After years in which many large institutions channeled their focus and resources into private markets, investors are taking a harder look at the stocks, bonds, and other public securities that still make up the bulk of their portfolios. Some institutional investors, in revisiting their public market exposures, are finding that broad index strategies come with structural frictions — from reconstitution effects to hidden cash positions — that can materially shape returns.

“A broad trend among institutional investors was go cheap and cheerful on the public side and put all their time in private markets,” says Gerard O’Reilly, co‑CEO of Dimensional Fund Advisors. “And I think that lessons that have been learned is that by doing that, and if 60 percent to 70 percent of your allocation is in public markets, you've left actually a lot of money on the table with a big chunk of your allocation.”

In episode 14 of In Conversation With Julie Segal, O’Reilly described how that renewed attention is reshaping institutional questions and behaviors — not away from indexing’s core virtues, but away from rigid indexing. It’s a shift that happens to align neatly with the philosophy Dimensional was built around when it was co-founded by David Booth and Rex Sinquefield in 1981. The co-founders wanted an asset management firm that would nurture the innovative theories about market efficiency that had been coming from the University of Chicago Graduate School of Business (now the Booth School of Business) since the mid-1950s. 

(Listen to the full conversation on Spotify, Apple Podcasts or by scrolling to the end of this article.)

For more than a decade, investment teams focused on building their private markets portfolios. The portion of public markets that was passive was often treated as a solved problem to be handled through funds that tracked broad, low‑cost benchmarks or managed in-house. 

But the combination of rising benchmark concentration, periodic liquidity shocks, and increasingly expensive index mechanics has chipped away at the idea that this is simple. If anything, O’Reilly argues, the S&P 500 and other benchmarks now require more scrutiny, not less.

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Dimensional’s approach has always been grounded in a simple academic premise: markets do a remarkable job of setting prices, so investors don’t need to outguess them — but they do need to make smart decisions around how to access them.

On the podcast, O’Reilly offers examples from day‑to‑day market behavior. One of the clearest is what happens when a company is acquired for cash. He describes Kellanova, which jumped from the low $60s to the low $80s after the all‑cash deal was announced and then effectively “traded like cash” while the transaction closed — even as the market returned more than 15 percent over that period. “We don’t need to have that stock in the portfolio if the market thinks that it’s going to trade like cash,” he says.

Momentum is another area where Dimensional departs from strict index rules. Using Alcoa as an example, O’Reilly notes that when a stock moves from small‑cap to mid‑cap territory, they don’t automatically sell it if it’s exhibiting strong upward momentum. Likewise, they avoid buying stocks with pronounced negative momentum until the downward trend has played out. These are small, local decisions, but they compound.

Whereas many institutional managers might represent 10 to 20 percent of a stock’s average daily volume when they trade, Dimensional typically represents 2 percent or less. The firm turns over portfolios incrementally every day, which gives it time to wait for natural liquidity rather than forcing trades.

The through line across all of these decisions traces back to Dimensional’s earliest days and the academic culture that shaped it.

The debate between active and passive, O’Reilly argues, misses the real issue. “Every investment approach makes active choices,” he says. “The question is what kind of active choices?”

Indexes make them in classification rules and country decisions, among others. Traditional active managers make them in forecasts, factor bets, and security selection. Dimensional positions itself between the two: embracing indexing’s virtues (low cost, diversification, low turnover) but rejecting its rigidity.

“Indexing is too inflexible,” O’Reilly says plainly. Instead, Dimensional asks whether patterns in the data have a sensible economic story, appear across regions and time periods, and add information beyond what the firm already accounts for. If not, they’re discarded.

Fixed income illustrates the point. When academic research suggested that equity‑style factors might also explain bond returns, Dimensional’s team put the idea through its usual gauntlet. Once they controlled for forward rates — the market’s own embedded expected return — most of these effects vanished. “Simple is generally better,” O’Reilly says.

As institutions rethink public market exposures, O’Reilly says some have shifted from in‑house index replication to Dimensional’s strategies, prioritizing implementation and total value rather than fee minimums alone.

One state pension saw that Dimensional’s securities‑lending revenues were several times higher than category averages in both developed and emerging markets. Others focused on withholding tax management in commingled vehicles. Still others have been motivated by global diversification and relief from U.S. benchmark concentration.

The pattern is consistent: institutions are scrutinizing the places where implementation decisions — trading, eligibility rules, tax handling, rebalancing — have a material impact on returns.

O’Reilly also sees growing interest in fixed income, especially global, core bond portfolios. Market‑weighted bond indexes, he notes, naturally overweight the most indebted issuers. “You're overweighting the parts of the yield curve that have the lowest expected return,” he says.

Dimensional takes in tens of millions of bond prices daily, using them to assess duration, credit quality, and currency exposure in near real time. The firm also adjusts based on how bonds actually trade, not just how they are rated. “If you have two bonds, both rated BBB, but one bond is trading like a BB … do you think that you have a great buy in that BB because it has a higher yield, or do you think the credit rating agencies will catch up to the market and that bond is more likely to be rated a BB in the future? Our view is the latter,” O’Reilly argues.

And index rebalances in fixed income carry their own distortions — investment grade bonds falling into high yield at month end, for example, face predictable selling pressure.

Despite all the implementation nuance, O’Reilly comes back repeatedly to a behavioral message. Dimensional’s recent collaboration with Errol Morris on a feature length documentary about the history of finance was, in his words, an effort to “encourage a set of behaviors in investors.”

“Stay calm, stay disciplined, stay invested,” he says. Public markets have delivered roughly 10 percent annualized returns over the long run; the job of an investor is not to chase 12 percent but to make sure they don’t fall short of ten. “You’re going to have disappointing outcomes and strong outcomes,” he says. “You’re going to have both over time.”

O’Reilly expands on these ideas in a longer conversation on In Conversation With Julie Segal, breaking down how institutions are re‑evaluating public markets and where seemingly routine implementation decisions can meaningfully shift outcomes.

Follow In Conversation with Julie Segal on Spotify or on Apple Podcasts.