An Inside View of Dimensional: Upfront and Personal with David Booth

An Inside View of Dimensional:  Upfront and Personal with David Booth

David Booth
Dimensional Fund Advisors,
Chairman and Co-Chief
Executive Officer

Seventeen years before Neo was plugged into The Matrix, David Booth was bringing history to life inside his own Matrix.

While the film version of The Matrix thrives on duplicity, Booth’s singular focus for his Matrix is to bring transparency, credibility and clarity to the investment decision-making process with an oversized, elegantly simple book that lays out global asset class returns — making sense of an otherwise complex web of stock market history.

Booth is the co-founder, Chairman and Co-Chief Executive Officer of Dimensional Fund Advisors, a mutual fund manager with $283.0 billion in assets under management, as of March 31, 2013.

Mark Hebner, President of Index Fund Advisors, recently joined Booth in Napa, California, where the two discussed the beginnings, evolution and impact of Booth’s firm, and of the annually published Dimensional Matrix Books. Booth also shared some poignant stories, giving a rare glimpse into some pivotal moments of Dimensional’s impressive history.

The Beginnings: A 2-bedroom Brownstone

Many people know the famous story about the early days of Dimensional. The firm was started in Booth’s brownstone in Brooklyn, New York. The first trading room was his spare bedroom, and a Quotron machine sat in the middle of his sauna.

When Hebner asked how market data was obtained prior to the year Dimensional was founded in 1981, Booth said, “Well, it was difficult. There was no Internet. In those days, we could get electronic data, but it had to be written down. We couldn’t download it to the PC or print it out. To run the Quotron machine, we had a CPU about the size of an upright refrigerator. When they came to install it a couple weeks before we went live, they plugged it in and it made about as much noise as a 747 – the decibel level of a jet engine. I ripped out my sauna and air-conditioned and sound proofed it the best we could.”

Although he never did get to use his sauna for health benefits, that sauna was the beginning of a revolutionary investing strategy that has benefitted millions of people for the past 32 years.

The Dawn of the Data

For Booth, historic data is a foundational component of Dimensional's success, delivering what is sometimes referred to as "the dimensions of stock market returns." Booth credited two major publications as being significant to the evolution of stock market research, the first being the development of the 1963 data book from the Center for Research in Security Prices (CRSP) at the University of Chicago.

People used to ask, “what have stocks done historically?” Booth recollected there was no answer to that question. “When we talk about data, we really need to go back to Jim Lorie at the University of Chicago. He persuaded Merrill Lynch to fund the development of the CRSP data. The CRSP data is important, because it is a survivorship bias-free database. Until that time, if a company disappeared, that data disappeared forever.”

Lawrence (Larry) Fisher teamed up with Lorie on that first study. Booth referenced the Lorie – Fisher duo as “kind of like Butch Cassidy and the Sundance Kid.” He said, “Larry was evidently a genius. I could never understand anything he said, but he was the guy that collected the data, and he was an obsessive compulsive, detailed oriented guy, which is what was needed. Lorie was the salesman – urbane and sophisticated.”

Together, the two colleagues faced the colossal challenge of researching the accuracy of each piece of stock information. They made use of their own formidable training and experience to fill in the blanks for missing stock prices. Lorie estimated that between two and three million pieces of information were entered onto magnetic tape. They analyzed total return, dividends received, and changes in capital as a result of price changes of all common stocks listed on the NYSE going all the way back to 1926. Their findings were published in an article titled “Rates of Return on Investments in Common Stocks” in the Journal of Business. The article cited the duo’s conclusion that the average compounded rate of return on common stocks listed on the NYSE from 1926 to 1960 (35 years) was 9% for institutional investors. For the first time, an average rate of return could actually be measured. The front page of the New York Times financial section heralded the pair's results.

Booth characterized that first book as big and thick, several hundred pages long. For calculating rates of returns over different time periods, Fisher used an IBM 360, which Booth indicated had much lower computing power than today’s blackberry.

That groundbreaking study wasn’t updated for many years. But when renowned economist Myron Scholes returned to the University of Chicago to teach in the early ‘70’s, he decided it was time to update the CRSP files. This decision then led to the development of the second historical, significant publication called, Stocks, Bills, Bonds and Inflation” (SBBI) - see the First Edition published in 1977, authored by Roger Ibbotson and Rex Sinquefield. More than 20 other editions can be found in the IFA library.

Booth offered a bit of background: “About that time, Roger Ibbotson and I were teaching assistants for Gene Fama. Part of our task was that one day a week, we had a Q&A session for the students in his class. One of the students was Rex Sinquefield. That’s how we got to know Rex, and Rex got to know us. Rex would show up every week. Nobody else would show up every week. A few years go by, and nobody’s updated the [CRSP] book. So Myron updates the files, and CRSP now has research data that people can use. But nobody recalculated it.”

