Rex Singuefield

Interview with Rex Sinquefield (transcript)

Rex Singuefield

Rex Sinquefield is Chairman and Chief Investment Officer of Dimensional Fund Advisors. Rex received his B.S. from St. Louis University and his MBA from the University of Chicago. He has contributed numerous articles for books, academics and professional journals. Best known among those are the studies of Rates of Return: Stocks, Bonds, Bills and Inflation , which he co-authored with Roger Ibbotson. He has received two Gramm and Dodd awards for best articles in the financial analyst journals. He was one of the first to successfully apply the academic findings of modern finance to money management. In the early 1970`s, he and his colleagues at American National Bank of Chicago pioneered one of the nation`s first index funds.  "Well, you know, that`s always a running debate between the folks at American and the folks who are at Wells Fargo. What we know for sure is that they both started in 1973, and by the end of `73, they both had about $25 million dollars in assets. So, both will continue, for the remaining history of the world will continue to say that they were the first, but I don`t think anyone really cares."

Rex is director of the German St. Vincent Orphan Home in St. Louis, Missouri. He is also a former trustee of DePaul University and a member of DePaul`s investment committee. Sinquefield`s childhood ambition was to become a priest, yet he left the seminary to study finance. One must wonder, what led to this complete turnaround?  "Well, they`re really separate decisions. First, I decided to leave the seminary and I`m sure that the Catholic Church is much better off as a result and then I went to St. Louis University and went into their business school for two years.  I maintained a major in philosophy, but I really didn`t get entirely turned on to the field of finance and financial economics until I went to the University of Chicago three years later."

The University of Chicago is well known for turning out brilliant economists.  What happens there to ensure such a reputation?  "There I really discovered what was going on in the field of modern financial theory and financial economics as it existed back in the early 70`s, and what attracted me was the well-ordered view of the market place, it reminded me very much of studying philosophy. The logic was very tight; it was very neatly ordered, and the empirical evidence supporting the theories and the models as they were being developed was overwhelming.  It was also clear to me that virtually none of this was being applied in the real world.  And, I decided, I think in probably the first or second class I attended, that I would take every finance course I could and look for an opportunity to apply that when I got out of school.  As fortune had it, things sort of went my way after that."  Is there anyone at the University, or elsewhere, that helped Sinquefield develop as an economist?  "I wouldn`t say I necessarily had a single mentor. You always look up to your teachers in various places, so early on I was most impressed and inspired by Eugene Fama and Merton Miller. When I went to American National Bank of Chicago, I was quite impressed by some of the bosses that I had then.  Here was an organization that no one had ever heard of outside of a few blocks of downtown Chicago and yet they gave myself and a few other people the opportunity to develop what arguably is the first S&P 500 index funds and went on to innovate a whole lot of index funds and that put that bank on the map nationally, at least in the investment business."

It is amusing to imagine how a newly minted MBA persuaded his superiors at American National Bank to support what seemed to be a radical idea.  "You, know I`ve thought about that, and, for a while, I thought it was my impressive powers of communication and persuasion. But as I look back on it, I think also that I had some very wise bosses and superiors. The manager of the bank was actually very wise. They knew that they needed something in the investment business, what they had wasn`t particularly effective and they used some of the academics at the University of Chicago, particularly Jim Lorie, the Professor of Finance there; it was Lorie who persuaded them to bring in a couple of MBAs, let them run around the place, sort of listen to what they do and apply their ideas, if they all made sense.  And so he was a bit of help early on in continuing to persuade some of the senior management, that yeah, you really ought to embark on this path. You ought to go down this road, and it surprisingly did not take long. From February of 1973, when I first proposed this fund, to May, June and July, when I showed that say 100 or so securities could emulate the S&P, to September, we were up and running. So that`s a very short period, seven months` time from suggestion to implementation.   That`s remarkably fast for an institution that large for an idea that was clearly very radical at the time." 

