Reposted from http://www.investmentnews.com
With its data-driven models the company attracted third-most money in 2014 behind Vanguard and JPMorgan
Jan 19, 2015 @ 9:14 am
By Bloomberg News
When Molly Bernet Balunek expressed interest in putting money into mutual funds run by Dimensional Fund Advisors, she didn’t know she was in for a rigorous courtship ritual.
Before getting the go-ahead to invest in Dimensional’s products last year, Ms. Balunek, a financial adviser from Cleveland, had to submit to an interview, fill out a questionnaire and pay out of her own pocket for a two-day trip to Austin, Texas, where she listened to the company’s executives explain how they do business. The process, which Ms. Balunek described as “intense,” took about five months.
“It is a two-way evaluation process — Dimensional wanted to understand my business structure and investment philosophy as much as I wanted to understand theirs,” said Ms. Balunek.
The ritual is part of a sales process that has helped Dimensional attract the third-most money last year after Vanguard Group Inc., known for its low-cost index funds, and JPMorgan Chase & Co. Like Vanguard,
Dimensional is capitalizing on a growing belief that stock pickers can’t consistently beat markets. Dimensional’s approach, though, comes with a twist: unlike traditional index strategies, the funds use data-driven models to beat traditional benchmarks.
Dimensional is among a small group of managers toppling the dominance of firms such as Fidelity Investments and Capital Group, which have built their reputations on picking individual stocks. Among the fastest-growing U.S. mutual fund firms after assets surged almost six-fold in the past decade, Dimensional attracted almost $28 billion in new money in 2014.
Dimensional believes beating the markets is an exercise in futility and most managers cannot justify the fees they charge. What sets Dimensional apart is its investment philosophy, using research pioneered by Nobel laureate Eugene Fama and Kenneth French, of focusing on specific factors or dimensions that have helped certain indexes beat benchmarks such as the S&P 500 Index.
Dimensional, which sells its funds only through approved advisers and never directly to the public, spends considerable effort educating investors on how its approach works. Its system of picking advisers breeds a high degree of loyalty. The firm received the highest grades in customer loyalty among mutual fund companies in a July 2014 survey of U.S. financial advisers conducted by Cogent Reports of Cambridge, Mass.
“They’ve developed a brilliant way of locking in money and the advisers who use them seem to love it,” said Lawrence Glazer, a managing partner at Mayflower Advisors, a Boston-based adviser that oversees $2 billion.
David Butler, who runs Dimensional’s financial adviser business, said he could “count on one hand,” the advisers who have stopped using the company’s funds in his nearly 20 years at the company.
Advisers who use Dimensional, “tend to buy into the firm’s unique philosophy and investment approach and direct a higher proportion of their mutual fund dollars to the firm,” Linda York, a Cogent vice president, wrote in an e-mail.
Dimensional’s assets have more than doubled since 2009 to $381 billion in a mix of mutual funds and institutional accounts. Part of the growth is the result of shifting client sentiment, as investors disillusioned with the ability of stock pickers to insulate them from losses during the 2008 crisis have increasingly turned to cheaper alternatives such as index mutual funds and exchange-traded funds.
Mutual funds that pick U.S. stocks experienced $98 billion in redemptions in 2014. During the same period, investors added $167 billion to domestic stock index funds and ETFs, according to data from Chicago-based Morningstar Inc.
Vanguard attracted $219 billion in mutual fund and ETF deposits last year. Fidelity had redemptions of $5.3 billion while American Funds, the mutual fund arm of Capital Group, won $345 million.
Mayflower’s Mr. Glazer said while low-cost indexing is popular at the moment, there is no guarantee it will remain so.
“If the history of asset management is any guide, the companies and styles that were the leaders in one decade, won’t be the leaders in the next decade.”
“Conventional active managers promised a lot that they weren’t able to deliver,” David Booth, 68, chairman and co-founder of Dimensional, said in an interview at his company’s headquarters in Austin.
