♪ >> eugene pharma is widely regarded as the father of modern finance. eugene: there is no -- >> say that again. eugene: there is no behavioral finance. >> the nobel laureate who has been at the university of chicago since the 1960's and educated thousands of students. one standout student, funded by the cofounder, david booth. >> we had a belief in markets, believe and how they work based on here.

look, we think we can go out, trading stocks, and not get killed. >> his relationship now extends five decades and is the bidding -- beginning of -- >> every new paper coming out was a landmark paper. it was all brand-new stuff. none of it was being applied. >> the two recently sat down at the school of business, named after david booth, following -- in 2008. for a wide-ranging conversation with barry. masters in business. barry: during your last year at tufts, you worked for harry ernst, who had a side gig running a stock market forecasting service. and you did research for him. what sort of work did you do with this stock forecasting research? eugene: the value schemes to beat the market.

[laughter] barry: and how did that work out? eugene: it worked out fine. [laughter] eugene: it didn't work out fine on the other sample. never did. that was a lesson [indiscernible] things that aren't really there. barry: and how did that research into forecasting the stock market, your thinking about whether or not the market could be beat? eugene: well, when i came here to chicago, research on asset prices begin to keep going in a very serious way. many people were interested in the question of stock prices adjusted to new information. put in context, they say it started because of computers. before 1960, we didn't have a serious computer to do data analysis on. says titian's and economist -- statisticians and economists.

stock prices were easily available. economists said how do we expect prices to behave if the world was working properly? in other words, if markets were working efficiently. that's what they were after. there were all kinds of theories proposed, that had lots of shortcomings to them. and you were in your senior year at tufts. you had applied here but never heard back from the school? is this an urban legend or it's true? eugene: it's true. [laughter] barry: so what happened? and the deanled, metcalf answered. that wouldn't happen today. the school is so much bigger. they wouldn't even have a telephone. way too important. he entered the phone and chatted for a while. he said we don't have any record

of your application. look at of grades do you have? we are tough. you need pretty much all as. i said i have a scholarship with your name on it. that's how i ended up at the university of chicago. [laughter] barry: you come here as a student, you're finishing your work. merton miller says to you, you want to stick around and do the researcher doing? is that how you became a professor here? barry: yeah. i had offers at some other places. but most of the places turned me down. they said i was to chicago. i don't know what that meant, actually. barry: these folks know exactly what that means. [laughter] weird tot was very have somebody from your own phd program on your faculty. barry: so david, you had a different experience. you grow up in kansas, get a ba in economics, and a masters.

what made you decide to come to chicago? david: i did a little bit of reading in finance. and i had a finance professor there, got his phd here. exploding,ance is really emerging as an academic discipline. it's one of the epicenters, clearly chicago. eo i thought, well it would b fun to be a professor. so i applied here. gene's class my first class. barry: was the dean correct? 50 years ago? eugene: yeah. it was the first year chicago had a football team in 34 years. [laughter] barry: and you had written about your experience taking a class with gene.

you called at life-changing and transformative. in what ways was at life-changing? life-changing, it led to a career. can't have a much bigger change than that. herechanging, everybody probably would like to think of themselves as having a public purpose. at the end of it all, when you get to be my age, you want to look back and think somehow the world was better for having been here. so, these ideas that were coming markets wasence of well-developed. they had already coined the term. and it was enormously useful. you look at the way money was managed 50 years ago, people were getting ripped off. fees are way too high. commissions were fixed by the government, about 10 times what they are today. sory: well, it's free today,

it's a lot more than gen x. david: yeah, yeah. i think there was a spirit we can improve people's lives, a real purpose to all of this. side.more on the research i thought my role in all this would be more on the application of the ideas. barry: so you become gene's teaching assistant. how did that come about? eugene: i was picked a student in the class from the previous year. barry: good student. eugene: he was the best in the class. [laughter] david: you don't have to left at that. [laughter] barry: so, that student, teachers a student -- teacher's assistant, why not a career in academia? david: first off, i realized i could not compete with gene. something that

