How is the wheat
sorted from the chaff? Since index funds are the only funds that use
risk and return data that deploy a constant set of rules of ownership,
they are the first level to screen over 17,000 existing mutual funds
in the Morningstar database.
This process of elimination limits the choices down to about 600 index
funds and exchange traded funds (ETF’s). ETF’s are essentially
index funds that trade like stocks, but like individual stocks, they
usually have commissions and spreads between bids and asks. Most importantly,
investors need to consider the net expected return of each index fund
representing each set of rules of ownership. A sorting of index funds,
loads, fees, and expenses will quickly eliminate all but Vanguard and
DFA index funds. Then another problem arises.
DFA funds require a minimum trade amount of $2 million per fund purchase
unless the purchase is made through a DFA approved fee-only advisor.
Most advisors require minimum account sizes of around $250,000. However,
Index Funds Advisors’ (IFA) minimum account size is $100,000. The
primary difference between DFA and Vanguard is that they use different
indexes to design their index mutual funds. DFA custom designs its indexes
to capture the risk factors that explain 95% of stock market returns.
Those factors include company size (market capitalization) and value
(book to market ratio or BtM).
There are smaller size and higher value oriented stocks in DFA indexes.
Based on the higher long-term returns of these factors, there are higher
expected returns for long-term investors with DFA index funds. However,
past performance is not a guarantee of future performance. Vanguard is
now a fairly aggressive proponent of “tandem investing,” which
is a post-Bogle slogan that encourages Vanguard investors to mix in some
actively managed funds in their portfolios.
It is as if the dark force has encroached on this champion of investor
protection and low costs. There is no conceivable or logical reason for
Vanguard to do this, other than it can make higher fees off uneducated
and unsophisticated investors.
DFA, for its part, is the purest among all mutual fund companies in their
application of the Efficient Market Theory and low-cost structure. They
have an added benefit of providing substantial index data going as far
back as 1926.
As proof of DFA’s unique position in the investment product industry,
Dalbar surveyed investment advisors four times between 1997 and 2004.
The study was titled “The Professionals’ Pick.” Dalbar
rated DFA the best overall no-load mutual fund company in 1997, 2000,
2002, and number two in 2004. DFA rated highest in the “Investment
Management” and “Current Use” categories in the 2004
survey. See Table 11-1. These funds are low cost, style
pure and well diversified.
One
unique advantage of DFA is their innovative execution of small
capitalization stock trades. Because of the low liquidity in these
stocks, the trading cost can be very high. DFA’s board members
and consultants include some of the world’s most distinguished
academic theorists: Eugene Fama, Kenneth French, Roger Ibbotson,
Donald Keim, and Nobel laureates Myron Scholes and Robert Merton.
We Add Value without Relying on Forecasts or Intuition
We believe that, over time, a structured investment approach based on financial science and the efficacy of capital markets will add value with a higher reliability and confidence level than one based on instinct and prophesy.
Investment Philosophy Is Grounded in Robust Academic Research
The Three-Factor Model has replaced the Capital Asset Pricing Model in the work of financial economists. Our equity strategies capture the insights of the model, which has withstood rigorous open review.
Minimal Style Drift
We adhere strictly to specific parameters to maintain reliable asset class exposures. Our portfolio managers have no discretion to purchase stocks that do not meet these parameters, and no financial incentive exists for them to deviate from our very specific disciplines.
Smart Trading Increases Returns
Careful trading can reduce or even reverse the costs borne by traditional managers. Because Dimensional focuses on capturing the systematic performance of broad market dimensions rather than the random fluctuations of individual securities, we can keep costs low, patiently and expertly. We concentrate on favorable price execution that neutralizes the effects of momentum and index reconstitution and we maintain portfolio-specific hold ranges that reduce turnover and trading costs.
Low Cost
In line with our structured, scientific approach to investing, Dimensional's investment management fees are positioned well below those of typical, traditional active managers. Our patient and price-conscious buy-and-hold approach to trading is designed to minimize costs.
Pioneers of Risk-Factor-Based Management
Dimensional has pioneered many strategies now taken for granted in the industry. The firm was originally founded to provide institutional investors access to US small cap stocks, underrepresented at the time in most portfolios. Dimensional later introduced its first value strategies based on the Three-Factor Model. In 2004, we launched core strategies that efficiently target risk factors across the total stock market.