Mr. Booth built his firm around the ideas of his University of Chicago mentor Mr. Fama, who won the 2013 Nobel Prize in economics for his work on efficient markets. In 2008, crediting the school for his success, Mr. Booth donated $300 million to his alma mater, which renamed its business school the University of Chicago Booth School of Business.
Mr. Fama and his research partner, Dartmouth College’s Mr. French, have argued that stock-price movements are unpredictable and that trying to pick securities that will beat the market is pointless.
“Most people are fooling themselves when they think they have the ability to hire a superior manager,” said Mr. French, in a video posted on Dimensional’s website.
The pair’s research also shows that certain factors can produce higher returns. Using historical market data, they found that over the long term, small stocks have outperformed large ones, value-oriented equities have beaten growth and more profitable companies have done better than less profitable peers. Dimensional’s funds reflect those tilts, with portfolios composed of small-cap companies, value shares and stocks of companies with above-average profits.
Over the past five, 10 and 15 years, Dimensional’s stock funds have outperformed about 70% of peers, according to Denver-based Lipper. Bond funds, a smaller piece of the business, trailed about 60%. Over the past 15 years, almost 90% of the company’s stock and bond strategies with a track record that long have topped their benchmarks, Dimensional data show.
Dimensional executives say that they can’t quantify or guarantee the amount of outperformance they can generate.
“If we can beat the benchmarks by 50 basis points a year — and in many strategies by 100 basis points — I will do handstands,” said Mr. Booth.
For the last 15 years, Dimensional’s funds have benefited from a rally in small-capitalization and value shares. Since the end of 1999, small stocks, as measured by the Russell 2000, have returned more than twice as much as large stocks, represented by the S&P 500 Index. Value stocks gained about four times as much as growth stocks.
The opposite pattern prevailed during the technology boom of the late 1990s, as big stocks and growth stocks outperformed, data compiled by Bloomberg show. In 2014, small cap stocks lagged behind large ones by a wide margin. They trailed again in 2015 through Jan. 13.
William Smead, a stock picker who runs the $952 million Smead Value Fund and invests in big companies, said if historical patterns hold, small cap stocks could lag behind large ones for the next six to nine years.
Setting realistic expectations for performance is just one piece of Dimensional’s close relationship with advisers, a relationship that began as an accident, according to Mr. Booth.
In the 1980s, the firm managed money exclusively for institutional investors. In 1988, an adviser approached Mr. Booth about investing in Dimensional funds.
The idea was intriguing and also somewhat disturbing, said Mr. Booth, who was concerned that advisers would move in and out of the funds too often, burdening other investors with higher costs. Minimizing trading costs is part of Dimensional’s plan for adding value. The solution was to create a system in which the company could pick advisers who bought into Dimensional’s approach and played by its rules.
“They don’t want advisers who are traders, they don’t want hot money and they don’t want people who are chasing performance,” said Ms. Balunek, who described the process of becoming a Dimensional adviser as more “invasive” than she anticipated.
Mr. Booth said the extended process — including having advisers pay their own way to the introductory seminar — has paid dividends.
“We have made it kind of a pain in the neck to buy the funds, but that has created a mutual affinity.”
Bob Rall, an adviser from Merritt Island, Fla., can speak to that affinity. He started out with a firm that tried to pick individual securities and said he got tired of client losses because of bad stock picks.
He found out about Dimensional 12 years ago and attended one of their conferences. Mr. Rall now has about 90% of the $35 million he oversees invested in Dimensional funds.
“They poured us big glasses of Kool-Aid, we drank it and haven’t looked back,” he said.
Advisers are also attracted to the credentials of the academics behind Dimensional’s investing and trading strategies. In addition to Mr. Fama and Mr. French, Nobel Prize winner Robert Merton of Massachusetts Institute of Technology is involved in designing products for the company.
Having advisers that believe in the firm creates another benefit for Dimensional and its customers, according to Michael Rosen, chief investment officer at Angeles Investment Advisors in Santa Monica, Calif., who oversees $45 billion for endowments and pensions.
