Dimensional Fund Advisors focuses on small cap stocks and value. Robust investment processes have put its 10-year track record for its Australian Value Trust 4.2% ahead of the S&P/ASX 200 accumulation index over the same time. DFA’s operating criteria include focusing on things within its control, staying disciplined and having diverse investments. Acting as neither a conventional manager nor index manager, DFA’s solid strategies have grown wealth for its investors.

Dimensional Fund Advisors (DFA) is a registered investment manager in Australia and the USA (DFA Australia Ltd is the Australian subsidiary).

It also provides investment research reports and insights. And it’s research that has seen DFA, which has global assets of $190 billion, be so successful for its investors: it’s ranked 34th out of 770 money managers worldwide.

While the 10-year track record of DFA’s longest-running fund, Australian Value Trust, sits at 11.5% (net of fees), some 4.2% ahead of the S&P/ASX 200 accumulation index of 7.3%, in the US, it’s even better. There, DFA’s Emerging Markets Value portfolio has a 10-year track record of 11.5% (also net of fees), which is 5% higher than the MSCI benchmark. (MSCI, or Morgan Stanley Capital International, has been providing global equity indexes for more than 30 years. Its global equity benchmarks are the most widely used by institutional investors in 23 developed and 27 emerging markets.)

Graham Lennon, who heads up DFA Australia’s international portfolio management team, says the fund aims to deliver above-market returns, cost efficiently.

DFA’s approach

Lennon says DFA’s approach is patient and flexible trading, so they earn a liquidity premium rather than paying a high price for it. DFA does not base its approach on forecasting growth and earnings, so is not a “conventional manager”. Nor is it an index manager (which would contract out security selection to commercial benchmarks).

Rather, DFA chooses securities that offer higher expected returns.

DFA bases its approach to valuing companies on the ground-breaking research by economists Kenneth French and Eugene Fama (the “Fama-French research”). This research showed that low-priced (value) stocks generally give higher returns than high-priced (growth) stocks. The Fama-French research also showed that in the long term, small-capitalisation stocks had higher expected returns than large-cap stocks.

DFA also sees a company’s capital cost as equal to an investor’s expected return.

Lennon says they use a basic measure of value: primarily price-to-book (“P/B ratio”) or book-to-market (“BtM”).

(“P/B” is a financial ratio that compares a company’s current market price to its book value — the latter essentially being the company’s total tangible assets less its total liabilities. “BtM” is the ratio of a company’s “book value of equity” (accountants determine this with historic cost information) to its “market value of equity” (buyers and sellers determine this using current information). For instance, a low BtM ratio points to the book value per share being low relative to the share price.)

Lennon says while in a nutshell DFA chooses stocks for their “buy universe” as those which are the most value-like, it’s not as simplistic as that. For instance, they also factor in tax effects; they also pay attention to the daily market conditions, and manage those against their modelling.

(A “buy universe” is a set of securities sharing a common feature — such as the same market cap, industry or index.)

Controlling costs — something within DFA’s control — is another emphasis in their approach. Lennon explains these as not just obvious ones (such as broking commissions), but other costs through buy-sell spreads.

The next 12 months: plan, don’t guess

Graham Lennon says as global markets recover, investors will continue to be concerned more with risk than they were before the GFC, when most thoughts were around return.

He says risk can be managed to a degree, but there will always be some uncertainty. DFA controls that as best they can by only taking risks that have an expected return, paying attention to things within its control (such as costs, taxes and implementation efficiency), and broad diversification.

And, he says, DFA does not base its strategy around any predicted future. That, he believes, is a recipe for disaster. Rather, it’s far preferable to develop and follow solid processes that can withstand whatever the future tosses up. 

The mix

Lennon says DFA’s Australian Value portfolio, which has about 200 stocks, goes through natural turnover: as the price of value stocks increases, DFA moves into different ones.

In Australia, its fixed-interest strategies are up to 5 years, focused on at least AA-rated credits. Sector exposures change due to the natural turnover, but are dominated by agency, semi-government bonds, supra-national bonds and sovereign paper.

Lennon is justifiably proud DFA’s results. According to measurements by Mercer, the Australian Value portfolio’s 10-year results put DFA’s strategy as the top performing long-only Australian equity strategy for that time.

Of the main “rules” DFA follows in investing, one of the most important is to stay disciplined. That is, change an investment when your circumstances or needs — but not for any other reason. 

DFA Australia Limited is one of the fund managers Summerhill Financial Services uses because of its robust investment processes. DFA is accessible to investors through fee-only financial advisers. Please contact us if you would like to talk about the suitability of including DFA in your portfolio. Summerhill can assess the appropriateness for your individual circumstances and financial goals.

Sources: Investopedia; DFA; Wikipedia; Index Funds Advisers.

Tags: investment philosophy