The best mutual fund company you've never heard of
I don't normally write about specific companies, as I prefer to talk more about concepts than about people or things. Having said that, I'm going to break from the norm today and talk about Dimensional Fund Advisors...mostly because I end up spending a lot of time explaining who they are, and I'd prefer the more efficient route of pointing people to an article!
So -- let's pretend you and I are having a conversation about DFA. You'd probably lead with a question like...
Who is DFA, anyway?
Dimensional Fund Advisors is a mutual fund company that manages around $460 billion in assets, putting them at the 27th-largest mutual fund company out there as of 2017. (For reference, Black Rock is #1 at $5.1 trillion, and Vanguard is #2 at $3.2 trillion.) They've been around since 1981, back when they were run out of an apartment. They happen to be headquartered in Austin, TX now, about 15 minutes away from my house.
That sounds...less than exciting. Besides the fact that you can drive to their headquarters, what makes them special?
Let's talk about the culture first. Booth set out to make a company that was driven by academic research, so the founders included several names that have since won the Nobel Prize for Economics: Eugene Fama, Kenneth French, Myron Scholes, Merton Miller, and Robert Merton, many of whom still work with DFA today.
What this means is that Dimensional, more so than any other mutual fund company out there, is driven by science. Peer review, laborious and thorough testing, and intellectual integrity are first and foremost. This puts them directly at odds with the culture of most of Wall Street, which is more interested in making a quick buck.
Sure, science is good -- but how does that actually change what they do, or how they do it?
As you might expect of a company lead by academics, DFA isn't an active management company; they would be the first to tell you that they believe wholeheartedly that markets work, and that attempting to find "mispriced" securities is a loser's game. Rather, they look for systematic factors of increased returns -- ones that persist over time, geography, company size, whatever.
They're not really an index company, either; they don't track to a public index like S&P or MSCI or FTSE or CRSP or any of those. Rather, one way to describe what they do would be to say that they create their own indices in-house and track to them; this gives them a certain degree of flexibility, while maintaining discipline (and low cost) that is key to long-term success.
That could work in theory, but does it actually work in practice? How has that gone for them in the past?
In short: quite well. Thought leader (and disinterested observer) Larry Swedroe recently took a look at DFA and Vanguard over the past twenty years. The article is worth a read in full, but I'd point you to his executive summary:
"In the U.S., the outperformance [of DFA over Vanguard, net of fees] ranged from 1.2% per year for large value to as much as 2.6% for small value. In developed markets, the outperformance ranged from at least 1.6% per year for large value to as much as 3.4% for small value. Finally, in emerging markets, the outperformance ranged from 3.4% per year for large value to 4.1% for small stocks and 5.0% for small value."
The advisor community is fully cognizant of this success, as well; in a recent poll of asset managers would recommend to their peers, DFA won the top spot in 4 out of 7 categories. I would argue that they would have won the "passive, index-based" category as well, except that many advisors don't consider them to fit in that category; regardless, they were #2. (The poll is worth taking a look at; haven't you ever wanted to know where the people who do this for a living are putting their money?)
OK, so they've had higher returns -- but is it just because they're taking more risk?
No, actually. Here's another quote from that Swedroe article I mentioned above:
"Despite the higher volatility associated with these riskier assets, in each case Dimensional’s funds earned higher Sharpe ratios. While investors should have expected the higher returns, they shouldn’t have expected the higher Sharpe ratios; if you believe markets are efficient, then you should also believe all risky assets ought to provide similar Sharpe ratios."
Higher Sharpe ratios means more risk-adjusted return; in other words, you're getting more returns for the same amount of risk, or less risk for the same returns, depending on what you're comparing with. And while I believe markets are efficient, I also believe in the power of DFA's multifactor tilts to increase risk-adjusted returns.
If they're so great, why haven't I heard of them?
It's simple: Dimensional funds aren't available to "retail investors". You can't just log in to your brokerage account and buy them. Rather, they are only available through institutions and financial advisors, both of which have to undergo a screening process in order to qualify. Moreover, said advisors can be suspended from trading DFA funds if they engage in bad behavior, such as rapid back-and-forth trading.
So it makes sense that you wouldn't have heard of them: advisors are their customers, not you!
Why do they do that? Why artificially limit their market that way?
By limiting their clientele to people who agree with their philosophy and are "in it for the long haul", they minimize their costs -- and hence maximize their investors' returns. Not to get too "woo", but they see their approach as an ideal that transcends the company. And they've done quite well for themselves!
If they're so exclusive, do I either have to be rich or pay through the nose (or both) to get access to them?
They're exclusive to investors who share their philosophy -- not just ones that have a lot of money. If you can find a good, low-cost advisor (e.g. one that charges 0.6% or less of assets under management), you can easily get access to DFA.
Why are we having this conversation, anyway? Is DFA paying you?
Nope. Seaborn is a qualified to use DFA funds, sure, but I "drank the DFA Kool-Aid" long before I even became a financial advisor. I like them because I'm an engineer, because the research is rock-solid, and because I believe your investment implementation should be determined not by sharks and salespeople and gut-feel investors, but by academics. I think everyone should use them -- which first requires everyone to know who they are!
What about Vanguard? What are they, chopped liver?
Not at all! I very much like Vanguard's approach as well. If you take a look at that advisor survey I mentioned earlier, you'll see they consistently come in at #2 or #1, and for good reason. They, too, are built in a way that's fundamentally different from other mutual fund companies, and that helps maximize their investor's returns.
If I had to choose between the two, I'd choose DFA, but if I didn't have access to DFA, I'd recommend Vanguard wholeheartedly.
Got any other questions about Dimensional? Drop a comment or an e-mail, and I'm happy to answer them!