“Educated advisers are more likely to prevent their clients from making radical changes when markets drop,” said Mr. Rosen. “The fact that those assets are sticky will add value for the investors.”
Dimensional’s approach to markets, with its tilts toward small and value stocks, at one time made it distinct in the money-management business, said Alex Bryan, an analyst with Morningstar. Many firms are now competing in the same arena including AQR Capital Management, he said, and products such as low-cost ETFs are also vying for investor capital.
“Investors have a lot of options now,” said Mr. Bryan. “They don’t have to go to Dimensional to get exposure to those strategies.”
Mr. Booth isn’t worried by the competition. He has invested in systems that will allow the firm to grow, although he refrains from projecting how big it might get. When the company passed $50 billion in assets in 2004, he said, “It was already bigger than we thought it could possibly be.”
Mr. Booth, who owns Dimensional along with other past and current employees and directors, doesn’t see that changing anytime soon. He said he has turned down repeated requests to sell Dimensional or take it public.
“The next generation of leadership is in place and they will worry about firm ownership,” said Mr. Booth. “For the time being we are ignoring the fact that we are getting older. This is what we want to be doing.”
*** June 2015 article with information worth repeating***
Wow. Vanguard had tremendous growth in 2014. An intake of $214.5 billion last year pushed this fund giant’s total assets to $3.1 trillion as of December 31, 2014. That growth represents a 56% increase for Vanguard compared to 2013. Early this year, they passed State Street Global Advisors as the second-largest exchange-traded fund provider as they close in on the top dog BlackRock.
Dimensional Fund Advisors (Dimensional or DFA funds for short) is another fund company that has been experiencing strong inflows. DFA funds added nearly $28 billion in assets in 2014, which was the third highest dollar amount of inflows last year, trailing only Vanguard and JPMorgan Chase.
That type of growth is doubly impressive because Dimensional Fund Advisors flies under the radar of many investors. Last year’s growth, however (not to mention a relatively steady inflow of assets since its 1981 founding), makes it clear that investors are attracted to DFA. What explains its rising-rock-star appeal, given its (yawn) nerdy tagline, “putting financial science to work”? Maybe it’s the firm’s laser-like focus and steadfast approach to applying academic research into the factors or “dimensions” that are expected to generate long-term wealth – fads and fashions be damned. For this blogger, anyway, it’s hard not to prefer that level of discipline to the usual frenzy involved in active stock picking and reactionary market timing.
Then again, Vanguard’s index and exchange-traded funds are no flashes in the pan either, also built on an investment strategy of substance. Admittedly, it can be confusing at a glance to understand how these two similar, but different fund companies compare. Let’s take a closer look at nine characteristics that help differentiate them from the crowd … and from each other.
Both trust the market knows best.
Yes, we are all brilliant, of course. However, when you consider that in 2014 alone there were some 60 million daily worldwide trades representing more than $300 billion dollars, it may be wise to embrace market pricing instead of trying to outguess the market. Vast, real-time, electronic information makes the market a highly effective price-setting machine. Trying to consistently outguess 60 million of your fellow investors is not unlike expecting to find enough single needles to outweigh an entire haystack, and to succeed at it over and over again.
In contrast, if you invested $1 in 1927 in a U.S. large-cap index fund and let it ride, your investment would have grown to $3,955 by 2014. Not bad. Vanguard and Dimensional alike prefer to invest in market “haystacks,” albeit with some procedural differences in how the assets get bailed, so to speak.
Both minimize trading.
Trades cost money, in both overt and clandestine ways. By trading according to plan rather than trying to time the market or jump into “hot” segments, both fund companies are well-positioned to trade less often. Since trading is expensive, we can expect lower costs with reduced drag on performance if we trade less often.
