Q+A: The father of index investing on strategy, life, & Warren Buffett

David Booth helped create one of the world’s first index funds in the 1970s, before launching Dimensional Fund Advisors in the early 80s. Since then, Dimensional has become a global giant, with $US915 billion (around $1.4 trillion AUD) in assets under management - including on behalf of Australia’s two biggest super funds.

David Booth, Founder and Chairman of Dimensional Fund Advisers, speaks to Sean Aylmer from Austin, Texas, after the launch of Tune Out The Noise - a film telling David's incredible story.

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Episode Transcript

Speaker 1 (00:06):
Welcome to Fearing Greed Q and A where we ask
and answer questions about business, investing, economics, politics and more.
I'm Sean Aylmer today a very special guest. David Booth
helped create one of the world's first index funds in
the nineteen seventies before launching Dimensional Fund Advisors in the
early eighties. Since then, Dimensional has become a global giant

(00:26):
about one point four trillion dollars under management. That's oussie
dollars nine hundred and fifteen billion US dollars, including on
behalf of a couple of Australia's big super funds. Last week,
a film telling David's story launched here in Australia. Tune
Out the Noise is a documentary by Academy Award winning
director Errol Morris. It's available now on YouTube, already been

(00:46):
viewed more than twenty seven million times, not bad in
the first week or two. It's an incredible story about
David's remarkable career, but also about the rise of index investing,
which has now become central to so many investment strategies.
David Booth is he founder and chair of Dimensional Fund Advisor,
and he joins me this morning from Austin, Texas stated,
welcome to fear and greed.

Speaker 2 (01:06):
Thanks for having me.

Speaker 1 (01:07):
What were those early days like in index investing? Like,
how did you come up with the idea?

Speaker 2 (01:13):
Well, I mean it traces back to the first major
review of the performance of professionally managed portfolios by Michael
Jensen in the mid sixties. And they've been doing these
studies now for you know, sixty years, and they always
show the same thing that professional money managers trying now

(01:35):
guess the market. They're not worth the cost, they don't
add any value. In fact, after Fezer considered, they subtract value.
And that was quite a shock. You know, before nineteen
sixty people, academic researchers, they didn't have the data, They
couldn't analyze the performance of professional money managers and all

(01:57):
the claims that the sales witches they were used. So
for the first time they could really examine real, live
data and the results were well disappointing, I guess you
would say. Yes. So people said, well, guys, should you
if I can't my I can't beat the market, what
am I supposed to do? They said, well, you know,

(02:19):
you can buy the market. And that was one way
of buying the market is an index fun which was
it was slow going at first, but eventually it really
took off. And that's really you know, kind of the
underpinnings of the two largest money managers and the world,
Vanguard and black Rock black Rock.

Speaker 1 (02:39):
Yeah, what I find interesting. I mean, some of that
early work showed that over the long term returns and
the s P five hundred was not that far off
ten percent, right, which must have astounded people, and a
couple of questions he has that continued through to today
and people are passively in active passive bok about there

(03:02):
and just explain how that works.

Speaker 2 (03:04):
Okay, Well, yeah, in fact, the results have even been
better the last fifty years, which is if you've ever
studied economic history, the idea of some research finding in
one data set ever repeating itself in the next data
set is very rare, and so it's really you know,
I think it's been more like eleven percent since the

(03:26):
first index was created. So that of course explains a
lot of the excitement about indexing. If you get a say,
a ten percent return, your money doubles about every seven years,
and if you let's say, have a forty two year
horizon that's six seven year periods, so you know a

(03:49):
dollar would grow to sixty four dollars. So if you're
truly a long term horizon, you know, the magic of
compounding is the real deal. I mean, it is the
way to provide for retirement or whatever.

Speaker 1 (04:02):
But it's all passive investing the sign No it's not.

Speaker 2 (04:06):
I mean, it's a strict index fund has basically a
lot of decision making taken away from from the manager.
You know, it relies on somebody else to create an
index and standard and pors. For example, it's a committee
and they sit around inside which stocks they want to
pick for the index and so forth. So it's a

(04:28):
form of stock picking. There's not much turnover fortunately. But
the big problem is when a new stock comes into
an index, an index fund manager, if it wants to
track perfectly, has to buy that stock that day. At
the same time, everybody else that's managing an SMP index

(04:50):
fund wants to buy the same stock. So when we
were found, we go, hey, we know where we don't
think that's particularly clever. Maybe if we developed some skills
and trading and paying attention to what you might think
of as market mechanisms. There are ways of adding a
little bit of value here and there, And that's what

(05:11):
we did, and over time, these small increments out up
when you take the magic of compounding over decades.

Speaker 1 (05:21):
One of the things I found interesting was the sixties
and seventies where a lot of your work began. David.
It was a time of computing. It was kind of
the computer revolution for one of a better phrase, and
you and I'll come to the film in a moment,
the individuals in the film. But I wonder now with AI,
whether the same rules are going to apply. Is there

(05:42):
a paradigm shift around about now at some point around
about now, just like there was in the sixties and seventies.
Do you think or not?

