,
41:27
Speaker 1: now we've had a bad period of this, but relative
41:30
Speaker 1: to all of that, it doesn't look that doesn't look
41:32
Speaker 1: that serious. And I have to ask you a question
41:36
Speaker 1: about behavioral economics. Um, we're here in Chicago, where we
41:42
Speaker 1: could short of call at the birthplace of behavioral finance.
41:46
Speaker 1: What do you think about that area and what's your
41:48
Speaker 1: involvement with it. Well, my good friend Richard Taylor, who
41:55
Speaker 1: is the king of the behavioral finance people and another
41:58
Speaker 1: Nobel law that no one I teach them and say
42:01
Speaker 1: I'm the most important person in behavioral finance. Are because
42:07
Speaker 1: most of the behavioral finance is just the criticism of
42:10
Speaker 1: official markets. So without me, what have they got? And
42:17
Speaker 1: and you and and Dick Taylor are golf parts are
42:21
Speaker 1: so do you argue across eighteen holes or you know?
42:24
Speaker 1: The reality is we agree on the facts, we disagree
42:27
Speaker 1: on the interpretation um For example, he thinks the value
42:34
Speaker 1: premium is the result of people's misperceptions of what accounting
42:41
Speaker 1: information and other information looks like. That it's all based
42:45
Speaker 1: on misinterpretation of information. Now, if you believe that, then
42:49
Speaker 1: you think it should go away, because it's possible to
42:53
Speaker 1: teach people that they have these these biases are professional
42:56
Speaker 1: managers should be able to get past them, but they
43:00
Speaker 1: still have emotional reactions that sometimes they can't get that.
43:05
Speaker 1: That's the thing about behavior lea going elements. What their
43:08
Speaker 1: studies seem to show is people don't learn from experience.
43:12
Speaker 1: If you're stupidly, repeatedly stupid, you don't learn. And most
43:16
Speaker 1: people are stupid. I mean, that's that's the provisation. Someone
43:19
Speaker 1: has to be on the wrong side of that trade.
43:21
Speaker 1: You said it's a zero sum, right, So so you
43:24
Speaker 1: guys agree more than you than you might realize the fact,
43:28
Speaker 1: but not the interpretation. But there is no behavioral finance.
43:33
Speaker 1: Wait say that again. There is no behavioral finance. There's
43:36
Speaker 1: no it's all just a criticism of official markets really
43:40
Speaker 1: with no evidence. Is dick here? I think he would
43:49
Speaker 1: disagree with that. So that's not so sure because when
43:52
Speaker 1: when I put the challenge to him twenty years ago,
43:54
Speaker 1: I wrote a paper that said, Okay, now you've been
43:57
Speaker 1: criticizing us for the last whatever, it's time for you
44:00
Speaker 1: to come up with a theory that we can actually
44:02
Speaker 1: test and see if it works or not. And what
44:04
Speaker 1: was response? We're still waiting. Actually you presented that paper
44:09
Speaker 1: at a at U c L A at Gene walks
44:12
Speaker 1: in and says, all the way over, I was thinking
44:15
Speaker 1: about breaking my leg or something. So I can catch
44:17
Speaker 1: some sympathy here. And to be fair, when Taylor won
44:22
Speaker 1: the Nobel Prize, he admitted his plan was to spend
44:26
Speaker 1: the money as irrationally as possible. So even he even
44:30
Speaker 1: he agrees with you on that. UM, I wanted to
44:34
Speaker 1: ask about, uh, some of your comments on Beta. You
44:40
Speaker 1: said beta is dead. Do you still believe beta is dead. Well,
44:45
Speaker 1: the evidence basically says that the relation between averaging tune
44:49
Speaker 1: and beta it's too flat to be explained by the
44:53
Speaker 1: capitalistic pricing model. That's a real shame because that model
44:56
Speaker 1: is so simple. Um, if it were true, it would
45:00
Speaker 1: really be like life, a lot simpler in many ways.