caused me to reflect internally, what am i about? what do i enjoy? i just saw this as a great opportunity to apply all these ideas. people were developing. every new paper coming out was a landmark paper. it was all brand-new stuff. none of it was being applied. barry: we're going to come back to the application shortly. you mentioned these new groundbreaking papers were coming out. professor farmer, your doctoral thesis in 1964 was the behavioral of stock market prices. and this sentence jumps right off the page, " chart reading, though perhaps an interesting pastime, is of no real value to the stock market investor." so, this gets published in the journal of business in 1965. what sort of pushback you get from the general concept that

charts are of no use past market? market is of no future pricked ability going forward? eugene: got a lot of pushback. academics looked at the data, what they were saying, what they were showing, and adopted it right away. mean, if you had to summarize, really, the impact of all this, what was going on in chicago than really changed the way people think about investing. that's really been the same. and gene has changed the way people think about investing. barry: that's the pre-and post line, pre-pharma and post pharma? wait, i don't like the post pharma business. [laughter] barry: meaning post publication of your work. [laughter]

we not only have your doctoral thesis. we have the efficient market player, the farma french three factor paper. there were a number of very, very influential papers that david, if i'm hearing you correctly, you saying changed're the firmaments of finance forever. david: for the better. students, there's this antipathy towards finance and economics. realize how't much finances change for the better. people's's lives have been approved -- improved by these ideas and this research. lower fees, better risk control, and so forth. eugene: truth is, prices are so volatile, markets are always really efficient. they don't look any more efficient than they ever have with the introduction of the new

technology. ♪

♪ back in the days when active managers were dominant, inefficiencies could still be easily found, as could 2% fees. professionals didn't believe markets were efficient. they thought they were kind of sort of eventually efficient. i doubt many of them would say that today. what do you think has changed to bring so many people over to the efficient market theory? accumulation of performance evidence. so back then, there was no real evidence on how these people did. one of the first papers was mike jensen's thesis here, which studied mutual funds for the previous 25 years. and so basically they weren't

beating the market. now we know, in hindsight, that has to be true. that active management is a zero-sum game because they can't win from the passive managers because the passive people hold cap portfolios. they don't overweight and underweight to what the active people do. anybody under wedding and overweighting has to be managing the other side, doing the opposite. if one wins, the other loses. some of those is zero, before costs. arithmetic of active management. he calls it the arithmetic because it is arithmetic. it's not a proposition. it has to be true. barry: for every winner, there's a loser. eugene: right. barry: what about technology? how does that impact how fast it

makes its way into prices? eugene: it should make it better. the truth is, prices are so volatile, markets have always been really efficient. they don't look any more efficient than they ever have with the introduction of new technology. information is spread much more quickly now than it was 50 years ago because you have so many sources and they're so quick. you can see in the data it's had a quantum effect on the adjustment of prices. to information. barry: so, we may not see it explicitly in the data, the when we look at hedge fund performance, they did well before the financial crisis. since then, not as well. we look at the money flows away from expensive active towards inexpensive passive, it sounds like lots of investors are voting with their dollars that the market is efficient and we

can beat it. doesn't it seem like technology's driving some of that? because there used to be information asymmetries. there used to be inefficiencies a manager might have been able to find. sounds like it's harder to find those inefficiencies today than 30 years ago. eugene: you have better information than i do. it's always been hard. it's always been zero-sum game. david: i've been in the business almost 50 years. every year people say next year is going to be the stock pickers market. what gene's saying is it's impossible. barry: so let's talk about index funds. gene, you introduced david when he's finishing his mba and was to go out in the world to work, to john mcgowan at wells fargo, where they were developing as institutional product, the first

index fund. what made you think that that was a good fit for david? well, the man who was in charge, came to the seminar for business depot twice a year. [indiscernible] he seemed very into the new stuff. and so, when it came time to say i see what you do but i don't want to do it. [laughter] barry: as an academic. eugene: right. i would work here if you had a place for me, and needed. barry: what was your experience like that wells fargo? david: terrific experience. great exposure. i learned the importance of client work. i mean, investment business is and parthnology

client work. as i've told gene, i studied finance for two years. been studying client work for the last 48. ♪ stuff,we got into other but we had an easier argument. we ought to hold large, then small. you're not holding small. that was the sales pitch that put us on the map. ♪