Speaker 2 (05:50):
Well, it's similar in a way. Let let me just review. Basically,
what the evidence showed is that the market does a
pretty good job of setting prices. In fact, it does
such a good job that professional money managers trying to
outguess the market end up doing worse after fees are considered.
So the market, you know, can e or take a

(06:10):
bit the best assumptions reflects all available information. That's the
efficient market hypothesis of Gene Farmer, and that which won
him his Nobel Prize in twenty thirteen. So with AI,
which presumably even has access to more databases, the market,
in my view, will become even even more difficult to beat.

(06:34):
The prices will even be better and better all the
time using more and more information.

Speaker 1 (06:41):
Far bait for me to question anything you've done, David.
But the part of the efficient market hypothesis which I
sometimes struggle with myself is non financial risk. So I
get that efficient markets price everything more or less correctly
in the long term, but sometimes I do struggle with
no financial risk, of which there's been a lot in Australia,

(07:02):
a lot of governmance issues over recent times, which can
totally hurt your holding in a stock.

Speaker 2 (07:08):
Well. I mean, you know, the government's government actions can
cause distortions in the market. Yeah, Unfortunately, those distortions sort
of predict when they're going to occur to extent they're predictable.
You know, you would think that the prey would be
big tender the prices fairly quickly. But I think that

(07:29):
the problem is that, you know, government, the effects of
government actions are kind of unpredictable. But that just makes
stock prices more unpredictable, which so that's that's a that's
a when for my sign reason.

Speaker 1 (07:42):
Yeah yeah, yeah, yeah. Look, the film is fantastic, as
I mentioned, and don't take this the wrong way, but
what I found remarkable is the four or five main
characters in it, including yourself, are really ordinary people. I mean,
you're a shoe salesman, who you know, since the masters
of the Finance universe are all very ordinary, and that's

(08:03):
almost reassuring.

Speaker 2 (08:05):
Well, no, I think you're right. In fact, one of
the things I'm really happy about is that for years
I've tried to describe how exciting it was to be
at the University of Chicago and in the late sixties
and early seventies and all these people that none of
them have gotten Nobel Prizes at the time, and subsequently,

(08:28):
you know, the University of Chicago's going to dominate it
Nobel Prize in economics. So these ideas were so exciting
you knew it just had to be true. And now
we have, let's say, fifty years later, fifty five, we've
had all this experience. So these ideas have lasted because

(08:49):
they've worked. I mean, it's here again in the field
of economics that happened so rarely that you identify something
as likely to be true and then it turns out
to show up in the next data set. Remarkable.

Speaker 1 (09:05):
Yeah, what are you most proud of? And for those
listeners who don't know, Dive's name adorns the University of
Chicago Business School, I'm guessing that's not your proudest moment.
But what's your legacy? What is it that you think
that you've done. That's the difference.

Speaker 2 (09:21):
Well, actually it's not just me by myself, but what
I'm really proud of has been part of that movement
over time to give better or much better investment experience,
a democratization of investing. You know, fees have come way
down from where they were when I got in the

(09:42):
business in nineteen seventy one, and portfolios are much better diversified,
so people there's no reason for people to pay outrageous
fees for subpar performance. And that's so I'm proud to
be part of that of that movement.

Speaker 1 (10:00):
I was going to wind up, but I can't not
actually just mention Morrean Buffett, and he could be talking
a lot about him at the moment. He's about to
retire from Berkshire Hathaway. Is he an exception to the
rule because he's a top picker. He has made it
living out of picking equities. But that's against what you're saying.

Speaker 2 (10:17):
Well, and it could be he could be the exception,
you know. You see the problem is if you have
all the thousands of money managers that are out there,
you know, just by sheer luck, a few of them
are going to have exceptional one returns. It turns out
the number that have exceptional returns are fewer than you
would expect by chance. So we can't tell you that

(10:40):
somebody had great performance. You know, we can't say it
wasn't skill. I can't say it wasn't luck either, So
that's a difficulty. I'm happy to give Warren his due
and say, Okay, maybe he may have been the exception,
and there may be others, you know, efficient market hypothesis.
It's just you didn't think of it as being a model,

(11:03):
and like all models, it doesn't explain everything. But I
do think for the average person, if there's no evidence
the pros can beat the market, why do you think
you can beat the market?

Speaker 1 (11:16):
Yeah, totally agree, David. Thank you very much for talking
to Fear and Greed Q and a well good I
enjoy it. That was David Booth, founder and Chairman of
Dimensional Fund Advisor, and the film is called Tune Out
the Noise. Tune Out the Noise. It is well worth
a watch you and get it on YouTube. I'm Seanoma
and this is Fearing Greed Q and a