Remembering John “Mac” McQuown, Whose Curiosity Drove a Life of Innovation

John Mac McQuown has been called an 80 year old whiz kid by Bloomberg Markets magazine, but he was a whiz long before entering his ninth decade. After graduating Harvard Business School and even while earning his stripes on Wall Street, Mac knew there had to be a better way to invest than trying to predict an unpredictable future. A self-described data dog with a long-running interest in share prices, Mac was among the first to use computers in his study and application of finance. When IBM asked him to speak to a group of West Coast executives about the way he used their machines, he met Ransom Cook, then, the President of Wells Fargo Bank. Soon, Cook had convinced Mac to relocate to San Francisco where he put together the team which designed and created one of the world's first index funds. One young member Mac chose for that team was David Booth, a newly minted MBA from the University of Chicago. The two men began a collaboration and friendship that would last for more than four decades. And the rest, as they say, is history. You've been involved very heavily in this transformation in finance and I think you, more than anybody I know, met everybody that's all the key players in this process. Probably the right place to start that point is, I met, my second year at Harvard, I met a professor from MIT who was a computer junkie. Now, sorry, but a computer junkie in those days, what would that, I mean, given that-- He had access to the 7090s at Lincoln Labs. Oh, okay. That was a sizeable machine, and at that time at Harvard, there was no computer. He was interested in stock price behavior and so I made a deal with my second-year professor to do a project with him and mostly what I did was, I was a data dog, I just collected data, he did most of the programming, I did some of the IO programming, input-output programming, and we examined share prices. The irony of the story, of course, is that we have no understanding of what was actually going on with share prices and it was totally conjectural. It's hard for people to believe that, let's say, when you were in business school, if you asked somebody, what's my historical rate of return on stocks-- You couldn't answer the question. Couldn't answer the question. No. So, since you couldn't answer it, people were free to speculate, so you would hear the wildest claim. Could be wild I think it's zero, or wild I think it's 15%. The teaching of finance, when I was in business school, was all about institutions. It was institutional finance, it was nothing to do with data, it was all about the banking regulations, the distinctions between savings and loans and commercial banks, what investment banks did or didn't. That was the whole story. I think that people thought returns were just there for the asking, which, of course, doesn't make any sense at all, right, 'cause in other words, the more you ask, the more returns you could get. Right. So everybody should be more or less infinitely rich. It doesn't quite fit the reality. Then the CRSP was a big turning point for a lot of reasons. So how did you get involved in CRSP and how did you hear about it the first time? In the fall of '63, I had been fussing around with share prices with the professor from MIT, in fact, the professor started a company and I was doing night duty when I was on Wall Street, continuing to be a data dog and doing some programming, mostly on weekends. Now you're doing this to try to pick winners, is that it? Yeah, we were trying to pick winners. You can admit to it, that's fine, that's what you did. So Bill said, you might be interested in going to a meeting because Jim Lorie and Larry Fischer from the University of Chicago are going to lay out their initial conclusions on returns on common stock. And it was in a little conference room, maybe 20, 30 people, and they spewed out what their initial conclusions were from returns from 1926 to 1960. My monkeying around with these prices, I couldn't make sense out of the distribution 'cause it didn't look like a normal distribution and while I certainly was not an expert in normal distributions, I had encountered plenty of them. It had tails, there was a lot of observations, they were way far away from the main. So I went up and introduced myself to Jim Lorie, and I asked him, I said, I wonder about these observations that are so far from the main. And he said, well, we have a student in Haskell Hall, the old business school building, his name is Gene Fama and he is working on that exact problem. So the long and the short of it is that Chicago and CRSP and the professors and students at Chicago were where all the work was going on. That's where you studied, look at Myron and Fischer Black, and Dick Roll and Mike Jensen and on and on and on. Those were pretty heady days, I mean, was it Chicago or is it just, did they just happen to benefit from random collection of bright young people coming