Index funds changed the world of investing, at least for those who saw its value.  One has to wonder if the investment community felt threatened, if it embraced this radical path?  Sinquefield remembers the overall reaction of the investment community, and what the community was doing as a whole at the time.  "Generally the reaction, well, first of all, everyone took notice. This got a lot of attention in the local press; it got attention in the national press. There were a few pockets of support, of course: the institutional organizations, the big pension funds, were behind us to some extent.  In each of these large organizations, like AT&T New York Telephone, they had their people who saw this as an eminently sensible way to invest.  In the popular press, it was met much more with, at the very best, curiosity, but probably more accurately, hostility. And people who were advancing these ideas were labeled as commies, un-American to pursue any investment strategy which strove from mediocrity and as I always reminded them, mediocrity was a lot better than what we`d been achieving to date. I also learned to, you know, soften my rhetoric a bit."

Since that time, there has been an ongoing debate regarding the efficiency of the markets.  Upon request, Sinquefield is happy to share an overview of what that particular debate is all about and how he was at the forefront of it.  "At least one part of the debate began in the academic world at places like University of Chicago and other academic institutions, and essentially the debate is about whether or not markets work. The academic evidence is important and persuasive for academics. A lot of it is not particularly useful in talking about investment products, and so much of the challenge that the early purveyors of passive investing faced was the need to communicate ideas that are couched in obscure esoteric academic journals in plain English. And we learned to do that in the early 1970`s. The debate amazingly continues to this day, although I think that the advocates of the idea that markets don`t work, at least in a practical sense, they`re hanging on by their fingernails and we`re going to all stand by and watch them drop into the nether region one by one."

Markets do work!  This message lead to another, which became important for Sinquefield to deliver, and it was one that was not easy to get out.  "Initially, unfortunately, it was not a very big step from classroom rhetoric and classroom logic and what we learned early on is debating on those terms doesn`t work. If you`re talking to a board of directors or an investment committee, they`re not ready and not prepared to discuss things in those academic terms. So we had to simplify ideas, and fortunately, there was the development of data about the performance of investment managers that came from other organizations, like AG Becker. And so, the evidence, while not rigorous in the scientific sense, nonetheless, was accurate. The message was supported fairly and accurately and made it easier for us to convey the idea that, in general, managers can`t beat markets.  The treasurers of corporations were beginning to see that with their own pension funds and as firms like AG Becker started producing more performance reports, the investment community at large had to slowly, maybe not willingly, but slowly acknowledge that in fact most managers under-perform the market. And that was the nature of the debate as it took place in the early and mid 1970`s."  As it turns out, markets work, managers don`t.

Sinquefield had to be very patient with the message; there was no national forum for him to get it out.  National attention was necessary, but not possible immediately.  "For the most part, it was one meeting at a time, calling on corporations, but in the early to mid 1970s, there were a lot of debates or discussions that were held by the trade press and industry-sponsored forums, so there was a lot of debating that took place. I participated in a good number of sort of `active versus passive` debates, and index fund type debates and discussions. There was considerable attention paid by the trade press, particularly pensions and investments and institutional investors focused on this topic heavily and constantly, hard to imagine now, but it was a raging debate in the institutional investment field. It was a very exciting time, but you`re right. You did have to be patient.  From the time we set up our funds in September of 1973, American National of Chicago, until July of `75, we got virtually no new clients. That was a period of 20 months and the same thing was true for Wells Fargo in San Francisco. We both in July of `75 had maybe 70 or 80 million dollars under management; this is after almost two years of marketing.  And then the floodgates were opened when New York Telephone gave 40 million dollars to American National and that seem to be the stamp of approval that all the large institutional investors were looking for. They were the largest subsidiary in the Bell system at the time, and that action sort of opened the floodgates for everyone else and within 15 months, American National and Wells Fargo had both increased our assets by over a billion dollars each! This is in 1975 dollars, that`s real money, back then."