He continued, “By this time, the Fisher/Lorie book was a distant memory. So they [Ibbotson and Sinquefield] came out with this book [SBBI] with tables of data and shocked the world.”

It seems the University of Chicago has been a hotbed of excellence of epoch proportions for many years. The university's business school was renamed the Booth School of Business in 2008, thanks to a $300 million gift made by alumnus David Booth, the largest donation ever made to any business school in the world.

The CRSP database has made the University of Chicago Booth School of Business the premier institution for financial and stock market research, boasting 26 out of 71 Nobel Laureates in Economics who have either attended or taught at the university to date, including Myron Scholes. Having celebrated its 52nd anniversary in 2012, CRSP is now the leading provider of historical stock market data to over 500 institutions around the world.

Dimensional Takes Shape with Heavy Hitters

Booth asserted that SBBI was important for the development of Dimensional, because Ibbotson and Sinquefield had big reputations when they joined the firm’s board of directors. He said, “Rex and Roger were well known in the investment community. Big names. So when Rex joined us when we started Dimensional, it was really a big shot in the arm.” These two luminaries were part of Dimensional’s initial core group.

Booth reminisced about the early days, “We decided to start a mutual fund, because we wanted to commingle assets. You could only have tax-qualified money and it had to be a particular type. So if you wanted to have a broad range of clients and didn’t want to do separately managed [accounts], you had to have a mutual fund. So the lawyers told us that if we wanted to have a mutual fund, we had to have a board of directors.”

Booth spoke candidly with enthusiasm about Dimensional’s original Returns Program. He recollected that “the other thing we did was create a little program where people could put in a percentage of the S&P and a percentage of small companies, and it would print out the rates of return for the S&P, for the small company index and for the portfolio for various years. Keep in mind we were dealing with PC’s with a floppy disk with 64K memory and a dot-matrix printer. People could play around and get various mixes.” Even today, the heart of the DFA Returns Program is the ability to perform portfolios analysis.

He then shared a story seldom discussed pertaining to capturing the small-value premium identified in the research. “Roger agreed with us that creating an index of small companies probably wasn’t as useful as looking at our actual returns on the micro-cap portfolio … the reason being … at the time we started the firm, most academics believed that trading costs would chew up most of our returns. The fact that now we know that you can actually beat indices because the trading costs go into the index - - the way index funds trade - - the trading costs get buried in the index returns.”

Inside the Matrix

The final and much anticipated subject of the conversation revolved around Dimensional’s colorful Matrix Books. The ideas and format of the SBBI books led Booth to create and publish the DFA Matrix Book that was first published in 1982. Hebner shared that he was fascinated by all the various covers designed over the years. He wanted to know about the creative process behind the book covers.

Booth explained, “I’ve been involved with every one of them. The basic format was created by Gene [Fama], Jr. He was a student at the school [University of Chicago]. I would tell him what to design, and he would design it. The first cover was done without a spine in the middle. Our sales people said it was horrible because people couldn’t fit it in a briefcase, but that’s exactly what I wanted – for it to stick out. You couldn’t hide it. You had to put it on your coffee table. But they won out eventually, and I was told we had to have a spine.” Booth’s solution was to split it right down the middle and make it into two halves.

When asked if he has a favorite Matrix Book cover, Booth answered, “the first one. I think it’s pretty cool.” Fast forward to the most recent cover. He wanted to add multiple dimensions to the Dimensional logo in the 2013 edition, so the graphic designer created a distinctive work of art to depict his concept. Here are all of the DFA Matrix Book covers from 1982 through 2013.

Hebner indicated that the matrix book was akin to a valuable calling card or a giveaway and inquired if it influenced people to invest in Dimensional. Booth responded that he thinks it helped because “it gave us credibility.”

Credibility is clearly a strong suit for Booth and Dimensional and a major contributor to the firm’s phenomenal success. One man with a vision of capturing the small corner of the markets from his 2-bedroom Brooklyn brownstone catapulted his company to a multinational supernova with over 700 employees and offices in eight countries.

Now, that’s definitely a Matrix worth plugging into.

David Booth's handwritten note comparing small stocks to various asset classes in 1980, a year when inflation skyrocketed.

Dimensional's beginnings: Booth's Brooklyn Brownstone where it all began.

The trading floor of Dimensional's first headquarters in Santa Monica, California.

David Booth and Rex Sinquefield on the cover of Fortune Magazine in July 1998.

Today's Dimensional headquarters in Austin, Texas.

David Booth receives praise for his $300 million gift to the University of Chicago Booth School of Business with Eugene Fama by his side.

 

Postscript: To see an interactive version of return matrices, visit this page. To see larger images of each DFA Matrix book cover, visit IFAlibrary.com and search DFA Matrix Book.