The passivists - The active-passive powerhouse - By Jason Zweig.


Here is a transcript of an article I was sent recently. It talks about Dimensional Fund Advisors LP, or DFA and their investment strategies. There are some excellent insights to be found here...

DFA has drawn nearly $2 billion in net assets per month while many other firms struggle.

AUSTIN, Texas—The fastest-growing major mutual-fund company in the U.S. isn’t strictly an active or passive investor. It is both.

Dimensional Fund Advisors LP, or DFA, is the sixth-largest mutual-fund manager, up from eighth a year ago, according to Morningstar Inc., drawing nearly $2 billion in net assets a month at a time when investors are fleeing many other firms.

DFA, whose founders and advisers include leading purveyors of efficient- market theory, is built on the bedrock belief that active management practiced by traditional stock pickers is futile, if not an absurdity.

DFA’s founders are pioneers of index funds. But these men concluded long ago that investors who respected efficient markets could nevertheless achieve better returns than plain index funds deliver.

'We think indexing is too mechanical,' says David Booth, chairman of Dimensional Fund Advisors.

The Austin, Texas, firm remains all but unknown to the general public, since its funds are available exclusively through financial advisers or to big institutions. But the firm manages $445 billion and already holds at least 5% of the total shares outstanding of 545 U.S.-listed companies, it says.

Here is how DFA invests: It designs its own indexes, often of small-capitalisation stocks, then waits—for weeks, if necessary—until an eager seller is willing to unload shares at below the prevailing asking price in the market. Such tactics can minimise and in some cases even erase transaction costs, providing a small but meaningful boost to returns.

The firm often emphasises cheap, small-cap stocks that are cumbersome for active managers to buy, whether because they are too tiny to make a difference for a portfolio or are costly to trade.

Research by Eugene Fama of the University of Chicago and Kenneth French of Dartmouth College, finance professors who also advise DFA and serve as directors there, has shown that stocks with smaller market capitalisation, as well as those trading at low prices relative to their asset value and those with above-average profitability, outperform in the long run.

DFA has leaned heavily on research from economists like Mr. Fama who taught at the University of Chicago’s business school, known for its embrace of efficient- market theory. Co-founders Mr. Booth and Rex Sinquefield both studied there, and since 2009, when Mr. Booth donated $300 million, it has been known as the Booth School of Business.

Messrs. Booth, Sinque- field and another person involved in the start of DFA, John “Mac” McQuown, helped launch the first index portfolios at Wells Fargo & Co. and American National Bank in the early 1970s.

DFA was the first investment manager to create an index fund of small- cap stocks after academic research conducted in the late 1970s showed that such companies had outperformed the overall market by roughly two to four percentage points annually. But with small caps, there were those big brokerage costs—often 2% or higher.

So DFA created a type of index that it would follow closely—but not exactly.

“We don’t try to do magic,” says Prof. French. “We’re doing engineering.”

Much of DFA’s growth came after 1988, when a financial adviser named Dan Wheeler approached the firm, which then offered its portfolios exclusively to big institutional investors. A former stockbroker, Mr. Wheeler had often seen purportedly market- beating investments generate big commissions for brokers but losses for clients. Mr. Wheeler recalled recently he could find other “advisers with a conscience” and get them to offer DFA funds to their clients.

Messrs. Booth and Sinquefield took a chance on the idea of selling funds through advisers who wouldn’t charge commis- sions. Mr. Wheeler, now retired, set up a daunting steeplechase that advisers still must hurdle before they can market the funds. First, DFA staffers talk with prospective advisers, probing for any disqualifying signs of performance-chasing behaviour. Advisers who seem in sync with DFA’s values then must pay their own way to attend a two-day training session at the firm.

Only then are they permitted to offer the funds—and DFA continuously hammers home more data on why active management, and other attempts to beat the market, fail. The result has been intense, almost religious, devotion to the firm among many advisers.

Cliff Asness, co-founder of AQR Capital Management, a close competitor, says DFA inspires such loyalty among advisers that “very few firms have been able to pull that off,” adding: “It comes from people feeling you have made them better at their jobs.”

Today, DFA faces three major challenges, competitors, clients and former employees say: Can it continue to grow without losing its edge? Can it maintain its prestigious reputation now that it has begun to expand into new markets? And can it fend off new competitors whose funds are often cheaper?

About 60% of DFA’s assets are attributable now to financial advisers, but the firm no longer has a lock on its market niche. Many advisers who once used DFA exclusively say they now combine its funds with comparable ones from several other firms.

“They’re no longer the only game in town,” said Frank Armstrong, a financial adviser who has invested his clients’ money with DFA since 1990.

Eduardo Repetto, DFA’s co-chief executive, says “the sense of quality is still there,” and that he expects much of the firm’s growth to come from overseas markets.

“If, over time, fees come down,” he said, “we’ll have to adapt. That’s life.”

Data cited in article is as of 30 September 2016, unless otherwise noted.

This article is distributed for informational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

All figures are in USD. Past performance is no guarantee of future results. There is no guarantee an investing strategy will be successful. Small cap securities are subject to greater volatility than those in other asset classes.

Gene Fama and Ken French are members of the Board of Directors for and provide consulting services to Dimensional Fund Advisors LP. John “Mac” McQuown is a member of the Board of Directors for Dimensional Fund Advisors LP.

The opinions expressed herein represent the current, good faith views of the author(s) at the time of publication and are not definitive investment advice, and should not be relied on as such.

“DFA” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., and Dimensional Japan Ltd.


February 2017

This article contains the opinions of the author but not necessarily of Dimensional Fund Advisors Canada ULC (“DFA Canada”), manager of the Dimensional Funds, and does not represent a recommendation of any particular security, strategy, or investment product. The author’s opinions are subject to change without notice. This article is distributed by DFA Canada for educational purposes only and should not be considered investment advice or an offer of any security for sale. Unauthorized copying, reproducing, duplicating, or transmitting of this material is strictly prohibited. Commissions, trailing commissions, management fees, and expenses may be associated with mutual fund investments. Please read the Simplified Prospectus before investing. Any indicated rates of return are the historical annual compounded total returns including share or unit value and reinvestment of all dividends or other distributions and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.


This material has been provided by DFA Australia Limited AFS Licence No. 238093 (DFAA). In providing this document, DFAA is not making an offer or recommendation to Australian investors to buy or sell securities or other financial products, nor a solicitation for deposits or other business, whether directly or indirectly.

DFA Australia Limited (AFS Licence No.238093, ABN 46 065 937 671).