A few weeks ago I pointed out the fact that Vanguard’s stock funds have had an enviable run of outperformance in relation to their benchmarks. I feel that the active fund industry can learn a lot from Vanguard’s process. In last weekend’s Barron’s there was a table that showed that 3 out of the top 4 active funds in terms of performance were from Vanguard.
A few people wrote in and urged me to point out another fund company with similar long-term principles and lower costs – Dimensional Fund Advisors (DFA). DFA has been in the fund business for over 30 years and has well over $300 billion in assets under management. DFA focuses most of their offerings on small cap and value funds based on the weight of historical evidence of the size and value premiums.
Here’s a list of some of the biggest DFA funds since their respective inception dates against their relevant benchmarks (all returns through year-end 2014):
DFA US Large Value fund vs. Russell 1000 Value Index since 3/1993 = +10.5% vs +10.0%
DFA US Micro Cap fund vs. Russell Micro Cap Index since 7/2000 = +9.5% vs. +7.6%
DFA US Small Value fund vs. Russell 2000 Value Index since 4/1993 = +12.5% vs. +10.6%
DFA Int’l Value fund vs. MSCI EAFE Value Index since 3/1994 = +6.5% vs. +5.7%
DFA Int’l Small Cap fund vs. MSCI EAFE Small Cap Index since 1/1999 = +9.3% vs. +7.9%
DFA Int’l Small Value fund vs. MSCI EAFE Small Cap Value Index since 1/1995 = +7.6% vs. +7.0%
Emerging Markets Stocks
DFA Emerging Mkts Value fund vs. MSCI EM Value Index since 1/1999 = +12.7% vs. +10.6%
DFA Emerging Mkts Small Cap fund vs. MSCI EM Small Cap Index since 4/1998 = +12.1% vs. +7.5%
DFA Five-Year Global Bond fund vs. Citigroup World Gov’t Bond Index 1-5YR since 12/1990 = +5.7% vs. +5.0%
DFA Intermediate Gov’t fund vs. Barclays Gov’t Bond Index since 11/1990 = +6.7% vs. 6.2%
You can see that these funds all have very long track records of outperformance. Many investors mistake passive investing with index investing but quantitative investing isn’t reserved for market performance. It’s surprising that DFA’s lower-cost hybrid passive/active fund process hasn’t been replicated by more fund companies. ETFs seem to be heading in the direction of creating a systematic process that’s based on historical evidence, but it’s taken quite a long time.
The unique aspect of DFA is that retail investors can only access their funds through DFA-approved financial advisors. To say their network of financial advisors is loyal would be an understatement. A recent piece in Investment News makes this clear:
Indeed, for many advisers, DFA’s investment philosophy is more than an approach to investing.
It is a religion.
“We are pretty passionate about it,” said Harold Evensky, president of Evensky & Katz Wealth Management, which allocates part of its equity portfolios to DFA Funds. “I joke about the “Kool-Aid,’ but I’ve drank it, and I believe in it.”
DFA goes to great lengths to ensure that their advisors think and act for the long-term when using their funds. Education and client coaching are important ways to reduce the behavior gap, so I think other fund firms could learn a thing or two from DFA’s approach.
No one knows for sure whether tilting to small caps or value funds will lead to similar outperformance in the future. It’s impossible to make that prediction with certainty. There will likely be long periods where these types of tilts don’t work over a number of years. Nothing works all the time. The reason most investment strategies work over the long-term is because they don’t always work over the short-term. But a disciplined process that focuses on longer time frames gives investors much higher odds for success, which really is the best you can hope for.
*Hat tip to Eric Nelson at Servo Wealth Management for pointing me in the right direction on the most popular DFA fund options.
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