Dimensional’s ‘Passive’ Course Pays Off
Rex Sinquefield gave up plans to become a Catholic priest in favor of a career in finance.
The church, he jokes, is better off. And so is the investment world, according to Sinquefield’s many fans.
The 61-year-old Sinquefield will end an era today as he steps down as co-chairman of Santa Monica-based Dimensional Fund Advisors, an $86-billion-asset money management firm.
Dimensional, under Sinquefield and co-founder David Booth, was one of the pioneers of “passive” stock market investing -- a discipline that sees no merit in trying to pick individual winners among equities, or in trying to time market swings.
Instead, passive investors believe in the so-called efficient market theory, which maintains that almost no one can be smarter than the market as a whole in the long run. So they buy and hold broad portfolios of shares, betting that their returns over time will trump the gains of most “active” managers who try to find the stocks with the brightest prospects.
Valley Forge, Pa.-based Vanguard Group is the better known passive money manager and is 10 times Dimensional’s size. But in the field of finance, Sinquefield’s work 33 years ago establishing key tenets of passive investing -- and his development of long-term market performance statistics that have become the bedrock of investing decisions -- place him in Wall Street’s pantheon, his admirers say.
“Virtually every investment portfolio has been influenced in some way by what he has done,” said Michael Rosen, head of Angeles Investment Advisors, a Los Angeles investment consultant.
“His contribution has been huge,” said Robert Arnott, a money manager and editor of the Financial Analysts Journal.
Today, trillions of dollars worldwide are invested in passive portfolios. The most famous such fund for small investors is the $108-billion Vanguard 500 Index fund, which replicates the returns of the blue-chip Standard & Poor’s 500 stock index.
Dimensional, under Sinquefield and Booth, has boomed by focusing on passive, low-cost investing in three niches: smaller stocks, value-oriented shares and foreign issues. All three have been among the hottest market sectors in this decade.
The firm’s largest fund, the $7-billion U.S. Small Cap Value portfolio, has helped make Dimensional’s case that the typical active manager can’t beat a passive portfolio: The fund produced an average total return of 18.3% a year in the five years ended Sept. 30. That trounced the 14.6% gain of the average small-cap value fund, according to Morningstar Inc.
Sinquefield, who grew up in St. Louis, entered a seminary after high school, expecting to become a priest. But his interests soon shifted to business, he says. He left the seminary for St. Louis University, then went on to the University of Chicago in 1970 to study for a master’s degree in business administration.
The University of Chicago had long been a bastion of free-market theory -- the idea that the economy, and financial markets, work beautifully for all when left unfettered.
It was just 10 minutes into his first class with the late professor Merton Miller, who would win a Nobel Prize in economics in 1990, when the lightning bolt struck, Sinquefield recalls.
“He was explaining the notion of efficient markets,” Sinquefield said. “It was like an epiphany to me. I thought, ‘This makes sense.’ ”
He had dabbled in stock investing on his own, but had come to believe that any success he would have picking individual shares amounted to being “somewhere between stupid and lucky,” he said.
Eugene Fama, a University of Chicago professor who is considered the father of the efficient market theory, became a mentor to Sinquefield in the early 1970s. But while academic research on the concept of passive investing was blossoming, there was no fund in which investors could test the theory with real money.
That was Sinquefield’s master stroke: Working in the trust department at American National Bank in Chicago in 1973, he convinced his bosses to launch a fund that would match the performance of the S&P; 500 index.
The fund made its debut three years before Vanguard’s S&P; 500 portfolio was born.
To market the American National fund to investors, however, Sinquefield knew that he needed data on how the index had performed historically. But he couldn’t find all the information he required. Standard & Poor’s, for example, didn’t keep statistics on how much companies in its index paid in dividends each year, which was key to figuring total gains.
Long before personal computers, when many financial statistics existed only on musty paper, the head of S&P;'s research department “said it couldn’t be done,” Sinquefield said.
So he put together his own historical data back to 1926, using stock dividend information in American National’s trust department records.
Working with Roger Ibbotson, another University of Chicago alumnus, Sinquefield’s efforts became the basis for a statistical reference simply titled “Stocks, Bonds, Bills and Inflation.” It was, and remains, one of the bibles of the money management business because it shows average returns since 1926 for large-company and small-company stocks, Treasury and corporate bonds, and Treasury bills.
As interest in passive investing grew in the late 1970s and early-1980s, Sinquefield linked up with Booth, another Chicago alumnus who also fervently believed in the efficient market theory. Booth launched Dimensional in New York in 1981 specifically to develop funds to invest passively in small-company stocks, a novel idea at the time.
Booth and Sinquefield moved their company to Santa Monica in 1985 -- in part, Sinquefield says, because back then they found the area’s housing affordable and the commute easy.
With his retirement from Dimensional, Sinquefield’s commute should get easier again: He and his wife, Jeanne, who has headed the firm’s stock trading unit, are moving permanently to their 1,000-acre farm on the Osage River in Missouri.
After three decades in the investment business, Sinquefield said he felt it was time to try something new. He has founded a think tank, the Show-Me Institute, which he says will focus on public policy issues in Missouri.
He will keep his board seat and ownership stake in privately held Dimensional. Booth, 59, will become the firm’s sole chairman.
Although many investors worldwide still shun passive investing, preferring to bet with active money managers in the hope of beating average market returns, Sinquefield and Booth believe they’re in a growth business in the long run.
Booth likens investors’ trust in active stock picking to buying lottery tickets: “While they have the lottery ticket they can dream the dream,” he said. The efficient marketeers insist that the odds of beating the market over time indeed are analogous to the odds of winning big with Lotto: It’s possible, but highly unlikely.