45:06
Speaker 1: But it just has never worked very well. All right,
45:09
Speaker 1: So what we're gonna do now? I have more, many
45:12
Speaker 1: more questions. But this thing is lighting up, and we
45:15
Speaker 1: have questions from the audience. So I'm gonna I'm gonna
45:18
Speaker 1: ask a few from this and see, uh see where
45:20
Speaker 1: we go from here. Um, let's talk about your views
45:23
Speaker 1: on the future of active management. Where do you see
45:26
Speaker 1: the industry going in ten years? And this is for
45:28
Speaker 1: both of you, active management active management, Well, it's been
45:31
Speaker 1: shrinking really slowly. So when Kenn did his American Finance
45:37
Speaker 1: Association Presidents did his president speech, what he's what he
45:43
Speaker 1: said was one of the things he said was we've
45:45
Speaker 1: gone from zero to and I think it was about
45:48
Speaker 1: forty years at that time, maybe a little more, and
45:51
Speaker 1: since then we've gone to like I think it's up
45:53
Speaker 1: to thirty or forty. Now that's passively man. So that's
45:56
Speaker 1: permeated very slowly through the profess Yeah, what where it
46:02
Speaker 1: will go from me? Or we'll see and and some
46:05
Speaker 1: people have made the argument you have to separate active
46:08
Speaker 1: from expensive locost active is attractive. Obviously this is a
46:13
Speaker 1: key tenant at dimensional funds. How much of the move
46:17
Speaker 1: away from active has really been away from expensive I
46:22
Speaker 1: think a big part of it. And in fact that
46:25
Speaker 1: a lot of the move to indexing is through e
46:27
Speaker 1: t f s and a lot of the a lot
46:29
Speaker 1: of that is just a new version of active management.
46:32
Speaker 1: Um or managers say, look, I don't think I can
46:35
Speaker 1: pick individual stocks, but I can tell them sectors of
46:38
Speaker 1: the market, So let me buy buy E t f s.
46:41
Speaker 1: So it's really kind of confusing as to uh, you
46:44
Speaker 1: know what the trend has been in active management. But
46:47
Speaker 1: I I think active managers are resourceful and always compe
46:52
Speaker 1: with new ideas of trying to entice people with magic
46:57
Speaker 1: with magic. So the pushback against um efficient market we
47:02
Speaker 1: always see this argument. Berkshire Hathaway had strong returns in
47:06
Speaker 1: its early years as the result of Warren Buffett's skill
47:10
Speaker 1: and security selection. How given Professor Farmer's comments and market efficiency,
47:15
Speaker 1: how can this early success be explained. So you take
47:19
Speaker 1: you have probably a hundred thousand people picking stocks right
47:23
Speaker 1: right over a period of time, then you pick out
47:25
Speaker 1: the one who does the best and impute that to skill.
47:31
Speaker 1: The problem is, if I have a hundred thousand people picking,
47:34
Speaker 1: what's the probability that one of them will look extraordinary?
47:38
Speaker 1: Purely on a chance basis, You'll you'll always have some
47:41
Speaker 1: outliers that look, you'll get a big old layer in
47:43
Speaker 1: that in that experiment. But that's the way that the
47:46
Speaker 1: newspaper accounts run. They take after, they look after the fact,
47:49
Speaker 1: and they pick out the winners. So every year, for example,
47:52
Speaker 1: they pick out the best performers of the last five
47:55
Speaker 1: ten years, and you look at the following period. No, no,
47:58
Speaker 1: no correlation between past the tay and and in fact
48:01
Speaker 1: we've seen the morning store manager of the year tends
48:04
Speaker 1: to significantly out before underperform in the decade once they
48:08
Speaker 1: win manager of the decade. But that would surprise me too,
48:12
Speaker 1: I would think they'd just be random. No, no persistency,
48:15
Speaker 1: In fact, negative persistency. We've had the sas in that subductative.
