Gerard O’Reilly: Deep Dive with Dimensional’s co-CEO & CIO (EP.198)
The Rational Reminder Podcast
Accrual-based Accounting and Cash Profitability
This chapter discusses the concept of accrual-based accounting and its relation to matching revenues with costs. They compare accrual-based accounting to cash profitability and argue that accrual-based accounting is more informative. They also discuss the differences between cash profitability and operating profitability as predictors of future operating profits.
You don’t need to be a rocket scientist to work at Dimensional Fund Advisors, but Gerard O’Reilly sees it as an asset, particularly when it comes to problem-solving. Now the Co-CEO and Chief Investment Officer of one of the fastest-growing US investment businesses, Gerard received a Ph.D. in aeronautics before entering fund management, attracted to Dimensional because of the opportunity it afforded him to learn from the world-leading economists at the company; including Eugene Fama, Myron Scholes, Merton Miller, Robert Merton, and Ken French. We recently sat down with Gerard to discuss the firm’s research-based culture and rules-based approach to investing. In this episode, we get into the nitty-gritty regarding Dimensional’s distinctive portfolio management decisions and the data sources they draw from and Gerard answers some technical questions regarding risk assessment, factor tilted portfolios, operating profitability, goodwill, and more. We also touch on the value of combining multiple metrics, why small-cap stocks deserve a place in your portfolio, and some of the biggest changes that Gerard has witnessed in Dimensional portfolios over the past decade, as well as how he applies his scientific learnings to make unique portfolio adjustments and some of the various benefits of Dimensional’s integrated approach. Make sure not to miss this informative, insightful, and in-depth conversation with Dimensional CIO and Co-CEO, Gerard O’Reilly!
Key Points From This Episode:
- Market-cap-weighted passive strategies versus Dimensional’s rules-based higher expected return strategy. [0:03:45]
- Assessing risk based on the Intertemporal Capital Asset Pricing Model (ICAPM). [0:07:07]
- Diversification in a factor tilted portfolio versus a cap-weighted market portfolio. [0:10:57]
- What criteria the variables that Dimensional uses need to meet before they’re considered dimensions of expected returns. [0:13:00]
- Sources Dimensional draws from regarding portfolio decisions and implementation. [0:16:09]
- How Gerard decides between underweighting or excluding securities in portfolios. [0:19:59]
- Why Dimensional uses operating profitability rather than cash-based profitability. [0:22:38]
- Gerard’s view on intangible assets, goodwill, and Dimensional’s investment strategy. [0:29:31]
- The value of including internally developed intangibles in value and profitability metrics. [0:37:49]
- Gerard reflects on the opinion that Fama and French’s findings are no longer valid. [0:42:58]
- Whether or not it’s better to combine multiple metrics to measure relative price. [0:46:41]
- How Dimensional targets value and profitability together (for large and small caps). [0:50:39]
- How Gerard thinks about capacity for investment strategies in small and micro-cap stocks as Dimensional continues to grow. [0:54:03]
- Understanding how entering into the ETF market has impacted his thinking. [0:57:24]
- Expected premiums for owning smaller stocks over larger ones. [0:58:50]
- The importance of security lending revenue for expected returns on Dimensional funds; improving the investor experience. [1:00:12]
- How Dimensional deals with sector weights and the role that diversification plays. [1:04:12]
- Why they decided to implement credit, despite research to suggest that it doesn’t add an independent source of expected returns. [1:06:08]
- Some of the biggest changes in Dimensional portfolios over the past 10 years. [1:10:23]
- How Gerard applies his scientific learnings to make unique portfolio adjustments. [1:12:52]
- Comparing Dimensional’s core and vector strategies with a combined cap-weighted portfolio; from fees to the benefits of hindsight and more. [1:15:15]
- Papers that seemed compelling but were deemed ineffective by their research team. [1:19:11]
- Insight into Dimensional’s decision to make their internal research public. [1:21:42]
- Why their rules-based approach is the hardest part of Dimensional to replicate. [1:25:55]
- What to be aware of when comparing backtests: how data can be manipulated. [1:30:06]
- Valuable lessons and perspectives Gerard has learned from their competitors. [1:32:22]
- Commonalities between aeronautics and asset management, like problem-solving. [1:35:20]
- Why Gerard believes that having his own financial advisor is invaluable. [1:36:55]
- Gerard explains why we might expect factor premiums to persist in equilibrium. [1:38:28]
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