David Booth: The First Index Fund, Competing Fiercely, and Keeping it Simple (EP.131)

Episode Summary

Executive Summary: David Booth, co-founder of Dimensional Fund Advisors, shares his journey from selling shoes to pioneering index funds and building a firm based on academic research. He emphasizes flexibility, client focus, and sticking with investment philosophy through tough periods. The conversation covers the creation of the first index fund, value investing, advisor relationships, and future innovations like ETFs and separate accounts.

Main Topics: David Booth's Background and Early Career (Priority: 4/5): Booth discusses his upbringing in Kansas, selling shoes to pay for college, and his transformative experience at the University of Chicago as a research assistant to Eugene Fama. Creation of the First Index Fund and Dimensional's Founding (Priority: 5/5): Booth details his role in developing the first index fund at Wells Fargo in 1971, the challenges faced, and the founding of Dimensional in 1981 with a focus on small-cap portfolios and flexible implementation. Small Cap and Value Investing Philosophy (Priority: 5/5): The rationale behind small-cap and value investing, supported by academic research and 95 years of data. Booth explains the importance of buying low-priced stocks and the role of uncertainty in expected returns. Client Focus and Advisor Relationships (Priority: 4/5): Booth emphasizes the importance of putting the end investor first, the decision to work with financial advisors, and the rigorous selection process to ensure good client behavior. Challenges of Underperformance and Staying the Course (Priority: 4/5): Discussion of periods when small-cap and value strategies underperformed, the difficulty of maintaining conviction, and the need for empathy and discipline. Innovation: ETFs, Separate Accounts, and Future (Priority: 3/5): Booth explains the recent launch of flexible ETFs, the potential for smaller separate accounts, and the ongoing tinkering with derivatives and technology to improve client outcomes. Culture and Luck in Success (Priority: 3/5): Booth reflects on the role of luck, the importance of respect and listening in building culture, and his definition of success as making a positive impact.

Key Arguments: Index funds were created at Wells Fargo in 1971, five years before Vanguard, but the first fund was a levered index fund that never launched. Flexibility in implementation adds value over rigid indexing, as demonstrated by Dimensional's ability to outperform benchmarks through careful trading. Value investing is sensible because buying low-priced stocks leads to higher expected returns, supported by 95 years of U.S. data and global evidence. Underperformance periods are normal and expected; investors must stick with their philosophy to capture long-term premiums. Dimensional's success is built on academic research, flexibility in execution, and empathy for clients during tough times. Advisors play a crucial role in helping clients stay invested and avoid behavioral mistakes, which is why Dimensional works primarily through advisors. Innovation in asset management is incremental; the next big thing is likely to be in customization and technology, not new factor premiums.

Data Points: Assets under management: $700 billion Canadian - Dimensional Fund Advisors currently manages approximately $700 billion Canadian. First index fund year: 1971 - The first index fund was developed at Wells Fargo in 1971, five years before Vanguard's fund. Dimensional founding year: 1981 - Dimensional Fund Advisors was co-founded by David Booth in 1981, celebrating its 40th anniversary in 2021. Small cap fund performance (7.5 years): 2% compounded annually - For seven and a half years, Dimensional's small cap fund compounded at 2% per year while the S&P 500 compounded at 14%. Value underperformance period: 3 years - Value stocks experienced one of the worst three-year periods relative to growth stocks recently. U.S. data on value: 95 years - There are about 95 years of U.S. data supporting the value premium. Assets at end of first year: $80 million - Dimensional had $80 million under management at the end of its first year. Years to pay dividends: 15 years - It took Dimensional 15 years before it could pay a dividend to its investors. Business from financial advisors: Two-thirds - Approximately two-thirds of Dimensional's business worldwide comes through financial advisors.

Pivotal Quotes: "I learned a lot about myself, which was, you know, at the end of the day, it's nice making a commission, but what's even better is going home at night feeling good about myself." — David Booth: Reflecting on his experience selling shoes and the importance of client focus. "We can improve people's lives by applying financial science. We can outperform index funds by using flexibility." — David Booth: Describing the core philosophy behind Dimensional's approach to investing. "Success is when you get to be my age. You look back and you take pride, maybe too much pride. I don't know, maybe it's false pride, or pride's one of the deadly sins, but I feel really good about what's happened to me. And I think I had some positive impact on that." — David Booth: Defining success and reflecting on his career and impact.

Implications: The interview reinforces the importance of evidence-based investing, patience during underperformance, and the value of a client-focused advisor. It highlights that innovation in asset management continues through flexibility and technology, but simplicity remains key for long-term success.