in 'cause there are bright young people other places too. No. I don't think it was quite that random. There certainly was, there's always plenty of randomness around but, no. Hutchins set the pace for this unbridled line of inquiry that, to this day, still survives in Chicago. And an awful lot of people, especially in, what I would characterize as the hard social sciences and you know finance became the hard social science. But if you look at social sciences and their ability to have meaningful empirical results, finance is the only place. It is the only place. And, of course, Lorie had the foresight and the persuasion skills to get Merrill to put up the money to get the CRSP data. That was pivotal. That was totally pivotal. That was pivotal. Without data, it'd be-- Still conjectures. Data dogs like you collecting it-- And we would be spending out time collecting data not interpreting data, right? Right. No, I don't think it was random at all. And, you know, Merton Miller, if you really want to put your finger on the grandfather, or the godfather of modern finance, you'd have to say Merton Miller. Yeah, no, I think that's-- I don't think there's any, there's no second candidate. Not only for his own academic work but the influence he had on all the young people coming in around him. I was going to say the same thing, I mean, look at the cod-rate of students that emerge from Chicago in the 60s and 70s. It was phenomenal. And if you ask some of these stars that we're still associate with, who was really important to them, Merton Miller always-- He always comes up on as the number one. And if you ask guys like, another one of my favorite characters in those days was Bill Sharpe. And if you ask Bill Sharpe who the most influential people were around finance when he was evolving the capital asset pricing model, also in the 60s, it was Chicago people. You know, one of the key things that I think was important for the faculty was starting with Merton Miller and then Merton and Gene Fama, together, was they really created a team spirit which is very difficult to do in an academic institution. Absolutely. And Merton was famous, of course, for every lunch over the faculty club. They would have this big table they'd go sit at and anybody that wanted to-- Came and sat down. There's just no question that that's right. Yeah. And, you know, and the line of inquiry benefited from that collaborative attitude. And it was competitive but it was collaborative. And it's still pretty much the same. Yeah, I'd say it is. A lot of things were, obviously, going on in the mid-60s and at that time, there were any number of firms that created think tanks. So, what you did, really, was create a think tank. You call it the management sciences department. How'd that happen and how did that work? It started out, we had about four or five people, pretty fast. Within a couple of years, we had 20 and within a couple more years, we had 35. And most were PhDs, well, most were master's level from Chicago, from Stanford, from Berkeley. Manager of science department, you worked on a lot of things; what were some of the projects you worked on there that turned out to be important? Well, I was actually hired to work on the investment problem. And an awful lot of my personal energy and a lot of initial work went into it but it wasn't long before Dick Cooley got about five or six of us together one day, not in my group but in several different groups, and said, you know what, we've got to do deal with the BankAmericard that had just emerged, piece of plastic credit card. Of course, at that time, Bank of America was a San Francisco bank and Wells Fargo was a-- Right across the street from each other, big competitors. So, having a BankAmericard was a big deal. That was a very big deal. So, he says, we have to figure out a solution for a competitive offering. So the group of us worked for quite a number of weeks to come up with a strategy that involved pulling together the other major banks in California and creating a collaborative card which we called MasterCharge, actually. Right, I remember. And so, MasterCard was a product of a lot of our think work. Now, we have kind of, that's the backdrop with the management science apartment think tank, you know. Now, let's focus more back on the investment side. You know, what was kind of the history that led up to the development of index funds? The think that I remember the most vividly and was a comment that Ransom made and Dick mirrored, in fact, both of those guys and, to tell you the truth, I can't really remember which came first, whether it was Ransom or Dick but they were both of the same mind. They said, DeFont, look, deposits and loans are insufficient offering for a bank. We've really got to have investment management working. They had the trust business, and a big one. Wells had the biggest trust bank in the west. Both corporate and personal trust. But Ransom or Dick said, you know, the big problem is