The DFA Difference
Beyond just reducing trades by avoiding market-timing or trend-chasing, DFA’s structured trading strategy is part of its secret sauce. Actually, it’s not such a secret: When it comes to trading, a trader who is in less of a rush to buy or sell can usually command better prices than one who is in a rush or under pressure to trade. By being more patient than an index fund manager can be and a market-timing manager chooses to be, Dimensional has developed a solid track record for minimizing the trading costs involved in capturing the asset class returns they are seeking.
Moreover, DFA takes it one step further and offers its funds through select financial advisors who have demonstrated a similar level of patience. The result? Less frenetic trading and even net inflows during times of market panic. For example, during the 2008-2009 market panic, most funds experienced massive redemptions, which wreaks havoc on a mutual fund management. However, DFA funds actually had net inflows during that time, and was able to put that new cash to work and buy securities at bargain basement prices. (This is a mutual fund manager’s dream!)
Neither firm tries to guess what asset class will outperform.
Vanguard and DFA offer funds with “style purity.” They invest in the asset class they say they will–small-cap value for example–and stay there. They aren’t making any kind of tactical bets that one asset class will perform better than the other.
The chart below says it all. Each column is the year, and each colored square is a separate asset class. Follow one color, such as “red” (the S&P 500), year by year. Look how much it bounces around! The performance of each asset class each year is anyone’s guess.
They don’t keep betting on the horse that won the last race.
Another common investment mistake is to chase stocks that have been on a recent winning streak and/or abandon recent underdogs. This continues to happen, despite the volume of evidence that past performance does not inform us about future returns.
Both Vanguard and DFA do not make “bets” on individual stock performance. They simply hold a large basket of stocks that fall into their well-defined criteria (in DFA’s case) or follow a published index (in Vanguard’s case).
The DFA Difference
DFA does not invest in public indexes like most of Vanguard’s index funds. The problem with public indexes is, well, they are public; everyone knows when a public index will change (and how it will change). Stocks tend to rise when it’s announced they will be included in a public index, and index funds will buy that stock on the effective date at the higher price.
This forces the index funds to “buy high,” which is exactly the opposite of what investors should do. It’s why Dimensional can afford to trade more patiently, as described above.
Here’s a nice visual to explain the concept:
Both firms make “going global” easy.
Only about half of the global market’s capital is in the United States. That leaves a big opportunity set outside our borders. Moreover, many of those other countries respond differently to economic forces, which has many benefits to investors (a portfolio of investments that “zig” while others “zag” can actually increase return and lower risk).
Both firms offer funds that cover broad sectors of foreign markets, so you can easily stay globally diversified.
The DFA Difference
DFA offers foreign funds (and even emerging market funds) with higher “tilts” towards small-cap and value stocks, which have historically been a source of higher long-term returns. They also “tilt” towards companies that have exhibited higher profitability. As an asset class, these stocks also have a history of higher returns.
They help to manage your emotions.
When you are well diversified, both domestically and in foreign markets, you reduce the risk of any one investment taking a nosedive, which can be unnerving and cause you to panic if you are over-concentrated in that investment. With many of Vanguard and DFA’s funds holding thousands of individual securities, the impact of a few dogs isn’t going to hurt as much. You aren’t as likely to panic sell when you have a global back-up plan.
Take a breath. Talk to your advisor. Don’t react emotionally to a buy high and sell low outcome.
Both firms help you to see beyond the headlines.
We are bombarded daily with catchy headlines about economic facts that seem to be on the verge of derailing our investment strategy. It’s easy to get swept into the hoopla about rising (or falling) oil prices, currency fluctuations, or political tensions in other countries. By participating in the market according to a disciplined, evidence-based process, turning to fund managers who help you accomplish that, it’s easier to take comfort in the fact that you are a long-term investor with a well-diversified global investment strategy.
They help you focus on the real drivers of returns.
Many investors believe the factors that affect their returns are stock picking and market timing. In reality, the bulk of your returns are actually driven by how you decide to split your money between stocks and bonds. (Well, another huge determinant is your ability to stay the course once you build your sensible portfolio, without succumbing to your human behavioral biases, but that’s a subject for another post, such as this one.)
