Barron's Article on Dimensional Fund Advisors


Beverly Goodman of Barron’s was accorded the high honor of being the first reporter to attend one of DFA’s Financial Advisor Colleges. The article that she wrote about her experience, A Different Dimension, shows that it was time well spent. Having the opportunity to see Professor Eugene Fama just one week after the announcement that he won the Nobel Prize, Goodman conveyed the sense of excitement that was in the air.

With $332 billion of assets under management, DFA is now the eighth largest mutual fund family. As we showed in this article, it is also the fastest growing family when measured relative to existing assets. About two years ago, Barron’s published a ranking of 57 mutual fund families based on Lipper rankings, and DFA was ranked number one. What was particularly amusing about the table was that DFA was the only fund family that did not have a toll-free phone number. Of course, this is explained by the fact that retail investors can only access DFA funds through advisors that are approved by DFA to use their funds. According to this article in RIABiz, DFA accepts only 14% of the advisors who approach them.

The advisor community often jokes about DFA approved advisors “drinking the kool-aid” which means fully accepting that markets are efficient, or at least efficient enough such that resources devoted to activities such as stock picking, time picking, and manager picking are unlikely to bear fruit. We think it is just the opposite, where advisors who think they can find a market guru to beat the market are drinking the kool-aid.

We also think that investors should not just buy a total market index fund and call it a day, as DFA’s own performance clearly shows. More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar. While David Booth, one of the two co-founders of DFA and its current chairman declares, “We are believers [in the theory of market efficiency] down to our toes”, he rejects the passive label, implying they do intense research into the dimensions of stock and bond returns and efficient trading strategies that have had excess returns over the total US market return.

“I recoil when people think that what we do is being passive, because it has nothing to do with being passive. We are trying to beat the market without forecasting in the usual sense." 

Even though we at IFA embrace the indexing and passive designations, we definitely understand and appreciate Mr. Booth’s perspective. We define an index fund as a mutual fund or exchange traded fund (ETF) with clearly defined rules of ownership (including trading strategies), that are held constant regardless of market conditions (no forecasting). The fund does not have to follow a well known or even published index, like the DOW or S&P Indexes. There are many unknown indexes such as Fama French Indexes, Dimensional Indexes, Market Vector Indexes, RAFI indexes, Wisdom Tree Indexes and CRSP indexes. We have noticed that there are well over 1,000 index funds in the Morningstar database, leaving investors with lots of confusion about which set of rules provide the highest expected return given a certain risk capacity. This is why investors need an Index Fund Advisor.

DFA's patient and opportunistic approach to trading differentiates their funds from what you may consider to be traditional index funds. Also, DFA does not publish a list of eligible securities for each of their funds, so active traders are not afforded an opportunity to scalp them--quite the opposite. For this reason, we at IFA like to refer to the DFA funds as "silent" index funds. Based on his recent article in Forbes on the 40th anniversary of indexing, we are quite certain that the other co-founder of DFA, Rex Sinquefield, would agree with us. The other argument against the passive label is DFA's very deep (and active) research bench that is headed by academics of the highest caliber such as Eugene Fama and Ken French. Their most recent contribution centers around the return dimension of profitability, which is currently being incorporated into all of the DFA funds. Goodman provides a beautiful explanation of profitability that she formulated herself after listening to the speakers at the DFA conference:

“Investors tend to pay too much for -- or, in other words, not apply enough of a risk discount to – ‘lottery’ stocks. Think of a bell curve of stock returns: You'll see far more returns to the left of the mean, and a few outsize winners on the right. That market's willingness to pay for the small chance of outsize gains means that other profitable firms, relatively speaking, have lower prices.”

For several years now, the DFA funds have avoided extreme small cap growth stocks which have a lottery-like (or venture capital) payoff structure. The fact that so many people are so willing to pay $1.00 for a lottery ticket whose true value is a fraction of that helps us understand the mispricing of these stocks. If a portfolio is underweight in low (or zero) profitability companies, then it must be overweight in high profitability companies.

Dave Butler, who oversees DFA’s advisor network summarizes why DFA will only work with advisors who understand and agree with what they do:

“Advisors who have gone through our process, who have the right language, and approach the market the way we do, have a much better ability to keep client assets deployed in the market. Look at 2008 and 2009 -- we had positive cash flows in both years. I don't think there's any other money manager that can say that. I credit the advisors; they kept their clients on track.”

We at IFA are devoted to keeping our clients on track so that they can capture the returns that are offered by different risk dimensions of the market. Our relationship with DFA has been invaluable in this regard. IFA is a fiducary for it's clients wealth, providing many services and education resources, such as selection and monitoring of risk capacity and risk exposures (investments), rebalancing, tax loss harvesting, asset location, deposit and withdrawal management, performance benchmarking and reporting, alternative investment analysis, automatic glide path strategy, continuing investor education, and estate planning and insurance advisor coordination and referrals. If you would like to learn more about DFA and the benefits of accessing their funds through a fiduciary wealth advisor, please give us a call at 888-643-3133.