performance. We've got to have a strategy, as he put it, that take performance off the table. You can't sell investment management if performance isn't relatively well understood and can be communicated. And we had gone to work on trying to solve that problem and we really were nowhere. Well, of course, the difference, everybody else was getting nowhere too. The difference in the management sciences group was that they understood how to sample test and so forth. They understood that they were getting nowhere. That's right. Whereas, a lot of other people thought they were getting somewhere-- No, that's right. Even though it turned out to be nowhere. No, that is absolutely right. And I'll tell you who I think for that, Myron Scholes. Well, how did you meet Myron. Well, I met Myron because of Gene. Oh, okay. It was one of Gene's students. Right, yep. And I invited Myron to come and spend a month or two, whatever it was, to evaluate some of our modeling efforts. And he basically cleared up the ambiguity for me. He just said, this isn't going to work. So, I said, okay, Myron, what is gonna work? And he says, I don't know. And I said, well, how are we going to solve that problem? He says, well, there's a very smart guy that I want you to meet. His name is Fischer Black. And we'll go to work on the problem if you'll finance it. Myron was an assistant professor at MIT. Fischer was very interested in the problem and he left Arthur D. Little and they formed Associates in Financing-- Oh, okay. The two of them. Oh, that's what, okay. And their first client and, for many years, their only client was Wells Fargo. Yeah, right, okay. So now we've got this, and we got Fischer and Myron coming out regularly to San Francisco. Once a month. Yeah. They focused on the issue of just having a massive portfolio, initially, of equal weight in stocks. And then we realized that they had their market cap rate weighted and that looked like an index. So, the next thing you know, we're fussing around with the S and P 500 index and while were messing with a number of indexes, actually, but we ended up settling on the S and P 500. And we were just getting better. We were getting better performance, especially risk adjusted out of the S and P 500 index than we were getting out of any one of these models. But you'd be surprised how radical, well, you wouldn't be surprised but the world would be surprised how radical a view that was in 1970 or 1969, or whenever that was, we finally emerged. You're working closely with Fischer and Myron and they're coming up with something that eventually becomes label and index fund, okay. Now, and you went around, talked to various people, Ford, R.J. Miller, and Bob White but then, Samsonite, the pension fund. Right. Stuck its head up and said, look, here's some real money to invest, I mean, that's when things changed. Goes from theory to here's some money. How'd that come about? That's right, Samsonite in Denver was a family enterprise, the Shwayder family owned most of it or whatever, controlled it, and their son, Keith, who was maybe a few years older than I was, at the time, had graduated from Chicago, PhD in finance from Chicago. Ray Clark got the assignment from Keith Shwayder to figure out what to do with the pension fund. Right. That was the problem. And Ray had gotten his MBA from Chicago. They called up Jim Lorie and Jim Lorie called me and I went to Denver and met Ray Clark and Keith Shwayder. Right. And it wasn't very long before they were ready to have a big chunk of their pension fund, five or ten million. Nothing, really, very significant. It was, hey look, you could still make a pay phone call for a dime, too, at the time. That's true. So, then, that put us in a position at Wells where we actually had to do it. Right. And that created a big controversy because we were supposed to be doing research, we weren't supposed to be managing money. Well, yeah, that's actually, it was about that time I met you. That's right. Summer of '71, right? Yeah, right. Well, one thing led to another and Dick Cooley, the boss, said set up a separate unit and go do it. Well, describe a little more fully the tension between the trust department and the management sciences department. Well, the trust department was a traditional trust department, right. Fiduciary responsibility over trust accounts that were set up by beneficiaries. And part of it was the law, even though you had a well-diversified portfolio. If any one stock went under, then you risked being surcharged in that one stock. So, all trust departments were pretty sleepy. Yeah, they were, and you put your finger on a very important point. Our lawyers, at the time, were quite concerned about running afoul in various banking regulations and especially the Prudent Man Rule. Just stop and think about the Prudent Man Rule. The Prudent Man Rule says, in essence, that the right way to conduct prudent investment management is to find a prudent investor and do what he or she does. It