- Stocks have historically offered a higher long-term return compared to bonds, but are more volatile.
- Smaller companies have historically performed better than larger companies.
- Value stocks have historically done better than growth companies (think WalMart vs. Groupon).
- High-profitability companies have historically performed better than low-profitability companies.
- Longer-term bonds have historically had higher yields compared to shorter-term bonds.
- Lower credit quality (“junkier bonds”) have historically had higher yields compared to higher credit quality bonds.
This is an important decision, so work with your advisor to design a suitable portfolio based on these core drivers of returns.
The DFA Difference
DFA regularly and closely collaborates with academic scholars, some of whom have been awarded Nobel prizes for identifying these factors or “dimensions” of higher expected returns. As such, they have been particularly early, strong and ongoing proponents of this sort of factor-based or evidence-based investing.
These firms help you focus on what you can control.
One of the few things you can control in investing is your costs. Both firms offer funds at significantly lower costs than many of their actively managed peers. They also offer a more disciplined approach to knowing what your own fund investments contain, so that it’s easier for you (especially with the support of an evidence-based advisor) to build and maintain a portfolio that you can stick with through thick and thin in your quest to build personal wealth. By minimizing the angst and second-guessing involved when you’re not sure just what is contained within your holdings, your own overall costs can be minimized as well.
You are in the busiest (and most profitable) time of your life. Working long hours. Struggling to figure out the best investments for your retirement. (Time, what time?) Why not work with a financial advisor who can help you clarify your goals and develop and plan to reach those goals?
An advisor will help you focus on factors you control — asset allocation, structuring a portfolio that takes into account the real drivers of expected returns and your ability to handle risk, broad diversification, low expenses, low trading costs and tax minimization.
Both Vanguard and DFA offer low-fee funds that operate on the principle that the market is an effective, information-processing machine that is nearly impossible to outguess.
DFA takes it one step further with some distinct tactics and also allowing for “tilting” towards areas of higher expected returns like smaller stocks, value stocks and higher profitability stocks.
The growth of these firms shows that investors are waking up to the reality that investment success is about capturing global market returns and keeping costs low, not about hunting down the next “rock star” money managers.
After more than 35 years in the financial services industry,
I have found that having an investment philosophy—one that
is robust and that you can stick with—cannot be overstated.
Just like a personal philosophy can act as a moral compass, an investment philosophy can guide your decisions on how to invest. While this may sound simple, the implications can be significant. People who
put their savings to work in capital markets do so with the expectation of earning a return on their investment, and there is ample evidence to support that long-term investors have been rewarded with such returns. But we also know that investors will encounter times when the results are disappointing. It is in these times that your philosophy will be tested, and being able to stay the course requires trust.
The alternative approach likely consists of moving between different strategies based on past results, which is unlikely to lead to a good outcome. At Dimensional, our investment philosophy is based on the power of market prices and guided by theoretical and empirical research.
What does that mean?
Markets do an incredible job of incorporating information and aggregate expectations into security prices, so it does not make sense to form an investment strategy that attempts to outguess the market. Our approach focuses on using information contained in prices to identify differences in expected returns. We conduct research to help us organize our thinking, improve our understanding of what drives returns, and gain insights on how to build sensible portfolios. One such insight is looking beyond average returns. By considering the entire distribution of outcomes, we can better understand what investors should be aware of to help them stay invested when results aren’t what they expect. As an example, the S&P 500 Index has returned about 10% annualized since 1926. But over that time period, there the S&P’s return was within two percentage points of 10%.1 If investors were to adopt a strategy that tracks the S&P 500 Index expecting 10% each year, they need to understand that returns over any given period can look different.