♪ post wells fargo, you decide to open the small microcap fund out of your second bedroom in an apartment in brooklyn. tell us how you applied professor fama's research to that microcap fund. david: we decided not to have a portfolio like an index fund,

even though at first we called it an index fund because is very similar to indexing, with the final step being that we don't trade market on close like many indexes do. we what that means it is, would be trading stocks around the day. that created a lot of skepticism, particularly among academics. as you're going to the marketplace, you know you don't have discounted information. people on the other set of your trade think they know a lot about the stock. why won't they just rip your eyes out when you're trading? that's a legitimate question. barry: so what's the answer? david: there's a lot of things you can do to use the energy of markets and the power of markets. it turns out, for example, if we want to buy a stock, let's say, an institution wants to sell it, they'r intuition -- there is

intuition iseir greater than ours is. there's plenty of information outflow data about the stock you can use to protect yourself. but that wasn't known back then. it was just we had the belief and markets, believe and how they worked based on what we study here and said look, we think we can go out and trade these stocks and not get killed. theses there were two done on returns, and most of the academics, as well, looked good in terms of the crisp, historical data. but if you tried to traded, you get swamped by trading cards, and so-called micro stuff. and then we figured out what dimensional was. you didn't have to pay those spreads you are seeing.

you could do better with the prices, so we could deliver the small stock premium. barry: but previous to that, people weren't able to -- eugene: they couldn't believe it. what the academics learned is the micro stuff was garbage. interesting what we learned about clients along the way. in 1981, our initial clients were all large pension funds, insurance companies around the world. and they weren't holding the stocks of small companies, so really the pitch, we got into all this stuff, we had an easier argument, which was you ought to hold stocks from large companies and small, and you're not holding small. we'll get you access to small. that was really the sales pitch that put us on the map. barry: so that sales pitch starts to take off, and dimensional operating out of your apartment gets bigger. there's kind of an urban legend

that you called new york telephone to have them add six phone lines and they refused. they thought you were running a booking joint. is that true? david: this was the model of brooklyn heights. we started on a shoestring. i was the person -- the first portfolio manager of my bedroom. i knew we needed more phone lines. i called up the new york telephone, which was the telephone company at the time. lines,ed terrell phone six or eight or whatever. they thought i was a bookie so they wouldn't give me the lines. i had to call the treasurer and say, can you send some people down here and give me some telephone lines? they went around the whole block and found that there were six lines available in the whole block, based on their equivalent. and they said ok, you can have those six lines.

that's how we got started. barry: and the punchline is he becomes a client. david: yeah, right. they were a client. isry: so, from day one, gene a board member of dimensional funds from the day it launches. david: even before, the idea to start the firm. my first call was to gene. been 10 years's since i been in school. there's been a lot of research. we need to have access to new research and thinking. founders be one of the in terms ofyes research? he agreed to do that right away. barry: who else did you recruit? david: eventually, we wanted to create a mutual fund. and the mitchell fund has to have an independent board of

directors. so, we went over to the business school, merton miller's office. ok. yadda, small-company fund, need a company director. said oh, sure. walked out the door and down the hall. yadda yadda. point, business school was a lot smaller than. phd program, you have to know the faculty pretty well. so myron agreed to join, so on and so forth. until recently, all the independent directors of the mutual fund had taught in chicago. eugene: rick springfield was in my class, as well. it was the first one to put out an index fund, was in a?