48:20
Speaker 1: How much persistence is there in performance? The answer is
48:22
Speaker 1: basically zero. Zero, and I have to the best predictor
48:27
Speaker 1: of future performance is FeAs and expenses that you know,
48:30
Speaker 1: it's ironic that came out of morning Star, that did
48:34
Speaker 1: a big study and they sell their morning Star rating
48:37
Speaker 1: and it turned out ignore everything else, just picked the
48:40
Speaker 1: cheapest fun pretty pretty astonishing, right, Well, they come up.
48:44
Speaker 1: I think they came out and said came out and
48:45
Speaker 1: said there's no relation between between future performance and the
48:49
Speaker 1: way we ran things. There's another question if it comes
48:52
Speaker 1: out to that, so so um. One one of the
48:57
Speaker 1: questions that is asked by the room. If the mark
49:00
Speaker 1: it becomes truly efficient one day, what happens to all
49:03
Speaker 1: the management farms? That question assumes that markets aren't truly
49:07
Speaker 1: efficient today. How do you respond to that? What's the evidence? No,
49:14
Speaker 1: I mean I don't think it's I think all of
49:16
Speaker 1: it is wrong. So it's different. There will still be
49:19
Speaker 1: a management business, you just will have very little active
49:22
Speaker 1: in it, so that you have to have some active
49:25
Speaker 1: investors to make price prices efficient. The problem is you
49:29
Speaker 1: don't expect them to be professional managers because the logic
49:33
Speaker 1: of being a good investor is that you should get
49:36
Speaker 1: their returns if you don't hand them back to other people,
49:39
Speaker 1: you take them back and higher fees. You know, that's
49:42
Speaker 1: the human capital activity is picking stocks or whatever investment management.
49:47
Speaker 1: So if you have real skill, you should be charging,
49:49
Speaker 1: you should go all the retention should go to you,
49:51
Speaker 1: Naz your clients. And and this is for both of you.
49:54
Speaker 1: What sort of opportunity for out performance do you see
49:57
Speaker 1: in private markets given that in for nation, in that
50:00
Speaker 1: space is so much more opaque than in public markets.
50:05
Speaker 1: The problem is there are lots of good people studying that,
50:08
Speaker 1: but they hamstrung by the lack of good data on
50:13
Speaker 1: people who live in people who die the fund. You know,
50:15
Speaker 1: the managers who live in what self reported. It's not
50:19
Speaker 1: like so you get you get it. You get a
50:22
Speaker 1: very kind of biased set of data on that. But
50:26
Speaker 1: you know, it's kind of depends on what into that
50:29
Speaker 1: business you go to. If you're looking at managers who
50:32
Speaker 1: actually run the companies that they buy, they may actually
50:35
Speaker 1: be able to add value, but it's management value. It's
50:37
Speaker 1: not stuck picking value. If they you're picking companies that
50:42
Speaker 1: have a good idea but a fully run probably you
50:45
Speaker 1: can have a lot of value added in that case.
50:47
Speaker 1: But again, if you go to the guy's doing it.
50:51
Speaker 1: That's the that's the downside of it. They're the ones
50:53
Speaker 1: who take all the profits out of it. Well, that's
50:56
Speaker 1: that's the logic of human capital, right right. And we
51:00
Speaker 1: didn't get to a question before I have to ask
51:03
Speaker 1: about bubbles. And this goes back to be okay, So
51:09
Speaker 1: I don't know how to bleep out the word bubbles.
51:11
Speaker 1: But what do you mean by okay? So folks like
51:16
Speaker 1: Failor and Chiller would describe a bubble as a period
51:21
Speaker 1: of excessive market enthusiasm that leads prices to far outstrip
51:26
Speaker 1: their fundamental valuation. What's the testable proposition here, though, I
51:30
Speaker 1: don't know, can you Well, the way I interpret it
51:33
Speaker 1: is you must be able to predict the end of it. Bubbles,
51:37
Speaker 1: it would be something with a predictable ending. So it
51:39
Speaker 1: has to be measurable by a predefined set of parameters,
51:43
Speaker 1: and you should be able to identify the end of it.