So what does it take to stay the course? Our view is that while there is no silver bullet, there are some basic tenets that can help. Developing an understanding of how markets work and trusting markets is a good starting point. Having an asset allocation that aligns with your risk tolerance and investment goals is also valuable. We believe financial advisors can play a critical role in this determination. Finally, it’s important that the investment manager can be trusted to execute the desired strategy. In this regard, an index-like approach is useful because of how transparent it is.
It is easy for an investor to examine whether the returns achieved by the manager matched those of the index. This is part of the reason indexing has been a positive development for investors, offering a transparent, low-cost way to access markets. However, index funds prioritize matching an index over potentially achieving higher returns—so we believe they are too mechanical.
So what does it take to stay the course? Our view is that while there is no silver bullet, there are some basic tenets that can help. Developing an understanding of how markets work and trusting markets is a good starting point. Having an asset allocation that aligns with your risk tolerance and investment goals is also valuable. We believe financial advisors can play a critical role in this determination. Finally, it’s important that the investment manager can be trusted to execute the desired strategy.
In this regard, an index-like approach is useful because of how transparent it is. It is easy for an investor to examine whether the returns achieved by the manager matched those of the index. This is part of the reason indexing has been a positive development for investors, offering a transparent, low-cost way to access markets. However, index funds prioritize matching an index over potentially achieving higher returns—so we believe they are too mechanical.
At Dimensional, we’ve sought to improve upon indexing, taking the best of what it offers and adding the ability to make judgments. Our experience has been that by incorporating a little bit of judgment, you can add a lot of value.
Dimensional began back in 1981 with a new idea: small cap investing. The premise was that many investors didn’t invest in small cap stocks, and that small caps behaved differently than large cap stocks and could offer diversification benefits to investors concentrating in large caps. We found clients who agreed the idea was sensible. Over the next nine years, the performance of small cap stocks was disappointing relative to large caps (at one point the S&P 500 outpaced our portfolio by about 10% annually), so on the surface it may have appeared that both we and our clients had a reason to be nervous. But clients were willing to stick with us because we were clear about our objective—providing a diversified portfolio of small cap stocks—and we delivered on it.2 Having compelling ideas is important, but the implementation of those ideas is what really counts. From the beginning, we focused on developing protocols about how to design and manage portfolios, and 35 years later we have amassed a track record of results that we believe stands out in the industry.
1. Past performance is not a guarantee of future results. Indices are not available for direct
investment; therefore, their performance does not reflect the expenses associated with the
management of an actual portfolio. The S&P data is provided by Standard & Poor’s Index Services
2. Diversification does not eliminate the risk of market loss. Investing risks include loss of
principal and fluctuating value. Small cap securities are subject to greater volatility than those
in other asset categories. There is no guarantee an investing strategy will be successful.
Consider the investment objectives, risks, and charges and expenses of the Dimensional funds
carefully before investing. For this and other information about the Dimensional funds, please read
the prospectus carefully before investing. Prospectuses are available by calling Dimensional Fund
Advisors collect at
(512) 306-7400 or at us.dimensional.com. Dimensional funds are distributed by DFA Securities LLC.
While our long-term results show an ability to add value over benchmarks, we still place tremendous value on helping our clients understand why we do what we do. Just like those first years, we have lived through other times when the results have looked disappointing. This is one reason our approach combines our ability to make judgments with the transparency we believe is necessary for clients to understand what they can expect from us. The solutions we provide are meant to help clients achieve their financial goals. We know that a big part of enjoying the expected benefit of long-term returns relies on the ability to stay invested. By clearly articulating what we promise to provide, and delivering on those promises with robust portfolios, our hope is that we can help increase clients’ confidence in their decision to invest with us and provide them with a more successful investment experience.
On behalf of all of us at Dimensional, we want to thank our clients for the trust you have placed in us. We will continue working hard to reinforce the decision you have made. For those of you who may not yet work with us, we look forward to the prospect of serving you in the future.
Founder and Executive Chairman
DIMENSIONAL FUND ADVISORS
LETTER FROM THE CHAIRMAN, 2017