-- wasn't he? david: no, s&p 500. rex was teaching. class. gene's he was a pain in the neck teaching assistant because he was interested in everything. barry: so gene, you moved pretty easily back and forth between academic theory and real-world application of theories. not a lot of people were able to bridge that gap between academics -- eugene: i hadn't been able to bridge it either until dimension came along. barry: but here it is 40 years later. eugene: right. the reason i couldn't is because one, i don't take a partyline. -- he and rexever never said would you do this? they said you do what you do and

we will figure out if we can use any of it. the university of chicago. they get nothing done. ♪ here, it all starts with a simple...

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glad i could help. at xfinity, we're here to make life simple. easy. awesome. so come ask, shop, discover at your xfinity store today. barry: so let me fast-forward a couple of decades to the mid to thousands. booth made the largest donation ever to a business school which has been called transformational. tell us about your thinking. to make ayou decide donation to your alma mater. david: it ties into the story we were talking about earlier. it got to be the stage where it

was time to pay back. i mean, i would not have been anywhere without chicago. i said i wanted to give a big chunk of what i had. barry: this is a mix of stocks and cash, correct? actually i did not have a lot of cash at that time. [laughter] we had just recently started to accumulate money. but i had stock in the firm and i gave them basically ownership of a big chunk of the stock i had. they were willing to take a bet on that. turned out to be a good bet. barry: and that comes with a dividend which continues to pay its way. were you at all concerned that you were right in the middle of a financial crisis, giving ownership of a financial firm? a lot of firms did not make it

through the crisis. david: maybe it ties in with the earlier question about what i learned about markets. in the depth of the financial crisis, you have to keep reminding people that markets are where buyers and sellers come together. voluntary-- a transaction both sides need to feel they have a good deal or they won't trade. a lot of well-known investors are investing. markets were functioning the way they ought to. gift: how did david's impact the graduate school of business? there was a lot of cash flow that was not there beforehand. [laughter] reacherst gave rise to -- research centers and made

everyone feel the future was more or less assured. the university also got a pretty good take out of it. they always do. [laughter] barry: david, you tell a charming story about sitting with the dean. it was not your intention for this to be a naming gift. they seem to have brought that up to you. david: for the reasons i outlined, i wanted to make a gift. so this is what i want to do. gosh,an at the time said, this is a lot better deal than what we were looking for. we will name a school after you. ok, whatever. [laughter] then, the school has continued to grow in both reputation and number of students. fast forward five years after

ne gets a phonee call from sweden. talk about that. what was that experience like? early in the morning, right? eugene: stockholm time, which is early in the morning here. it never expect to get because a lot of people could qualify to get it. there were newspaper people at my door not 10 minutes later after the call. they wanted to come in my house. i said, no way. [laughter] i had a class that morning. barry: you don't get a special did sensation? -- dispensation? eugene: you could, but i had

never missed a class and i was not going to start now. and i wasn't letting anyone in. the kids in class were paying a lot of money to take that course. no way i wanted people disturbing us. barry: david, you ended up going to stockholm. what was that experience like? course, being chicago-trained, i had been to the ceremony before. you are kind of used to this. [laughter] barry: third time is the charm? i said to gene, give me a night to organize something special. abba has a museum in stockholm and i talked them into renting me out of the museum for the evening. gene has four kids, eight grandkids, they are all big

music fans. has a lot of things you can do to have fun. withf them is a big stage for musicians singing and a microphone right in the middle. it looks like you are singing with them. the kids went wild. i looked over at could see they were having fun -- and could see they were having fun so it made it special for me. barry: some have described it as a surreal. eugene: the day after, they had a big event at the school. news and everything. of the circles around the building were full of students. peoplet day, the nobel had a camera committee, follow me across the harper center and the big atrium in the middle.

students over on one side, we walked down the middle and nobody looks up. we get to the other side and the television guy says nobody looked up. i said this is the university of chicago, if they had to look up every time a nobel prize winner walked by, they would get nothing done. [laughter] barry: and to show you how true that is, we got in an elevator on the floor to come down here and a student gets in wearing headphones. does not say a word to either view and we rode in silence. he was completely oblivious to who was in the elevator with him. i am always fascinated by that sort of stuff. i am the most important person. barry: you are? why is that. eugene: most of it is just criticism. --hout me, what have i got have they got?