51:46
Speaker 1: So if we were to say every time that fails
51:49
Speaker 1: the test, I mean, I mean you can't. People can't
51:53
Speaker 1: identify bubbles that way until after the fact. After the fact,
51:58
Speaker 1: it's it's easy. But this is famous theory around about
52:02
Speaker 1: you know, the early origins of market efficiency, which home
52:05
Speaker 1: work working, went into the faculty lounge at Stanford. He
52:09
Speaker 1: was agriculturally uh prices, and he showed them chats of
52:15
Speaker 1: of of prices, and he said, these were chats of
52:17
Speaker 1: commodity prices, and he wanted to not see if they
52:20
Speaker 1: could identify bubbles and the prices, and every to a man,
52:23
Speaker 1: they all could. There were no women. To a man,
52:26
Speaker 1: they all could. The problem was what he was showing
52:29
Speaker 1: them was accumulative random numbers, as those just generated uh stuff.
52:34
Speaker 1: So that the message there's people see bubbles where there
52:37
Speaker 1: are now h. So here's a here's a really broad question.
52:43
Speaker 1: Given the societal angst of people attacking the value of
52:47
Speaker 1: a business education, what is your belief in the value
52:51
Speaker 1: of this education booth and how should we communicate this
52:56
Speaker 1: better to society? Well, I think it's it's incredibly valuable
53:01
Speaker 1: to society, um, because if we are going to make
53:06
Speaker 1: lives better for people, part of the answer has to
53:09
Speaker 1: come from better and safer financial products. And just that's
53:13
Speaker 1: the reality. And that's been the history. I mean, it's
53:16
Speaker 1: like I say, I look back on my career and
53:20
Speaker 1: uh working with Gene and you know, we've been part
53:23
Speaker 1: of the movement towards lower fees and better controls. So
53:27
Speaker 1: I can find it irritating when somebody says, really, the
53:30
Speaker 1: only advanced the last fifty years has been the A
53:33
Speaker 1: T M. You know. Uh it's uh qu yeah, live,
53:40
Speaker 1: we've live based all this work live, We've improved lives. Uh,
53:45
Speaker 1: and there and other people with sharing the I s
53:47
Speaker 1: we're not the only one. But I mean, I don't
53:50
Speaker 1: think it gets much better than that. And uh so
53:53
Speaker 1: I would hate to have people, um not to get
53:57
Speaker 1: into business or particularly financial services. You can have a
54:01
Speaker 1: good career in financial services and at the end of
54:05
Speaker 1: it you can look back on it and take pride
54:07
Speaker 1: in what you've accomplished. It's as simple as that. So
54:10
Speaker 1: so that leads to the next question. What keeps both
54:13
Speaker 1: of you working? Neither of you have to work, Why
54:16
Speaker 1: do both of you still get up and go to
54:18
Speaker 1: the office each day. It's fun, it's fun challenging, it's important.
54:24
Speaker 1: I mean, it's exciting to see the retired people living
54:28
Speaker 1: better as a result of these ideas, or better able
54:32
Speaker 1: to send their kids to colleagues or whatever. I mean,
54:34
Speaker 1: these are These are not you know, ideas that have
54:38
Speaker 1: no importance. I mean, these are you know that's you
54:42
Speaker 1: can get behind that kind of idea. You get a
54:44
Speaker 1: lot of satisfaction out of coming up with stuff people
54:47
Speaker 1: haven't seen before. I have been recognized, and we have
54:51
Speaker 1: time for one last question, and I'm going to go
54:54
Speaker 1: with something about, um, what do you think the future
54:58
Speaker 1: of Chicago Booth looks like? What is next in store
55:02
Speaker 1: for the school? And this is for both of you. Well,
55:05
Speaker 1: I can tell you that. So I've been on the
55:07
Speaker 1: faculty since nineteen sixty three, students since nineteen sixty. In
55:12
Speaker 1: the sixties, basically there was a pretty good economics group.
55:17
Speaker 1: There was a developing finance group, and that was it.
55:21
Speaker 1: I mean, there's the school's junk. Well, but look that
55:27
Speaker 1: was not unique to us. So I remember when I
55:29
Speaker 1: was recruiting as a student, UM in college not from here.
