In the world of finance, you might think passive investing was just a passing fad, but it’s clear it has fundamentally transformed the investment landscape over the last four decades. David Booth, co-founder of Dimensional Fund Advisors (DFA), has been a key player in this shift. His journey highlights how empirical research and a willingness to challenge the norm can reshape not just markets, but the very behavior of investors.
Historical Context and the Birth of a Movement
Finance is a field shaped by pivotal historical moments, and the mid-1960s was one of those turning points. From my experience at Deutsche Bank, I’ve learned that understanding the past is crucial for making informed decisions today. This era saw significant advancements in computing and the rise of robust datasets from the Center for Research in Security Prices (CRSP), which allowed researchers to empirically test investment theories. This marked the beginning of the end for the myth that active managers consistently outperform.
As a PhD student under Eugene Fama and a contemporary of Roger Ibbotson, Booth was right in the thick of this transformation. He witnessed the collapse of long-held beliefs about manager superiority firsthand. The groundbreaking realization that equities historically yielded returns exceeding 9% annually left many in institutional trust departments stunned, as they struggled to match such performance. “We suddenly had a science,” Booth recounted. “We could test what worked and what didn’t.” This newfound ability to analyze data fundamentally shifted investment strategies.
The Emergence of Factor Investing
The upheaval in investment philosophy wasn’t just a critique of active management; it provided a roadmap for more effective investing practices. Investors were encouraged to embrace market returns, cut costs, and adopt a flexible approach. Booth’s tenure at Wells Fargo, alongside influential figures like Fischer Black and Myron Scholes, positioned him at the forefront of the burgeoning index investing movement. Yet, he was also aware of its limitations—mechanical rigidity and missed opportunities often plagued traditional index strategies.
In 1981, Booth and Rex Sinquefield launched DFA with a vision that went beyond simply replicating market indices. They focused on building diversified portfolios, especially in underrepresented areas like small-cap stocks, without becoming overly reliant on any single index. By leveraging data to inform structural decisions while applying market judgment for informed trades, they embodied what Booth called “flexibility with discipline.” This innovative approach laid the groundwork for what we now recognize as factor investing, well before the term became popular in the industry.
Despite the promise of their strategies, DFA faced significant challenges in its early years. Small-cap stocks lagged behind their larger counterparts throughout the 1980s, causing DFA’s flagship fund to fall behind the S&P 500 considerably. Many firms might have thrown in the towel, but DFA persevered. Their resilience stemmed from a firm belief in diversification and the principles of empirical research. “How do you survive?” Booth advised. “You go back to the fundamentals. You believe in diversification. You believe in markets.”
Implications for the Future of Financial Advice
As I reflect on the conversations between Booth and Larry Siegel, it’s clear that the evolution of passive investing is more than just a history lesson; it’s a testament to the lasting value of research and innovation in finance. The advisor channel, which has quietly reshaped the industry, emerged as a vital source for disseminating knowledge and improving investor outcomes. Listening to their dialogue unveils the intricacies of this transformation and the personalities behind it.
For young professionals stepping into the finance sector, Booth offers valuable insights: embrace uncertainty, identify your unique strengths, and create something you can proudly stand behind. He emphasizes the growing opportunities within financial advising, especially as technology paves the way for personalized solutions. “People don’t want robo-advice,” he stresses. “They want to be heard. They want someone to help them connect life to money.”
Booth’s journey is a compelling case study in the power of applied research, showcasing how it can foster enduring value within the financial industry. As the CFA Institute Research and Policy Center celebrates its 60th anniversary, this narrative underscores the significance of its mission to enhance investment knowledge. While the lessons of the past remain relevant, they also guide our future, shaping the investing landscape for both advisors and clients alike.