Gallery:Step 11|Step 11: Risk Exposure

Selecting Investments Part 2

Gallery:Step 11|Step 11: Risk Exposure

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The Advantages of Investing in Dimensional Funds (Continued):

10. Low Professional Turnover Strengthens the Team Process

IFA has known the DFA leadership since 1999 and they have remained committed to fostering a culture of learning, teamwork, innovation, and dedication to always doing what’s right for investors. To this end, the firm’s leadership brings a valuable perspective to their work and deep resources to enhance their offering. They have had very few departures among the portfolio managers and key personnel. The hiring of investment managers at Dimensional is the antithesis of the "Morningstar Star" system of managers that is the rule at most firms. 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.

11. Successful and Independent

Dimensional is one of the largest independently owned investment management firms in the world, with over $330 Billion in assets under management as of December 30, 2013. In the opinion of IFA, the firm has operated its business in a true fiduciary manner, keeping the the best interest of its investors in their business practices.

12. Excellent Service Provided to IFA

Dimensional appears 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. Dimensional serves a distinguished group of institutional and advisor clients. They structure support teams to connect with firms like IFA, to learn from them, to inform them of the key research and practical work that will shape current and future investment strategies.

A regional director services Index Fund Advisors. This approach keeps IFA fully informed of current research and developments while quickly addressing any questions we may have.

Dimensional also provides IFA with a wide range of communications resulting from internal and sponsored research. These range from investment research reports commissioned from leading academic centers to Dimensional's seminars providing general discussions on issues facing plan sponsors and advisors. Their direct links to the academic community provide a large body of original research supporting existing investment strategies and creating the foundation for new investment approaches. This is one of the many reasons we advise clients to invest in Dimensional funds.

13. DFA versus Vanguard

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 96% of stock market returns, going back to 1928. 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]

IFA's concern with Vanguard: Here is an actual proposal with active funds! And now they are offering a Hedge Fund (12/15/07)! "When asked about this departure from low-cost indexes, Ms. Chain pointed out that Vanguard actually manages more active assets ($680 billion) than passive ($600 billion). 'We serve many clients beyond the investor who holds the 500 fund in an IRA,' she said."     

Here are a few charts explaining why IFA prefers to advise clients to invest in DFA funds.

These differences in fund returns are explained by the difference in small and value tilts of the funds. When we assemble diversified portfolios and scatter plot the data, the chart below shows the combined impact of these fund differences based on risk and return.

 

The Vanguard Target Retirement Funds have not been around very long, but over this period, it clearly would have been better to be in the IFA constructed index portfolios. This is a short period, but the small value tilt is less in the Vanguard Funds than it is in the DFA funds.

14. 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 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. iShares are now owned by Blackrock, of which Merrill Lynch owns about 30% of the shares. Enough said.

 

15. Comparisons of Various Alternative Portfolios

IFA recommends that its clients invest primarily DFA funds when implementing a risk exposure. We also have a Diversified Index Manager implementation that we mostly recommend for large institutional investors. Short articles on DFA can be found at these links, 1 - 2 - 3 - 4 - 5 .

DFA originally designed their funds for large institutional clients. If you become our client, you will have the opportunity to invest alongside some of the world's largest institutional funds.

Here are several portfolios constructed based on portfolios based on Vanguard Funds or iShares, portfolios recommended in various books or in target date funds. They are compared on the basis of risk and return. As you can see in every case, the portfolios based on IFA Indexes, using DFA indexes and DFA funds stitched together provide a more optimal solution. This is why we advise clients to invest in DFA funds. In a 2010 contest of 25 various passive portfolios, IFA's Index Portfolio 100 took top prize, beating the number two portfolio by an absolute 4.5%.

 

To compare Dimensional funds, based on Dimensional Indexes to the closest third party indexes, see the table below. You can see the positive difference over the last 10 years and since inception. The explanation for this is greater exposure to the Fama French factors and Dimensional's expertise is trading and various exclusion rules. This is why you may have heard DFA funds referred to as Factor Funds.  

As you can see below, the returns of portfolios of DFA funds closely tracks a same allocation of indexes of similar names, mostly indexes from DFA. If you add back the 0.41% annual expense ratios of Portfolio 100, the return is almost exactly the same as the same allocation of indexes.

16. The Only Pure Passive Play is DFA

In our opinion, DFA is the only fund company that adheres to a non-forecasting, efficient markets strategy for all of their funds. All other firms that offer passive or asset class funds, also offer active funds. One possible reason for this is that the actively managed funds are more profitable for the firm.

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 IFA and DFA. DFA has no loads or trailing 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, in our opinion, they are the best in the business.

For reference, here are links to several other index providers: Russell Indexes - Wilshire Indexes - Dow Jones Indexes - MSCI Barra Indexes - S&P Indexes - WisdomTree. The Wikipedia page for Index states "ieconomics, index numbers generally are time series summarising movements in a group of related variables.