55:34
Speaker 1: The people recruiting said, why do you want to go
55:36
Speaker 1: to a business school? They don't teach you anything, we
55:38
Speaker 1: don't pay anything for what they what they do. And
55:42
Speaker 1: that was too at that time. I think, and what's
55:45
Speaker 1: happened through time is not just finance, but every other
55:48
Speaker 1: area has been academically made more become more successful. So marketing, accounting,
55:56
Speaker 1: statistics was always pretty good, but it was never part
55:58
Speaker 1: of of of business schools. So now we have really
56:04
Speaker 1: front rank faculty and every single discipline. The school is
56:08
Speaker 1: so high, high level, competitive on the faculty side, on
56:12
Speaker 1: the research side. But it's just there's no relation to
56:16
Speaker 1: what it was fifty years ago. It's a totally different
56:19
Speaker 1: professional place. On the students side, I think there was
56:23
Speaker 1: a challenge, and I've been complaining about it for a
56:26
Speaker 1: long time. Students don't work as hard as they did
56:29
Speaker 1: in the old days. I've heard this is a very
56:32
Speaker 1: very difficult school to work your way through. Well, but
56:36
Speaker 1: the reality is we keep track of hours work per
56:39
Speaker 1: per per class out of class. When I started teaching,
56:44
Speaker 1: everybody was around fifteen per class. That number has dropped
56:49
Speaker 1: dramatically through time. I bet this room would disagree with that. No, no, no, no,
56:53
Speaker 1: we have the statistics. It's not it's not it's not
56:56
Speaker 1: a guess. And and David, what do you see as
57:00
Speaker 1: the next decade holding for the Booth School? Well, I'm
57:04
Speaker 1: not really in a position there. I mean, wow, I
57:07
Speaker 1: just gave him some money. I figured they can figure
57:12
Speaker 1: that stuff out. If I had to figure that out
57:14
Speaker 1: as well, I mean that would be a real hero.
57:17
Speaker 1: You know, I I'm just um, I'm not. I don't
57:22
Speaker 1: know where it's gonna go, but wherever it goes is
57:25
Speaker 1: going to be important. And and that's the perfect spot
57:28
Speaker 1: to end. Ladies and gentlemen, please say thank you to
57:31
Speaker 1: Professor Gene Fama and David Booth. That's my conversation with
57:40
Speaker 1: David Booth and Gene Fama. If you enjoyed that, we'll
57:44
Speaker 1: go to Apple iTunes, look up an inch or down
57:46
Speaker 1: an inch, and you could see any of the nearly
57:49
Speaker 1: three d conversations we've had over the past five years.
57:54
Speaker 1: We love your comments, feedback and suggestions right to us
57:57
Speaker 1: at m IB podcast at bloom Berg dot net. Be
58:01
Speaker 1: sure and give us a review at Apple iTunes. Sign
58:04
Speaker 1: up from my daily reads at rit Halts dot com,
58:08
Speaker 1: follow me on Twitter at rit Halts. I would be
58:11
Speaker 1: remiss if I did not thank the crack staff that
58:13
Speaker 1: helps us put these conversations together this week and this
58:17
Speaker 1: week was an unusual expedition. We all had to slip
58:21
Speaker 1: out to Chicago. The folks at the University of Chicago
58:24
Speaker 1: were great. They did a really great job in setting
58:27
Speaker 1: things up so that we could both videotape and audio
58:30
Speaker 1: record this. Michael Boyle is my producer, and he was
58:33
Speaker 1: on hand there along with a few other folks from
58:36
Speaker 1: Bloomberg that really made everything go very smoothly. Charlie Volmer
58:39
Speaker 1: is my audio engineer who helped cut this monstrosity together.
58:44
Speaker 1: Atica val Broun is our project manager. Michael Batnick is
58:48
Speaker 1: my head of research. I'm Barry rit Halts. You've been
58:51
Speaker 1: listening to Masters in Business on Bloomberg Radio.