Investors today truly believe that active managers add value.  The evidence against the reliability of this belief is compelling: Every study of mutual funds indicates that in past performance, some active managers consistently fail to beat the market.  "Well, it`s certainly a case of hope springs eternal.  It`s much more exciting to talk about active managers and who`s holding the hot hands today. That is sort of the sizzle of the press, you know. If there weren`t those kinds of articles then magazines like Money and Forbes and television shows like Wall Street Week, wouldn`t be able to exist. They feed on that kind of stuff and in a certain sense that appeals to common sense, certainly in the case of sports and baseball, the way-above average athlete is going to get way-above average results. The same thing might be true in certain intellectual fields, but it`s not true in the market. A person that`s more brilliant than everyone else will not be able reliably to earn higher returns than everyone else, because the market process squeezes out any pricing imperfections or at least tends to do that, such that there are no high expected return securities just sitting on the table waiting for the smart person to come and take them. So in that kind of market it`s impossible to consistently to pick winners, just like it`s impossible to consistently to pick losers. So, a market that works protects everybody. Protects the little guy just as much as it prevents the genius from getting above average returns. But why it (faith in active managers) persists, I really don`t know. I think once someone really gets the message, one, they have the answer about how to get good and decent performance and two, it should free up their Friday and Saturday nights from burning the midnight oil looking for undervalued stocks. They can go out and engage in socially enjoyable activities."

Sinquefield might be saying too that the genius of these stock pickers is already factored into the market.  He adds, however, "Nobody knows precisely what causes markets to price securities and assets the way it does. Their opinions are factored in, but so are the opinions of six billion other people, and so the market is the only thing that possesses the implications of all the information and insight and preferences and actions of all six billion people in the world. So you can think of the system of market pricers as a vast processing machine that takes all of this information and brings it together. It`s the only place where it`s brought to bear, so you can have one individual who can be very, very smart and actually know a little bit more than everyone else. But does he know more than six billion people combined? No. He knows a tiny, tiny fraction of what is knowable and what is built into prices. That`s sort of the intuition why no one`s ever going to get an edge over the market." 

Sinquefield has heard that active managers do better in down markets, but he dismisses the claim as empty.   "I don`t see any reason why they should do better. The argument that`s made is they hold more cash, therefore, they do better in down markets, but I`ve never seen that documented or verified anywhere."  If this is so, why do the names of market superstars stand out from the rest?  How can there even be market superstars like Peter Lynch at Fidelity Magellan? 

"Well, when you know who the big star is, if you look back over a 10 or 20-year period, you`ll always be able to ask that question. Every 10 years, or every year, you can look back and see who was the winner over the last 10 years. Now how do you explain his performance?  You have this huge distribution of managers. There are thousands of money manager firms now worldwide. At the end of any period, just by chance, some of them are going to have very good returns and some are going to have very bad returns. You never get to interview those who have very bad returns, because they leave the game. The managers that have very good returns, they go on talk shows and write books about how to pick stocks. And so it`s a case of expose selection bias. We know about Peter Lynch after the facts, so we`ve asked, how do you explain his performance?  Of course you could never go back and explain an individual performance. It`s kind of like anecdotal evidence. And it would be difficult scientifically to go back and explain how this particular portfolio did what it did. You would never be able to tell if that was due to skill or luck.  When you look at the population as a whole, you can then answer that question, that everything seems to perform as if most of the superior performance and the bad performance is due to good and bad luck, respectively, which is what you would expect in a system that works and a market that`s efficient."  Survivorship bias can also play a part in making a portfolio seem more impressive than it actually is.

Sinquefield defines survivorship bias as "when you have someone collecting your performance on, let`s say mutual funds, and now we have a mutual fund that`s just had horrible returns. The investors start to leave and the fund has to liquidate and shut down. Now we look at the database of mutual fund managers, say five years later, and we`re examining the performance, but the performance of that fund that died that did so terribly is not in that database. So, the only ones we get to look at are the survivors. Those who were good enough, regardless of how bad they might have been or how good they might have been, they were good enough to make it to the end of the period. But all of those that died before the end of the period are omitted and for the most part, the returns of those funds are atrocious.  The difference in performance between those two groups is about 100 basis points per year, about one percent a year. So that`s a huge difference, that`s the effect of survivorship bias."  Long story short, it changes averages.