[laughter] ♪

barry: value has a tendency to go through longer. priods, and for the past decade, if you weren't in big cap u.s. growth, you were underperforming. when we look at emerging markets, small-cap, value, heaven forbid you are in emerging markets. it has been terrible. what sort of lessons should investors take from this -- period?iord eugene: the question they want to ask is if a value is dead. i am writing a paper at the moment, but the bottom line is, there is so much volatility in

premiums you cannot shell if the premium -- tell if the premium has changed. the experience is well within the range of chance over the time it has occurred. there have been other times where value has done a -- done poorly. i remember hearing this value investor was washed up, this guy named warren buffett. usually, when you hear that, it is near the end of underperformance. you are suggesting we won't know for some time if the value premium is gone or if it is just a regular, cyclical underperformance. eugene: i don't think there are cycles to it. you go through good and bad per iods. you can't recognize them until after the fact.

we try predictive tests and they have marginal value. nothing worth focusing on. stucklly what you are with the volatility of equity returns. there's not a lot to say about expected returns going forward. , we have seen a huge proliferation of various effector funds. there are now hundreds identified. what does this mean for investors? has the proliferation of these factors been good or is it a nonevent? , it has beenance overstated, whatever it is. identified factors that seems to explain differences in average returns. but there can't be hundreds of

factors. at the end of the day, there are probably a few. , they try to-- ken take the research out there and get it down to -- barry: factors that matter. eugene: a lot of these are just different manifestations of the same thing. value can be in many different ways. you can use the market ratio come up the price, different variables to identify what is basically the same thing. there are thousands of finance professors out there who all want to get tenure. they have to publish to do that. so they are all searching through the data. stuff that may be there only on a chance basis. so there is lots of work being done and that remains to be done on what we call robustness.

how does it stand up with new data? we have always been into robustness in the sense that , we we found the 92 paper went back to data that started at 63. we collected data back to 26. then we looked at international data. pretty much the same thing everywhere. we have a bad period of this. i have to ask you a question about behavioral economics. where were in chicago could call it the birthplace of behavioral finance. what do you think about that area and what is your involvement? , my good friend richard taylor, king of behavioral finance -- barry: and another nobel

laureate. eugene: i tease him and say i am the most important person in behavioral finance. barry: you are? eugene: i am. most of behavioral finance is just a criticism of markets. without me, what have they got? [laughter] barry: and you and nick taylor -- dick taylor or golf partners. do you argue over 18 holes? eugene: we agree on the facts, we argue over interpretation. for example, he thinks the value premium is the result of perceptions of what economic information looks like. it's all based on misinterpretation of information. if you believe that, you believe it should go away. barry: but they still have

emotional reactions that sometimes they can't get by. eugene: that's the thing about behavioral economics. what the studies seem to show is that people don't learn from experience. if you are stupid you are repeatedly stupid. most people are stupid. barry: someone has to be on the wrong side of the trade. so you guys agree more than you might realize. eugene: we agree on the facts. barry: but not the interpretation. eugene: there is no behavioral finance. barry: say that again. eugene: it is all just a criticism of efficient markets with no evidence. [laughter] here?: is dick i think he would disagree. eugene: i am not so sure. when i put the challenge to him, he wrote a paper that said, ok, you have been criticizing us.

time to come up with a theory we can actually test. barry: and what was his response? eugene: we are still waiting. david: actually, you presented that paper at ucla. gene walks in and says, on the way over, i was thinking of breaking my leg so i could catch some something. fair, when taylor won the nobel prize, he admitted his plan was to spend the money as irrationally as possible. so even he agrees on that. wanted to ask about some of your comments on beta. 1993, you said data is dead. do you still believe the data is dead? the evidence says the relationship is to flat. it's a shame, because the model

is so simple. if it were true, it would make life a lot simpler, in many ways. it just has not worked well. can have a good career in financial services and look back on what you have accomplished. it is as simple as that. ♪

barry: if the market comes truly efficient one day, what happens to all of the management firms? that question assumes markets are not truly efficient today. how do you respond? eugene: what is the evidence? i think all of it is room. a studio management business will have very little active investment. you need some to make prices efficient.

