1950- Today

1.CONVENTIONAL WISDOM, CIRCA 1950

“Once you attain competency, diversification is undesirable. One or two, or at most three or four securities should be bought. Competent investors will never be satisfied beating the averages by a few small percentage points.”The Battle for Investment Survival, Gerald M. Loeb 1935Analyze securities one-by-one. Focus on picking winners. Concentrate holdings to maximize returns.Broad diversification was considered undesirable.

2.DIVERSIFICATION AND PORTFOLIO RISK,

1952Harry Markowitz,

Nobel Prize in Economics 1990 Diversification reduces risk.Portfolio risk vs. security risk.Assets evaluated by their effect on portfolio. An optimal portfolio can be constructed to maximize return for a given standard deviation.

3.THE ROLE OF STOCKS, 1958

James Tobin, Nobel Prize in Economics 1981

Separation Theorem:

1. Form portfolio of risky assets.

2. Temper risk by lending and borrowing.

Shifts focus from stock selection to portfolio structure.

“Liquidity Preference as Behavior Toward Risk” The Review of Economic Studies February 1958

4.INVESTMENTS AND CAPITAL STRUCTURE,

1961Merton Miller and Franco ModiglianiNobel Prizes in Economics 1985 and 1990

M&M Theorems

Theorem relating corporate finance to returns.

A firm´s value is unrelated to its dividend policy.

Dividend policy is an unreliable guide for stock selection.

5.SINGLE-FACTOR ASSET PRICING RISK/RETURN

MODEL, 1964William SharpeNobel Prize in Economics 1990

Capital Asset Pricing Model:Theoretical model defines risk as volatility relative to market.

A stock´s cost of capital (the investor´s expected return) are proportional to the stock´s risk relative to the entire stock universe.

Theoretical model for evaluating the risk and expected return of securities and portfolios.

6.BEHAVIOR OF SECURITIES PRICES, 1965

Paul Samuelson, MITNobel Prize in Economics 1970

Market prices are the best estimates of value.

Price changes follow random patterns.

Future stock prices are unpredictable.

• “Proof That Properly Anticipated Prices Fluctuate Randomly” Industrial Management Review Spring 1965

7.EFFICIENT MARKETS HYPOTHESIS, 1966

Eugene F. Fama, University of ChicagoConducts extensive research on stock price patterns.Extends work on unpredictability of stock prices and finds that prices quickly incorporate information.Develops “Efficient Markets Hypothesis,” which asserts that prices reflect values and information accurately and quickly. It is difficult if not impossible to capture returns in excess of market returns without taking greater than market levels of risk.Investors cannot identify superior stocks using fundamental information.

8.FIRST MAJOR STUDY OF MANAGER PERFORMANCE,

1968• Michael Jensen 1965

A.G. Becker Corporation 1968First studies of mutual funds (Jensen) and of institutional plans (A.G. Becker Corp.) indicate active managers under perform indexes.

• Becker Corp. gives rise to consulting industry with creation of “Green Book” performance tables comparing results to benchmarks.First studies showing investment professionals fail to outperform market indexes.

• Jensen, Michael, “The Performance of Mutual Funds in the period 1945-1964” Journal of Finance December 1965.

9.OPTIONS PRICING MODEL, 1972

Fisher Black, University of ChicagoMyron Scholes, University of ChicagoRobert Merton, Harvard UniversityNobel Prize 1997The development of the Option Pricing Model allows new ways to segment, quantify and manage risk. It spurs the development of a market for alternative investments.

10.RANDOM PRICES AND PRACTICAL INVESTING, 1973

John McQuown and Rex SinquefieldThe birth of index fundsAmerican Natl Bank (Sinquefield)Wells Fargo Bank (McQuown)

Banks develop the first passive S&P 500 Index funds. Years later, Sinquefield chairs Dimensional and McQuown sits on its Board. Dimensional further develops passive and structured investment strategies.

John McQuown and Rex SinquefieldThe birth of index fundsAmerican Natl Bank (Sinquefield)Wells Fargo Bank (McQuown)

Banks develop the first passive S&P 500 Index funds. Years later, Sinquefield chairs Dimensional and McQuown sits on its Board. Dimensional further develops passive and structured investment strategies.

11.A MAJOR PLAN FIRST COMMITS TO INDEXING,

1975New York Telephone Company Invests $40 million in an S&P 500 Index fund.

The first major plan to index.

Helps launch the era of indexed investing.

“Fund spokesmen are quick to point out you can´t buy the market averages. It´s time the public could.”

Burton G. Malkiel A Random Walk Down Wall Street 1973 ed.

12.DATABASE OF SECURITIES PRICES SINCE 1926, 1977

Roger Ibbotson & Rex Sinquefield“Stocks, Bonds, Bills and Inflation”An extensive returns database for multiple asset classes is first developed and will become one of the most widely used investment databases.The first extensive, empirical basis for making asset allocation decisions changes the way investors build portfolios.

13.THE SIZE EFFECT, 1982

Rolf Banz, University of ChicagoAnalyzed NYSE stocks 1926-1975.Found that, in the long term, smallest companies had largest expected returns.Small companies behave differently from large companies and deserve stronger than market representation.

14.INTERNATIONAL SIZE EFFECT IMPLEMENTED, 1986

Structured Investing vs. Indexing:

With no index, Dimensional Fund Advisors Inc.creates a structured product in an undiscovered asset class.Dimensional´s product returns become the index used in Ibbotson Associates´ database.