doesn't say anything about how to find such an investor. It doesn't tell you what criteria you judge prudence. What did the trust department think of all your work? Oh, they didn't like it at all. We were mutually ostracizing each other, I would say. I caught some of that, yeah, right. Ultimately, of course, we ended up being quite mutually simpatico but, boy, it was pretty rugged for a while but, anyway, Dick insisted that we do it and he just told the trust guys to work with him and the traders were going to come out of the trust department, we didn't have any traders but we did set up a completely separate group. And the initial index fund, of course, they decided they wanted the New York Stock Exchange index and, of course, that index was equally weighted, originally. Yeah, right. They rarely talk about equal weighted indexes but back in those days, whether you had an S and P 500 which was capitalization weighted or an equal weighted index or make up your own index, it was-- It was just all kind of, or how about the Dow-30, right? Yeah, right, the Dow. A really, really incredibly complicated algorithm, I mean, nobody could, you couldn't understand it if you tried. Right. So, anyway, that didn't actually work. We figured it out pretty fast. But went live though. We went live with equal-- It turned out to be a big success but just wasn't something that you could replicate it indefinitely. That's right. So, that causes us to morph to an S and P 500 index. And the reason we chose that was because it was common parlance. Yeah, right. And it had become kind of the established benchmark. We didn't even call them benchmarks in those days but, today, we would call it benchmark. And that's, I came work with you to create the Stagecoach Fund. You know, Mac, one thing I've always, I've never asked you and I'm curious about was that when we first met, your view of how that meeting came about and what you thought when you met me-- Well, the part I remember is I got this call from Gene-- From Fama. From Fama, from Fama. And he said, you know, I have this fellow, David Booth, who's been in the PhD program, he's been my research assistant, now, for a year or two or whatever, and he's made up his mind that he doesn't want to finish the doctoral program, he wants to actually go out into the world and work. So, of course, you and your management sciences efforts and so forth came to mind, immediately, and I'd like to have you meet him. I said, why don't you tell me a little bit more about him. He said, well, he was trained in math and he's a Kansan. And he came to Chicago because he was interested in finance and he's been here, now, for three years or whatever. It was two, yeah. Two years. I'm really fond of him, I like him personally and I said, well, I'd love to meet him. So, I more or less got on an airplane. I was always in the market for people, especially when Gene or anyone like Merton or Gene or Jim or anybody liked one of their students, I was always there. And it was, right away, clear to me that you were a straight-shooting guy and my style, for sure. And I didn't take me more than, I think within the first 15 minutes, I pretty much made up my mind that I was ready to make you a deal. And from my side, it was incredibly exciting because this notion, indexing was really the first application of the new way of thinking. You know academic research totally changed the world, it uh, it created the optional pricing model index funds. I didn't know about the option pricing law, this was a couple of years before the option pricing law. It was in the works. But it was in the works. But it wasn't out. So, indexing was the only application of-- It was. Of the research. So it was an incredibly exciting opportunity for me, plus, getting to work with you was a bonus. You know, the two biggest ideas in my view in the 20th century or, maybe, in the history in finance, are the options pricing model and index funds. That's right. Like, I don't know anything else-- I agree with you. Or the time weighted rate of return, you know. Well, I was going to say, I would agree with the time weighted rate of return. But I also think the capital asset pricing model. Yeah. However, that's a much more conjectural subject. Yeah, but, no, it's very important. But if you look at what's transformative, you look at how the world changed as a result of something, it's the index funds. Of course, index funds were related to the capital asset pricing model. Yeah. Indexing and options pricing are the biggest thing in finance and there aren't that many industries in any field that have had such a paradigm shift as that came from those two things. That's right. Most of them come to life in the early 70s. That's right. You know, in some ways, it's kinda funny, I tell people, you know, this period is windowed from mid-50s to mid-70s, starting with Markowitz's dissertation. Yep. True to the development of the Merton's multifactor theory and, of course, option pricing