Broad Line of Strategies for a Complete Total Portfolio
Dimensional's broad array of investment strategies offers calibrated exposures to the full spectrum of key asset classes across dimensions of size, value, and geography. Our goal is to provide investors with global investment solutions that, at the total portfolio level, maximize returns for a desired risk level.
Clear and Accessible Philosophy and Approach
Dimensional strives to keep its process transparent so that clients can easily understand it.
Combination of Theory and Practice
By acting as a conduit between scientists and practicing investors, Dimensional has pioneered many strategies and consulting technologies now taken for granted in the industry. This feedback loop serves as an idea growth engine, positioning us to research tomorrow's solutions today.
Low Professional Turnover Strengthens Our Team Process
Longevity characterizes the nucleus of our investment and research team. We have had very few departures among our portfolio managers and we hire in advance of future growth. The decision-making approach for strategies at Dimensional is the antithesis of the "star" system.
Successful and Independent
Dimensional is one of the largest independently owned institutional investment management firms in the world. The firm is dedicated to managing investments on behalf of clients and to operating its business in the best interests of clients.
Exceptional Client Service
We are eager to continue building relationships with institutional clients, financial advisors, and consultants through development of customized investment programs and an interchange of investment research and ideas.
We
recommend that you purchase primarily DFA funds for your portfolio.
Short articles on DFA can be found here, 1 - 2 - 3 - 4 - 5 - 6 .
Some key advantages of DFA can be found HERE.
DFA originally designed their funds for large institutional clients.
These funds are low cost, style pure, and well diversified. If
you become our client, you will have the opportunity to invest
alongside some of the world's largest institutional funds. For
a list of institutional clients of DFA, click here.
One unique advantage of DFA is their innovative execution of
small capitalization stock trades. Because of the low liquidity
in these stock, the trading costs can be very high. To see how
DFA addresses this issue, click here.
DFA
versus Vanguard:
Not
all indexes are the same, see these comparisons
of similar funds from DFA and Vanguard: Large
Value - Small
Caps - Int'l
Value - Emerging
Markets - TM-Int'l - TM-Small
Cap. (source: MSN Money.) Vanguard has changed
their indexes to the MSCI indexes. For a Three
Factor Model comparsion of these indexes (S&P
vs MSCI) and the DFA indexes, see HERE.
We are sometimes asked what the difference
is between Vanguard, ETFs and
DFA Index Funds. The short answer is they use different
indexes. DFA has custom designed their indexes to capture
the risk factors that explain 95% of stock market returns, going
back to 1929. Those factors include company size (market capitalization)
and value (based on the company's Book Value divided by its Market
Capitalization, or Book to Market Ratio (BtM)). [also see DFA
vs Vanguard]
The only pure passive play is DFA. DFA
is the only fund company that adheres to a non-forecasting, efficient
markets strategy for all of their funds.
IFA's concern with iShares: "To
generate more revenue, Barclays has worked in recent
years to build up its actively managed funds like hedge
funds. About 21% of BGI's assets are actively managed,
some of in hedge funds. A recent report by Sanford
C. Bernstein & Co. says BGI has been successful
in subtly shifting
to the higher fee, actively managed funds." WSJ
08/13/07
The grid below illustrates the differences between the indexes
used by DFA
and Vanguard mutual funds. As you can see, they are very
different. Because returns have correlated with risk factors
like size and value, this is an important distinction to
make.
You get smaller size and higher value oriented stocks with DFA
indexes. Based on the higher long-term returns of these factors,
there would be higher expected returns for long-term investors
with the DFA index funds. However,
we must caution you that past performance is not a guarantee
of future performance.
Below is a chart that plots factor loadings of various indexes.
Factor loadings are a comparison of indexes and mutual funds.
As you see, the 0,0 point is the total market.
For loading factors on entire portfolios, see below:
Here are two
tables that illustrate some of the differences in the indexes.
They use a Three Factor Regression Model to compare funds
to the Total Market.