the problem is, you don't expect them to be professional managers. you should get returns, you don't hand them to other people. that is of the human capital activity -- is the human capital activity. if you have a real skill, you should be charging. barry: this is for both of you. what sort of opportunity for outperformance do you see in private markets? given that that space is so much more opaque. eugene: the problem is there are lots of good people studying that, but they are hamstrung by the lack of good data on people who live and die. funnily enough, the managers who live and die -- barry: it's not like funds were they have to report. eugene: you get a very biased set of data.

it depends on what and of that business you go to. managers basically run the companies they buy. they may be able to add value, but it is management value. thatre picking companies have a good idea of how it runs. you probably will have a lot of value added in that case. that's the downside of that. barry: they are the ones who take all the profits out of it. eugene: that is the logic of human cap. -- capital. barry: i have to ask about bubbles. eugene: what do you mean by a bubble? barry: folks would describe a iod of excessive market enthusiasm that leads

prices to outstrip their fundamental valuations. isene: the way i interpreted you must be able to predict the .nd of it barry: predictable parameters and being able to define the end of it. eugene: it fails the test every time. people can't identify bubbles that way. barry: until after the fact. eugene: after the fact is easy. arounds a famous theory the early origins of market efficiency. when he went into the faculty lounge at stanford, he showed charts of prices and said these were charts of commodity prices. he wanted to know if they could identify bubbles. to a man, they all could. -- problem was, he was

showing them q motive numbers -- cumulative numbers. people see bubbles where there are none. barry: here is a really broad question. given the societal angst of people attacking the value of a business education, what is your belief in the value of this education here at booth and how should we communicate this better to society? it is incredibly valuable are toety because if we make lives better for people, part of the answer has to come from better and safer financial products. , i look back on my career working with gene. we have been part of the movement towards lower fees and better controls. i find it irritating when

somebody says the only advance has been the atm. that was paul volcker's quip. david: yeah. all this work, we have improved lives. and others, we are not the only ones. i think it is much better than that. people note to have get into business, particularly financial services. you can have a good career in financial services. at the end of it, you can look back on it and take pride in what you have accomplished. it's as simple as that. barry: that leads to the next question, what keeps both of you working? neither of you have to come up what keeps you going to the to, what keeps you going to the office? david: it's fun. it's fun to see retired people

living better as a result of these ideas. sending their kids to college or whatever. these are not ideas that have no importance. you can get behind this kind of idea. eugene: you get a lot of satisfaction out of coming out -- up with stuff people have never seen before. barry: we have time for one last question. i am going to go with something thet what do you think future of chicago booth looks like? what is next in store for the school? david: i have been on the faculty since 1963. a student since 1960. and in the 60's, basically, there was a good economics ruth -- group and a developing finance group. that was it. the business school was drunk. barry: -- junk. barry: right. eugene: that was not unique to

us. when i was recruiting as a student in college, the people recruiting said, why do you want to go to a business school? that was true them at the time. -- true, at the time. not just finance, but every other area has been more successful. marketing, accounting, statistics was always good whenever part of business schools. -- but never part of business schools. now we have really front rank faculty in every discipline. the school is so high-level competitive on the faculty and research side. there is no relation to what it was 50 years ago. it is totally different. , there was aside challenge and i had been complaining about for a long time, they don't work as hard as

they did. barry: ladies and gentlemen, thank you to eugene fatma and david booth. eugene: thank you. ♪ the game doesn't end after that insane buzzer beater.

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taylor: i am taylor riggs in for emily chang and this is the "best of bloomberg technology." hour, up in the next wilbert shares fall to a record low as the ride-hailing companies walk out period ends. plus, disney releases