DIMENSIONAL ADVANCED CONFERENCE 2018 (EP.15)

Episode Summary

Executive Summary: This episode recaps the Rational Reminder team’s visit to Dimensional Fund Advisors’ conference in Chicago, highlighting the University of Chicago’s central role in modern finance, the origins of index investing and factor research, and Eugene Fama’s discussion of a new paper on volatility. The conversation emphasizes the importance of academic research, implementation, and long-term investing discipline, while also noting Dimensional’s close ties to foundational finance scholars and its evolution in advisor support and communications.

Main Topics: University of Chicago as the hub of modern finance (Priority: 5/5): The hosts trace how the University of Chicago fostered applied economics and finance research, producing many of the field’s most influential thinkers and Nobel laureates. Origins of Dimensional and index investing (Priority: 5/5): They recount David Booth’s path from Fama’s student to co-creator of the first institutional index fund, and how Dimensional emerged from the academic-industry pipeline. Factor research and the development of the Fama-French framework (Priority: 5/5): The episode explains how size and value effects were identified and how Dimensional adopted research before it became mainstream, long before factor investing was widely discussed. Eugene Fama’s volatility paper and long-horizon return distributions (Priority: 4/5): Fama’s discussion of bootstrapped return samples shows how outcome distributions change over longer horizons, while also warning that larger negative outcomes remain possible. Risk, retirement, and real-world investing (Priority: 4/5): The hosts and Fama discuss how averages and statistical models differ from lived investor outcomes, especially around retirement sequencing risk, bonds, and real returns. Factor proliferation, statistical significance, and research rigor (Priority: 4/5): The discussion addresses the ‘factor zoo,’ Campbell Harvey’s higher t-stat threshold idea, and Marlena Lee’s view that robust economic rationale matters more than a simple cutoff. Dimensional’s evolution in advisor support and communication (Priority: 3/5): Brenda Bartlett describes how Dimensional has expanded beyond technical research into helping advisors communicate evidence-based investing to clients.

Key Arguments: Chicago’s unique ecosystem connected academic finance directly to real-world application, creating an incubator for ideas that shaped modern investing. Dimensional’s roots are deeply tied to the academic discovery process; it implemented ideas before they were broadly published or widely accepted. The first institutional index fund predates the retail index-fund era and is an important part of Booth’s and Dimensional’s history. Small-cap investing was originally introduced for diversification, not because a premium had already been proven. Long-run equity investing still involves meaningful downside risk; lower probability of loss over time does not mean lower severity of losses. Fama’s volatility analysis suggests that longer horizons reduce the probability of negative returns but can increase the magnitude of losses when they occur. The presence of many proposed factors does not invalidate core factors like size, value, and profitability; many newer factors are spin-offs or weakly supported variants. Statistical significance thresholds alone are insufficient; economic intuition, robustness checks, and implementation quality are essential. Dimensional’s competitive edge comes not just from research, but from its ability to implement portfolios efficiently and communicate the strategy effectively to advisors and clients. Public pension accounting was criticized as unrealistic because discount rates and liability estimates may materially understate true obligations.

Data Points: University of Chicago Nobel laureates: 87 total - Mentioned during the history of the university and its academic legacy. Chicago economics Nobel laureates: 34 of 84 - The hosts cite the share of Nobel Prize winners in economics associated with the university. Princeton? no—Pulitzer winners: 24 - Used to underscore the university’s broader academic influence. Year Eugene Fama arrived at Chicago: 1960 - Referenced as the start of his long academic career there. David Booth’s PhD arrival at Chicago: 1969 - Marks Booth’s entry into Fama’s research environment. Dimensional founding year: 1981 - Mentioned while discussing the firm’s early years before factors were mainstream. CRSP initial grant: $200,000 - Merrill Lynch funded the Center for Research in Security Prices to develop total-market stock return data. Fama’s age at time of talk: 79 - Used to highlight his continued daily work ethic. Bootstrapped samples: 100,000 - Fama and French used 100,000 bootstrap resamples in the volatility paper. Return history analyzed in paper: Monthly returns from 1963 to 2016 - The data period used in the volatility analysis. Long-horizon periods tested: 20 and 30 years - Among the multi-horizon samples examined in the paper. Equity premium negative probability over 30 years: 4% - Fama noted that even over long horizons there remains a chance of negative excess equity returns. Negative premium frequency: 7.8% - Another quoted statistic on the chance of negative outcomes in the long-horizon samples. Campbell Harvey suggested t-stat threshold: 3 - Discussed as a stricter standard for modern factor discovery due to factor proliferation.

Pivotal Quotes: "Behavioral finance is a subset of the efficient market hypothesis." — Eugene Fama: Fama’s joking dismissal of Richard Thaler’s behavioral finance framing. "If you did the type of accounting that public institutions do as a private entity, you would go to prison." — Eugene Fama: A sharp critique of public pension liability accounting and discount-rate assumptions. "You eat real returns." — Eugene Fama: His reminder that investors experience outcomes in real terms, not statistical averages.

Implications: For listeners, the episode reinforces that evidence-based investing rests on academic rigor, good implementation, and patience. For the industry, it highlights why Dimensional’s research culture and advisor communication remain a durable advantage even amid factor-product proliferation.