Structured investing is innovative. It is based on a rational risk dimension, and does not slavishly follow indexes or investing conventions.

15.NOBEL PRIZE RECOGNIZES MODERN

FINANCE, 19901990 Nobel Prize in Economic SciencesRecognition of Financial economists who shaped the way we invest.

William Sharpe for the Capital Asset Pricing Model, beta and relative risk.

Harry Markowitz for the theory of portfolio choice.

Merton Miller for work on the effect of firms' capital structure and dividend policy on their price.

The Nobel Prize of 1990 emphasized the role of science in investing.

16.MULTIFACTOR ASSET PRICING MODEL AND VALUE

EFFECT, 1992Eugene Fama and Kenneth FrenchUniversity of Chicago

Improved on the single factor asset pricing model (CAPM).

Identified market, size and “value” factors in returns.Developed the three-factor asset pricing model, an invaluable asset allocation and portfolio analysis tool..Revolutionized the way we construct and analyze portfolios by identifying independent sources of risk and return. Introduce first concentrated, empirical value strategies.Led to similar findings internationally.

17. From 1992 todateFinancial science over the last fifty years has brought us to a powerful understanding of the risks that are worth taking and the risks that are not. Three Equity FactorsMarket: Stocks have higher expected returns than fixed income.Size: Small company stocks have higher expected returns than large company stocks.Price: Lower-priced "value" stocks have higher expected returns than higher-priced "growth" stocks.Everything we have learned about expected returns in the equity markets can be summarized in three dimensions. The first is that stocks are riskier than bonds and have greater expected returns. Relative performance among stocks is largely driven by the two other dimensions: small/large and value/growth. Many economists believe small cap and value stocks outperform because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk.

18. Applied Core Equity

Dimensional portfolio construction methodology weights securities by size and value characteristics instead of

market capitalization.Total market strategies launched to provide efficient,

diversified risk factor exposure while limiting turnover and transaction costs.

Core equity portfolios move beyond traditional, component-based asset allocation via vast diversification

and cost-efficient market coverage.

19. Dimensional-Engineering

Portfolio Construction

 

                                                                                                                                                                           

                      

JSP Approach Compared to One of the Best and to Traditional Portfolio Management

DimensionalManagement(One of the Best)

JSP Management

Active Management

IndexManagement

Assumes markets work.

Assumes markets work.

Assumes markets don't work.

Assumes markets work with no liquidity cost.

Captures specific dimensions of risk identified by financial science.

Captures specific dimensions ofRisk

+Expectations [Competitive Advantage Period (CAP)]

identified by financial science.

Attempts to beat the market through security selection and market timing.

Allows commercial benchmarks to dictate strategy.

Minimizes transaction costs and enhances returns through portfolio design and trading.

Minimizes transaction costs and enhances returns through Portfolio design and trading.

+Advances in market microstructure.

Generates higher turnover, transaction costs, and taxes due to speculative trading.

Accepts high transaction costs and turnover in favor of tracking.

Question posée à Merton Miller (Prix Nobel d’économie en 1990): Do you believe in active

management in any form?Not really. That’s based on my study of finance and my belief that markets know much more as markets than an individual does as an indivividual…I favor passive investing for most investors, because markets are amazingly successful devices for incorporating information into stock prices. There are really two different groups of investors. One group, the overwhelming majority, has no significant private information not already in prices, and they should invest passively. They are not going to make above-normal returns, except by accident But there is another group that can hope to make money by careful research in the market. How much money can they expect to make ? Taking the group as a whole, they make just enough, on average, to cover the cost of their research. This distinction I’ve been making, between traders with significant non-public information and those without it --which includes most investors, including pension fund and mutual fund managers-- is known as the Grossman/Stiglitz theorem. Their proof that both the informed, and the uninformed, investors can expect to make the same return, on average, is neat…I believe that most economists would accept the view that, while you sometimes can make a score by sheer luck, you can’t do it constantly, unless you’re willing to put the resources in. One way or another, you have to get significant non-public information, which most fund managers don’t have. (l’emphase est de moi).

Source: Peter J. Tanous, Investment Gurus : A Road Map to Wealth from the World’s Best Money Managers, Prentice-Hall, 1997.

À titre de conclusion, je fais miens les propos de Horace W. Brock, Ph.D. Président et fondateur de Strategic Economic Decisions de Menlo Park, Californie dans «

Rethinking market efficiency and active/passive management from scratch », 1998.

« After a decade in which passive indexed strategies occupied center stage--often for good reasons, active strategies now deserve fresh consideration subject to one important proviso : plan sponsors and investment managers must start to invest in their « human capital » (their professionals) with an aim to develop better than average inferences as to how the economy and financial markets actually function. For the quest for such an « inferential » (as opposed to « informational ») advantage over the market will be seen to offer the principal rationale for adopting an active stance. At present, neither plan sponsors nor money managers place due emphasis on human capital investment. This is in contrast to their excessive investments in « systems », in blak-box forecasting software, and in databases of dubious value. As a result, it is entirely predictable that many active managers fail to outperform market indices. Their priorities must now be ordered.»

Transformation en connaissances de

l’informationEn effet, c’est dans le développement et le raffinement d’un référentiel comme le Schéma de création de valeur (SCV)©, et l’utilisation de sources de données financières comme Stockpointer, donc dans une transformation en connaissances de l’information, que le gestionnaire qui adopte une stratégie active peut se donner un avantage concurrentiel sur celui qui utilise une stratégie dîte passive.

20. SourceDimensional