was in that. Let's call that the inventive period. That's the fundamental shift. Miller-Modigliani theorems and all of that. There hasn't been anything in the last 40 years. No. That's that transformative. No. So, those were really heady times. No, they were incredibly heady times and, you know, it felt like it too. The critical part of it, David, I think was respect for customers. I don't know where we got that, exactly. Maybe I got it, in my case, in think, from my father. You may have gotten it from your dad too. I mean, it could easily have been-- Well, I got a healthy dose from Fama, you know. He's basically had a lifetime of truth-- Yeah, for sure. And that's really what it's about, I mean, that's what sharing, understanding what the truth is about investing. Right. The best we knew it, at the time. Well, I mean, that the customer comes first, somewhere along the line, I learned that. And you learned the same thing. Well, yeah, my job's selling shoes, you know. Yeah, that's right, that's right. I mean, I don't think anything is more significant than that particular point, to tell you the truth. No, if you're willing to work for the clients, eventually, you-- I mean, they're the ones that are paying you, right? They're the ones paying you. I mean, I don't understand an awful lot of the existing financial industry because they don't honor that point at all. We had a very bizarre way of trading. Most people can't remember that you had fixed commission rates. That's right. Back in those days. Instead of negotiated rates like we have. And so, commissions were about, roughly, 10 times what they are today. That's right. So trading had to be done a particular way and we did spend a lot of time thinking about how does a passive person go into the marketplace go and trade. So, I think we had two problems. And you and I, among others, talked about both problems. One was we had the trading problem. 'Cause when you're faced with no information, and everybody on the other side of the trade has, that you know they have more information than you do 'cause you have zero. You have a problem, right? Right. And the second problem we have is marketing. How do we actually build a story? How do we sell these ideas? And, I think, especially initially to the institutions, but we were still already focused on individuals, right, 'cause we knew that we needed to get to the individuals. Not just the institutions. Right. And that flies in the face of the entire investment management industry, the securities industry, and it was clear that we were going to be running against the tide on that one and we had to figure out a way to do it. Tell us what the move onto 1980 and the formation of Dimensional and your incredibly important role in the formation of the company. It became clear that there was a business opportunity and from my side, I never, I'd actually never managed money and hadn't managed people. That's why I gave you a call and also, just your experience and just being you, I mean, it was exactly the same month that Reagan got elected for the first time. And we talked about forming the company and we really laid it out just almost precisely the way it evolved. And on Friday after Thanksgiving, we sat down and, I think, within the course of an hour, we said, okay, what are we going to do. And I said, they're something in small caps. And you said, there must be something in small caps. Yeah, right. But the most important thing was that the pensions funds weren't invested in the stocks. Well, that's right, we had a natural, I mean, going back to the issue of marketing. Right. We had a natural strategy. Exactly. And because institutions weren't-- They were underweighted in those stocks, right. And they knew they were underweighted. That's right, and they didn't know how to get out of it. So, I think, it couldn't have been more than, in an hour, we, more or less, made up our mind that we were going to do Dimensional. Right. And we were going to start with small caps. So you're starting out with a new strategy, you got a time bomb ticking away. Exactly. I often tell people, when they say, were those the good ole days, I said, people think those were the good ole days-- Boy, oh, boy. Didn't live through them. And wow, I mean, I don't know how in the hell you pulled that off. One of the big issues was cash. I was still single at that time and, living in New York, I hadn't saved any money to speak of but, nevertheless, we didn't pay ourselves anything for several years. In fact, then, we went and borrowed some money-- That's right. And we had to sign personally on it. We went to American National Chicago, got the bank to lend us money. That's right. And we all signed our lives away but the trick was, the only one that counted was yours because none of us had any assets and, of course, world headquarters was my apartment in Brooklyn Heights. And I remember, you know, there was a writer's terminal, I guess, what, no-- No, it was a Quotron