Where The Smart Money Is Headed
In a recent Barron’s article titled, “Where the Smart Money is Headed,” reporter Beverly Goodman highlights mutual fund manager Dimensional Fund Advisors’ success in attracting a growing number of financial advisors who seek to invest their clients’ money in a more “evidence-based” fashion. The attraction is mutual as the folks at DFA refuse to make their funds available directly to individual investors. It isn’t that the company wouldn’t like to gather more assets; it’s that even more than that, they’d like to make sure that their philosophy is properly understood. This helps to ensure that the strategies they employ won’t be undermined by market timers, who can create unnecessary and costly turnover in a fund.
As a consequence of its fundamental belief in markets, DFA doesn’t believe one can add value through individual security selection (aka “hot stock picking”) and this sometimes causes them to be characterized as indexers, a label the company would reject. Here’s how Goodman describes the sometimes subtle distinction between DFA’s investment approach and that of traditional index funds:
DFA’s focus is on academic research that isolates the factors that cause stocks to outperform the market, as well as the risk characteristics that can be eliminated from a portfolio. Indexes are simply measures of an asset class; DFA funds are aimed to capture more of the returns of an asset class with much less risk and at far less cost.
And here’s how the company itself lays out the differences between their approach and that of traditional stock pickers and index managers:
|Believes that, in liquid markets, prices reflect all available information||Attempts to identify mispricing in securities on a consistent basis||Allows commercial benchmarks to define strategy|
|Focuses strategies on the dimensions of higher expected returns||Often relies on forecasting techniques to pick securities and/or time markets||Tethered to a benchmark, reducing flexibility|
|Seeks to add value through portfolio design and implementation||Generates higher expenses, trading costs, and excess risk||Accepts lower returns and increased trading costs in favor of tracking|
|Source: Dimensional Fund Advisors|
As detailed in the Barron’s article, DFA’s approach is firmly grounded in academic research and the company has strong ties to top economists like Eugene Fama and Kenneth French, of the University of Chicago and Dartmouth College, respectively. It was Fama and French who first introduced the “3-factor” asset pricing model that explains the performance of a portfolio in terms of its exposure to the stock market in general, and to small company and “value” stocks in particular. In this context, “value” stocks are those that are trading at a low price relative to their earnings or assets. The research of Fama, French, and others, has shown that these lower-priced value stocks produce higher returns over the long run than high-priced “growth” stocks. DFA also focuses heavily on cost management and credits a substantial part of its funds’ superior performance to the company’s success at minimizing fees and expenses.
Yeske Buie has had a long and successful history with Dimensional Fund Advisors. Like DFA, we believe that markets work and that belief allows us to think differently about investing and, as Goodman puts it, “to capture what the market offers in all its dimensions.”