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Exclusive Interview: Academic Icon Roger Ibbotson says Rush to Regulate Inhibits Competitiveness

July 21
00:02 2015

If you’ve ever invested for yourself or have been involved in the investment industry, you’re very likely familiar with the famous Stocks/Bonds/Cash Return comparison chart. Would you believe, for decades such a universally accepted chart
Roger_Ibbotson_300did not exist? It wasn’t until the 1970s, when a young finance researcher decided to assemble the data, that the basis for that chart was born. This month, FiduciaryNews.com is honored to interview Roger Ibbotson, Professor in the Practice Emeritus of Finance at Yale University’s School of Management and founding author of the oft-referenced
Stocks, Bonds, Bills and Inflation Yearbook series (“SBBI”).

Professor Ibbotson isn’t merely a researcher, he’s also a practitioner. He sold his company Ibbotson Associates to Morningstar, Inc. in 2006 and is now Chairman and CIO of Zebra Capital Management. Among the things he explains to our readers is how the interplay of research and practice management enhances both endeavors. Professor Ibbotson received his bachelor’s degree in mathematics from Purdue University, his MBA from Indiana University, and his PhD from the University of Chicago. A frequent speaker at industry conferences, university forums, and other events, he currently serves on numerous boards including Dimensional Fund Advisors’ funds.

FN: Tell us a little bit about your background. How did a nice guy like you end up studying and researching finance? What led you to become a practitioner? Which side of the profit line do you prefer?
Ibbotson: I’ll go way back to the 1950s when my father was getting back into the stock market. People were reluctant to get into the market following the 1930s. As a teenager I wanted to get into the stock market, which I did through a Uniform Gift to Minors Account I had set up on my behalf. I started investing and I soon found out my stocks were going up more than my summer job was paying. My interest in stocks and the market carried over into my college years. Although I majored in physics and math, I was one of the few student who avidly read the Wall Street Journal every day. One of the companies that interested me was Comsat. At the time it was about to go public. While looking for a summer job in Chicago during college, I managed to subscribe to 100 shares. I got in at the IPO price of $20 per share. That summer Comsat’s price got to $70. I knew it would go up because it was way oversubscribed. To have $2,000 go to $7,000, it had a big impact. I sold it. Back then, $7,000 was a lot of money, and not just for a college student. I ended up doing my dissertation on IPOs at the University of Chicago. My dissertation showed IPOs tended to pop up 15% on average.

FN: How has your academic research made you a better practitioner?
Ibbotson: All my practices are informed by not only my own academic research but the cumulative research of the entire academic field. It essentially tells you what to look for – what’s an alpha, what’s a beta. It’s a great background to understand markets because there’s a huge literature where people study all angles of the market. Try to see it from the perspective of what you can do. This research is freely available.

FN: How has being a practitioner enhanced your research insights?
Ibbotson: All my research is applied – it’s practical research. I’m aware of the theories, but I’m doing research that has an immediate benefit. A lot of my co-authors come from the industry. I’ve often worked with practitioners and it has enhanced my academic research to know what the relevant questions are. Essentially, real-world practice helps you know what to look for. It’s a lot easier to search for insights when know what you’re looking for.

FN: What’s the most memorable thing you’ve accomplished?
Ibbotson: It’s SBBI. It was done in the 1970s. I was studying for my PhD at the time, but I was working in the investment office at the University of Chicago (managing the bonds).  Back then, we knew there were premiums in the market, but there was no data. All the anecdotal evidence said there were risk premiums, but there was no empirical data to support this in general terms. We put it together to demonstrate what those premiums were. You could measure all these premiums and break them up into their components. You could also make forecasts. The real key was putting the data together. I wasn’t surprised that SBBI became an industry standard because the industry needed the numbers not only in the investment field, but also in the valuation and corporate finance fields, (via the discount rate and the cost of capital). The data in SBBI gives you an empirical understanding the connections between the various markets.

FN: In looking at the broader industry, what’s your take one the fiduciary debate going on in Washington?
Ibbotson: I was originally on an Advisory Committee regarding the fiduciary standards. I advocated that when you’re participating in investing activities they should adhere to the fiduciary standard. I recognize the complications of this issue, but when they’re acting as an investment adviser they should be a fiduciary.

FN: What’s the most significant (i.e., positive) thing to come out of the finance departments of academia? What’s the most irrelevant idea to spawn from the area?
Ibbotson: The whole idea of efficient capital markets, I think this is the basic starting point. This comes from the classical Modern Portfolio Theory. Your starting point is always equilibrium. There are so many irrelevant ideas. Unfortunately, a lot of the work is specialized and technical and uninteresting to practitioners. Academics move in their own way. One paper can be a catalyst for other papers. The real problem is that academics mostly tend to write about other academics’ papers.

FN: Your work has become the backbone of much of the data-oriented research in matters relating to Modern Portfolio Theory. Indeed, it – in particular through your famous “Stocks-Bond-Cash” investment return comparison chart – has crossed the divide and become a de facto standard in nearly every business presentation. At the same time, your colleagues at Yale (notably Robert Schiller and James Choi) have moved our understanding of behavioral finance to unprecedented levels. What’s your take on the evolution from the stochastic logistical models of Modern Portfolio Theory to the almost quantum-like psychology of behavioral finance?
Ibbotson: We know that markets are not perfectly efficient and that there are distortions. Behavioral finance begins to pick away at this. Together with Thomas M. Idzorek, I recently co-authored a paper on “popularity” (“Dimensions of Popularity,” Journal of Financial Management, Fall 2014 Vol. 40, No. 5: pp 68-74). In order for a premium to be a permanent premium it has to be systematically unpopular. Once you begin looking at things from a behavioral perspective you can discover this. The kinds of things that people like and don’t like drives long-term premiums. For example, people don’t like value, so the value premium is likely to be permanent. Mis-pricings occur when something becomes unpopular, but only for a short time.

FN: Turning back to the industry, what’s the most important development in the financial services arena you’ve seen? What is the one thing it has done that you wish it hadn’t?
Ibbotson: The industry has developed tremendously in the last 30/40 years. It’s hard for me to pinpoint any one thing because it has dramatically changed from just stocks and bonds to almost everything. It’s become institutionalized. We have ETFs. We have alternatives. The industry has become much more complex. Distribution channels have changed. Individuals don’t typically buy stocks anymore, they buy investment products. The danger is that there may be a lot of fees in these new business models. While trading costs have gone down, fee structures have risen. I think we’re offering individuals a much better service and product, but the fees have gone up as a result. The good news is that the cost is starting to go down as fees are becoming more transparent and people recognize that costs have a significant impact on long-term returns.

FN: OK, you’ve had your toe in the water in both those previous environments, but here’s one you might have less experience with (at least on the hands-on side): What’s the best action (post 1926) you’ve seen from government investment regulators? What’s the worst act government investment regulators have committed?
Ibbotson: The single best thing that came out of the government regulatory apparatus was deposit insurance – we’ve had limited runs on banks since then. This means there’s always a safe haven for individual investors, just like Treasury Bills represent a safe haven for institutional investors. Having a risk free investment is important, especially if it’s accessible. On the flip side, I’m not happy with the rush to regulate after every crisis. These regulations have made finance so complicated that they may have reduced the competitiveness in the industry.

FN: Professor Ibbotson, we are honored to have you been this month’s exclusive interview. Your thoughts and comments have been most enlightening.

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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