machine. It was a Quotron machine. Oh, gosh. Because I had actually never managed money before, I didn't realize that, to drive the desktop, it required having this enormous CPU which was the size of an upright refrigerator. And when they delivered it, the other thing I didn't know was it made a noise unlike, not unlike out of jet engine. I mean, it was, it was so overwhelming that you couldn't sit in the same room with it. So, I did have a sauna, so we ripped that out and soundproofed it the best we could. And air conditioned it. So I had the only air conditioned sauna in Brooklyn Heights. I think the absurdity of it all may be best reflected by the, here we are, we have a startup firm with a conceptual idea in somebody's apartment in Brooklyn Heights that had never traded any money and who has got money in. Did they have confidence in us or were they just nuts? What I've learned from all of this in my 35 years is the power of ideas. If you have an overwhelming idea, you can be an underfunded firm operating out of your apartment. Rational fiduciary people were buying into it. Actually, we haven't even stated the problem hard enough yet. And, not only are you operating in Brooklyn Heights, and your first nine years, your performance is very disappointing, as we happened to start at the beginning of the worst nine-year run for stocks ever. A big down-draft. Yeah, so, I go back to this profound idea, the set of ideas around which we built the firm were just bigger than the firm. That's right. It helps explain how we were able to attract clients in those early years. And keep 'em. And keep 'em. It also helps explain, I think, the culture that we've been able to create-- And exists to this day. To this day. People sometimes say, how were you able to attract these academics and, even more importantly, keep them involved and very active in your firm? It's 'cause it's the ideas, it's not, it's not anything that you and I, you know, said or did in those early years that was particularly clever. No. It's the ideas. No, no. It was the ideas and, David, I'll tell you, I think maybe the most surprising thing of all was we collected around us a group of idea-centric individuals sharing the same principles that were willing to be entrepreneurs. That doesn't happen in the same individuals very often. When I reflect on that beginning, David, I'm struck by the unusual mix of ideas and analytical skills and, all of a sudden, we all kinda became entrepreneurs and Fama included and he might be one of the least likely candidates to be an entrepreneur if you read his papers. You have to get to know Gene-- Yeah, right. To recognize his entrepreneurial nature. Right, that's true. I think it's so rare to find that combination in just a couple of individuals. Usually, it's a much more complicated story, the inventor or the idea guy has to get teamed up with some kind of a managerial skill and it usually gets financed by a venture capital firm of some kind or an angel or whatever. And that wasn't the case, that wasn't the case. You were my investment banker, Mac. Yeah, yeah, well it was, we were creative. What I recall is just cutting deals wherever I could. Anything that increased the chance of surviving. That's the story. We also didn't pay out a dividend to shareholders in the maximum-- Oh yeah, no, no. For 15 years. That's right. So, it was, as we got successful, we kept plowing everything back into the firm. Back into the firm, right. So, if I had to do it all over again, I'd love to do it again, you know. Why, are you kidding? It just, it wasn't quite as easy as it now appears. Well-- It wasn't but, you know, I wasn't focused on whether the firm was going to get the 400 billion in assets under management or 500 billion of assets under management, what I knew then and I know now is that this set of ideas is compelling. And, sooner or later, the world is going to come around to seeing the validity of this form of investing. When you stop and think about it, what we've had, almost, what, 40 years since index funds emerged, and I don't know what fraction of the total investment market is represented by passive today but it's something like 30 or 40%. Amazing. There's never been an investment strategy that took 30 or 40% of the entire market in 40 years. No, that's uh-- That never happened. Reflecting on the history, you've been a director, now, since we, even before we had the firm. What are some of the thoughts you'd like to leave with new employees coming into the firm? Well, innovation is going to continue to be the hallmark of Dimensional, I'm really persuaded. I see it not only in you but I see it in Dave Butler and Gerard and the people we hire are interested in innovation. And they're not complacent in playing the hand that they've been dealt, they want to improve things and it's client-focused, it's completely client-centric. I think that that's a winning combination. And I don't know what the upper limit is, I don't thing there is one.