Value
Index
Fund
Book
to Market Ratio (Value)
relative to the Total Market
Vanguard
Large Growth Index
-0.31
Total
Market
0.00
Vanguard
Small Value
0.20
Vanguard
Large Value
0.38
DFA
Small Value (CRSP 6-10)
0.59
DFA
Large Value (CRSP 1-5)
0.65
Size
Index
Fund
Market
Size Relative
Total Market
Vanguard
Large Growth Index
-0.32
S
& P Index
-0.17
Total
Market
0.00
Vanguard
Extended Market*
0.52
Vanguard
Small Value
0.83
DFA
Small Value
0.96
DFA
Small (6-10)
1.02
DFA
Small (9-10)
1.11
*total
market, without the S&P 500
Because higher returns have been achieved with smaller and value
type stocks, DFA has created indexes that are focused more on
those factors.
Actual
Weighted Average Market Capitalizations and Weighted Average
Book To Market Ratios
For Small and Large Indexes as of Dec. 31, 2000
IFA has advised clients to invest in DFA funds since March,
1999. IFA receives no compensation from any product or service
they advise their clients to use. IFA only receives fees from
their clients, other advisors who license their software and
book sales. The best strategy for investors is to invest in
a globally diversified portfolio of index funds and rebalance
as needed. As Louis Pasteur said, "Chance favors the prepared
mind."
It is normal for investors to be suspicious when an author
or advisor leans so heavily toward one mutual fund company.
Indeed, it is wise to be cautious of loads or 12b-1 fees
that may be kicked back to the advisor. This is not the
case with DFA. DFA has no loads or tailing fees for advisors
and they provide the absolute best education of any fund
company, including monthly updates on risk and return data
and a software package to analyze the data. Simply put,
they are the best in the business.
11.4
Solution
11.4.1 Twenty
Index Portfolios
The answer to the
investor’s dilemma is to design the most efficient portfolios of
available investable indexes. (See Table 11-2 and Appendix
A for a listing of the portfolios and data concerning them.) Input into
efficient analysis must be based on at least 20 years of risk and return
data. But there are now 80 years of reasonably good index simulations.
Table 11-2
CLICK
ON THE IMAGE FOR A LARGER VIEW
The Flash Graph below
show the risk and reward plots for all 20 portfolios and the component indexes
for 20,
35, 50, and 80 year periods.
We have assembled
a continuum of risk exposures as summarized in histograms below.
They are depictions of both the risk and return of all 20 index portfolios.
They are numbered and color coded to denote their risk level beginning
with Portfolio 100 — Bright Red at the highest risk, down to Portfolio
5 — Ivory at the lowest risk. The charts show a histogram of 780 months of returns data on the left and the growth of one dollar on the
right. The risk capacity painting is also included to give an idea of
the age appropriateness of each portfolio.
The 20 Index Portfolios
and S&P 500 Returns (Table 11-3) show the risks and
simulated returns of all 20 portfolios. An investor’s actual returns
will vary from these asset class allocations due to differences in asset
allocations, timing of withdrawals and contributions, index tracking errors,
rebalancing strategies and costs, fees, and other factors.
Table 11-3
- Risk Return Table
Twenty Index Portfolios and S&P 500
Simulated Returns, Growth of a Dollar and Risks (Standard Deviations)
Jan 1927 to Current Month
Note: An investor's actual returns will vary
from these index portfolios due to differences in index allocations,
timing of withdrawals and contributions, index tracking errors,
rebalancing strategies, costs, fees, tax related strategies, and
other factors. According to the Financial
Economists Roundtable, index portfolios are the best
estimates of the principal risk factors that are likely to influence
fund risks and returns in the future. The annualized returns
shown below are after an advisor fee of 0.90%/year (your fee may
be lower) and after a DFA
mutual fund fees for the entire period, including simulated
data periods. Returns data includes an annual rebalancing of indexes.
The DFA
US Large Company Fund (which tracks the S&P 500) is shown
with no IFA advisor fee deducted and is similiar. For monthly
and YTD returns, the percentage return corresponds to the total
period. Index
returns DO NOT represent actual mutual fund performance and are
for illustration and comparison purposes only. For individual
Mutual Fund performances, see the appropriate DFA Fund
prospectus. Past performance does not guarantee future performance.
In fact, the Risk - SD or Standard Deviation number shown
below quatitfies the uncertainty of expected returns. The higher
the historical Standard Deviation number, the higher the risk
or uncertainty, and the wider the range of future probable outcomes.
To visualize and compare these risks, click: .
For a complete portfolio analysis, take a ride in the Portfolio
Simulator.
Not
all indexes are the same, see these comparisons
of similar funds from DFA and Vanguard: 