Another popular claim that Sinquefield dismisses for lack of evidence is that active managers have an opportunity to do better in foreign markets or even with small company stocks.  "I don`t think their chances are any better in those markets than they are in the United States.  I`d never seen any evidence in support of it, and in fact I am aware of evidence that directly contradicts these claims."

Rex Sinquefield is known throughout the academic community and the investment industry as the co-author of [the book] Stocks, Bonds, Bills and Inflation , or SBBI.  "SBBI was a work that Roger Ibbotson and I started in 1972 or so, basically it`s just a study of the rates of return on the major asset classes in the United States. Back in its day in early mid-70`s, in fact even up until the early 80`s, it was one of the few sources of reliable rates of return of the major asset classes in the United States. But in the last 10 to 15 years or so, there has become available so many different time series.  It is hard for anyone who, say has been in the business only 10 years to imagine that there was a time when the rate of return availability was a desert, where nothing existed at all. And so it (SBBI) was the first long-run study of asset classes across the U.S. Stocks, bonds, government bonds, corporate bonds and treasury bills, and inflation."

This book also helped to get the message out, but that was not its original purpose.  "Actually the way it started was Roger Ibbotson was a consultant for the University of Chicago`s Treasurers office and I was working at American National Bank trying to write a little paper or monograph, supporting the idea of investing in an index fund, and we both independently realized that we needed data to do the work that we were doing for our respective organizations. And Roger and I just kept in contact from our days on campus and Roger was still working on his Ph.D. at the time. So we got to talking about the work that we were doing and we said why don`t we pool our efforts.  Roger would do the stuff on the bonds and I would do the stuff on the S&P 500 and on inflation and then we would have a memorandum that each of us would use in our respective organizations.  That`s all we intended to do.  However, Jim Lorie entered the scene, he got wind of what was going on and told us that we would be speaking at the next Crisp conference. And so that created the challenge for us to come up with something that was much more worthy academically and scientifically. So we re-doubled our efforts and produced the historical return series and following that, based on an idea, a little hint from Fisher Black, came up with a way to provide a service simulation methodology for creating the future return distributions for all of these assets classes. And that`s how it all started, just a simple desire to write a memo that each of us would use in each of our own organizations.  There`s no question that the publicity that was generated back in the early and mid 70`s was helpful to American National Bank, and was helpful to me and Roger too."

The case for index funds grows stronger each year, with each study.  How the world would change if everyone chose to invest exclusively in index funds!  Sinquefield knows this is improbable.  "Oh, that`s like asking me:  What would happen if everyone became virtuous?  I don`t know, it would be heavenly, I suppose. I certainly don`t know what the economic effects would be, but it`s not anything that going to happen in our lifetimes, despite the fact that we`re now 25 years into indexing.  In the area of retail investing in this country, I doubt that there`s even one percent of assets invested in index funds.  In the instant and large pension funds community, it might be as much as 30 percent of equities, and around the world I`m sure it doesn`t approach one percent, so it`s not anything to worry about. I don`t know the answer, but I know it`s not one that we`re going to need to know for another 100 years or so."  Nevertheless, Sinquefield is happy about how far the message has come even in this short period.  "I would be even happier if the word got out more to the retail investors, because they`re still the ones victimized by the age-old myths about stock picking, and the high costs that go along with them."  Asked where he thinks the market may be headed, he can only say with a laugh, "Well, I know where the market is headed. I just don`t want to share that with anyone."

There can be no doubt of Rex Sinquefield`s enormous contribution to finance since the 1970s.  His years of experience and research afford him the luxury of dispensing advice that is actually valuable.  "Diversify your investments. Don`t trade very much. Realize losses when you can and don`t realize gains. Write your Congressman and Senators and demand elimination of taxes on capital and dividends and interest. It`s an onerous tax, particularly at the time when most of the people need to save for retirement." 

"And I think everybody should root for the Cardinals."