Preferred Funds: The DFA Advantage
Cardiff Park is among a select group of advisors qualified to offer clients direct access to passively managed, index-like funds designed and offered through Dimensional Fund Advisors (DFA). Founded in 1981, DFA works with some of the world's leading financial economists to bring their theories and research into practice.
Note that we do not receive compensation of any kind from DFA. We work with them because they offer a complete selection of low cost, tax aware and tax efficient passively structured portfolios covering all major domestic stock, foreign stock and bond asset classes.
The DFA Difference
The DFA investment approach draws upon the work of Nobel laureates and financial economists, including Eugene Fama (University of Chicago), and Kenneth French (Dartmouth). These are just two of the renowned names to be found on the DFA Board of Directors. Professors Fama and French are among eminent academic leaders whose breakthrough theories challenged and changed the practical world of modern investing by examining the behavior of markets, the relationship between capital structure and firm value, and the common risk factors in stock and bond returns. Among other things, their research demonstrated that holding the market and over-weighting portfolio exposure to size and value risk factors offer more attractive expected returns than most active investment advisors, the majority of whom fail to beat market benchmarks.
DFA mutual funds offer broad diversification and are structured for low turnover and reduced trading costs and capital gains distributions. Fund management fees are low, in part because DFA funds do not charge 12B-1 fees to cover marketing and advertising expenses. DFA total mutual fund fees and costs tend to be lower than the total fees and expenses incurred by most other mutual funds, including many similar exchange traded funds (ETFs) and other index funds
DFA offers over 60 passively managed index-like portfolios with precise asset class characteristics. The investment process is straightforward, well defined, and consistent across all funds, resulting in reliable exposure to specific asset classes.
What Makes Dimensional Funds Different?
In their quest to understand and capitalize on risk dimensions in the market, DFA forged a practical new model centered on asset class investing. To understand this, consider how their philosophy differs from traditional indexing approaches.
Traditional managers fall into two camps: active and indexing. Active managers spend time and resources attempting to identify mispricing in the market. These imbalances are not easy to exploit consistently or cost-effectively. An active manager's stock choices and market-timing efforts may result in poor diversification, frequent trading, and high turnover, which can undermine asset class exposure and generate higher costs.
DFA recognizes that indexes are not model portfolios, but proxies of a market segment for performance comparison. Hence, strictly following an index is generally not the best or most efficient way to capture the returns of an asset class, due to the fact exact replication requires minimizing tracking error. This in turn forces predictable trades when indexers are trading at the same time. Upward and downward movements can be anticipated and exploited, creating indirect costs for investors.
DFA sidesteps this issue by targeting an asset class rather than a commercial index. This “price seeking” model (as opposed to “price tracking”) minimizes upward and downward momentum by introducing new names into the investment mix every day. It’s an opportunistic approach that allows DFA to trade when conditions are good, and withhold trades when conditions are less favorable. Practically speaking, it results in a bonus for investors that’s measurable in basis points and adds up over time.
Asset class investing as practiced by DFA takes a different approach to pure indexing, offering more flexibility in portfolio composition, broader diversification and greater exposure to key risk factors that generate returns. Asset class investing also gives traders the freedom to lower transaction costs, leading to more precise asset class exposure and higher expected returns.
How Dimensional Manages Costs
DFA’s dynamic approach to investing seeks to control the forces that influence returns. Fees, commissions, market impact costs, and bid/ask spreads consume a high proportion of the gross investment returns offered by the markets. DFA works to minimize these costs in strategy design, management, and execution. A structured, engineered approach combined with patient trading translates into lower management fees and higher returns.
Many of DFA’s portfolio design filters are applied to eliminate hard-to-trade securities and to maintain a large list of substitutes for cost-effective trading. Portfolios are also managed to reduce the momentum-effect, the tendency of securities that have outperformed or underperformed the market over the previous three to twelve months to continue to do so. And, as noted above, DFA avoids the adverse price impact that occurs when a manager trades index securities around periodic reconstitution dates. These trading costs are largely controllable, and avoiding them makes a difference in ultimate returns.
In short, DFA is an astute trader, buying and selling solely on price, not according to the pressures of time, limited alternatives, or commitment to a forecast or index. The result is formidable trading power. By being patient when others are pushing to buy and sell, and price sensitive when others pay a premium, DFA works daily to improve results.