There’s a classic riddle that asks, “What weighs more – a pound of bricks or a pound of feathers?”
To most, at its surface the nature of the trick question is immediately clear. Because no matter what substance you’re measuring, a pound is a pound, and thus they should be the same. But is that quickly-drawn conclusion true?
At a conference that I recently attended, a similar question was asked: “What has more value, a dollar of stocks or a dollar of bonds?” On its surface, it’s the same word play with the same easily drawn conclusion. If each asset is worth one dollar, then each should be equivalent and thus viewed as interchangeable.Whether I have a dollar’s worth of stock or a dollar’s worth of bonds in a portfolio, each should be able to be converted to one dollar of cash, and each should allow me to buy the same amount of goods or services. But when viewed as a long-term investment within a portfolio, these two seemingly equal assets may not be equivalent.
The conference I attended was the annual Dimensional Advanced Conference at their headquarters in Austin,Texas, where, among dozens of other firms in the country, I was joined by other Carlson Capital Management and Zero Alpha Group investment team members. For most of you, Dimensional is a familiar name. For almost 20 years, funds managed by Dimensional (or DFA as they’re often known) have been a key part of our clients’ portfolios. The foundation of their academically-driven approach has shaped how we structure our clients’ investments and gain access to markets across the globe. What’s unique with Dimensional is not simply that they’ve quietly become the sixth largest mutual fund company in the U.S. , it’s that they retain the intellectual curiosity and drive toward discovery that keeps them growing and staying at the leading edge of portfolio management. I don’t know of any other firm that hosts conferences where multiple Nobel laureates are keynote presenters alongside what may be the next wave of academicians to receive the honor.
What we hear at these types of conferences is not along the lines of a typical update on what fund XYZ is doing this quarter or what a firm’s prediction is for the future returns of German small cap stocks; rather, we instead learn firsthand about some of the most impactful research being conducted today in empirical financial economics. This year the topics ranged from a comparison of metrics used in structuring ‘value’ portfolios, evaluations of simulated versus empirical observations of dimensions of equity returns, and new ways to build portfolios for sustainable retirements.
The ideas discussed this year may evolve and grow into the ‘next big thing’ or they may have reached their intellectual end. It’s hard to know where the research stands in the process because of the rigor put into the work that is peer reviewed and scrutinized. This is a major differentiation between a firm that is academically rooted and one that is simply looking for investment strategies they can sell. As Eugene Fama puts it, “By the time a paper is published, you’re probably looking at the 200th draft.” When it comes to taking this research to the next level, it’s another laureate, Myron Scholes, who captures it best: “Ideas alone are cheap – implementation is what really counts.” This is what Dimensional has figured out better than most. Ideas around the dimensions of returns are all out there in the academic literature, and free for the taking. In fact, all of the data that Fama and French use is publicly available on Ken French’s website. The value Dimensional adds is how they as a firm implement these ideas. That is—the implementation is what matters.
Avoiding the trap of high fees and confusing “alpha” for “beta” are the foundations of another one of our primary partners for portfolio allocation and goal implementation on behalf of clients. Vanguard and their founder, Jack Bogle, are celebrating the 40th anniversary of the firm and their flagship S&P 500 index fund. Like many who have been in the industry for some time, Bogle knows that the outcome most are seeking is a stable and secure retirement. And as he puts it, one conclusion is clear: “So we know we have to invest. And there’s no better way to invest than a diversified list of stocks and bonds at very low cost.” 
At last I come back to the original idea of the weighing machine of the market. It’s easy to say a pound is a pound or a dollar is a dollar. But when you put these concepts through a long-term view of achieving goals, they’re clearly not the same. Feathers help you rest easy and sleep at night, while bricks are the basis of a strong foundation; both are necessary and important in their own way. A portfolio with bonds and stocks serves the same purposes for a successful retirement. Balancing the “pillow factor” of safety in quality bonds with the long-term foundation of tapping into the economic growth of owning companies of all sizes and values from across the globe should help us sleep well at night.
1 Source: Morningstar Direct. As of 8/31/2016 by assets under management
2 Source: http://www.wsj.com/articles/jack-bogle-the-undisputed-champion-of-the-long-run-1472855372