It all started with a giant computer in a Brooklyn apartment


Anyone walking around the quiet, tree-lined streets of Brooklyn Heights in the spring of 1981 at noon may have heard strange, otherworldly sounds emanating from the brown stone at 48 Remsen Street.

The mysterious buzz came from the roaring fans of a Quotron, a refrigerator-sized machine that spat out stock prices in real time for brokers and investment managers around the world. Booth had purchased a two-bedroom apartment on the top floor of the house for $ 75,000 in 1979. During DFA’s early months, his head office was Booth’s spare bedroom – which involved ejecting his brother into the process. The dining room became DFA’s first conference room, and the kitchen its first staff canteen.

The Quotron – the dominant working house in the financial industry until the emergence of Michael Bloomberg’s eponymous data empire a few years later – was vital. But the machine was so loud that Booth eventually had to rip out his sauna and build a soundproof room for it. For breaks away from the “office,” Booth would do 149 midday jogs on the nearby Brooklyn Bridge that connects the borough to lower Manhattan.

Things were a little better in Chicago, but at least the Sinquefields had a small office at 8 South Michigan Avenue, right next to Grant Park. But the first year was mostly on the road, with cheap flights and cheaper hotels. During a winter visit to Honeywell, the industrial conglomerate based outside of Minneapolis, Sinquefield and a colleague had to climb through a huge snowdrift to get to the office at the Red Roof Inn and swipe their card. credit through a narrow opening in the bulletproof glass window. “You know, if we ever make any money, we’ll never stay in a place like this again,” Sinquefield told his colleague that evening.

Fortunately, the US stock market rebounded in 1982 and small caps had a particularly strong year. The first DFA fund returned nearly 29%, compared with a 14.7% gain for the S&P 500. It was a godsend for DFA’s sales pitch, and by early 1983 its assets under management were approaching the billion dollar mark. “David Booth makes it look easy. . . Business seemed to fall on his knees ”, the New York Times sprang up in September of the same year. Klotz describes the atmosphere during the intoxicating days of DFA as palpable: “You could taste success. “

At that time, DFA had a powerful weapon in its sales arsenal. Rolf Banz, a Swiss protégé of Myron Scholes, had used CRSP data compiled in Chicago to calculate average returns for smaller stocks, and found that while they are much more volatile than the better-known blue-chip stocks, they offered much better long-term returns. During the period 1926-1975, Banz studied, the average annual rate of return of large stocks was 8.8%, while smaller stocks had a rate of return of 11.6%.

It was surprising. Not only did smaller stocks offer theoretical diversification – the only free lunch in finance, as Markowitz had shown decades earlier, and DFA’s main marketing argument to pension funds – but they also outperformed bigger stocks in the long run. “Giant gains thanks to midget stocks” Fortune trumpeted in a June 1980 article highlighting Banz’s provisional conclusions. His doctoral thesis on the subject was officially published in the Financial economics journal in March 1981, and showed that even taking into account their greater volatility, small-cap stocks beat the bigger ones. Sinquefield was already aware of the study, but Fama brought the thesis to the attention of Booth, who now had strong evidence that DFA’s small-cap fund could give investors not only the ability to spread their eggs in. more baskets but also a larger one also comes back.

It was a watershed moment, paving the way for the development of a new approach to money management. Recognizing the marketing opportunities, DFA initially dubbed them “dimensions”, but today other proponents primarily refer to it as “smart beta” or “factor investing”.

Of course, factors don’t always work. They can go through long periods of fallow where they underperform the market. Value stocks, for example, suffered a miserable performance in the dot-com bubble, when investors wanted to buy only trendy tech stocks. And much to DFA’s chagrin, after small caps had a strong year in DFA’s first year of existence, they would then suffer a long and painful seven-year lag significantly behind the S&P 500.

DFA managed to continue to grow, losing very few clients, in part because it had always pointed out to them that such stretching could happen. But it was an uncomfortable time that led to many awkward conversations with clients.

At one point, Booth was cornered by the assistant treasurer of a large client, who grabbed his arm angrily and growled, “I want you to know that you are the worst performing manager we have in all.” asset classes. Do you still believe that small cap stocks have higher expected returns? Booth stuck to the DFA script and replied, “We believe that small cap stocks are riskier than large cap stocks and that risk and reward are linked. What part of the argument are you more comfortable with? DFA has finally come through the lean years, but not without taking its toll.

Adapted from BILLIONS: How a gang of Wall Street renegades invented the index fund and changed finance forever by Robin Wigglesworth, published October 12 by Portfolio, a brand of Penguin Publishing Group, a division of Penguin Random House, LLC. Copyright © 2021 by Robin Wigglesworth.

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