Under The Hood At DFA

You will never once hear praise heaped on a DFA fund manager for successful stock-picking. This is not because DFA doesn’t post good returns, but because the managers at this relatively unknown Texas-based firm don’t pick stocks at all. However, this unique firm doesn’t index either; they promote themselves as an alternative to both indexing and active management. So if they don’t actively manage funds, and they don’t try to track an index, just what have they done to attract over $225 billion?

This is where the bragging comes in: DFA’s directors are some of the biggest names in academic finance, including multiple Noble-prize winning professors. This firm, Dimensional Fund Advisors, builds its entire investment philosophy on the academic works of its directors, such as Robert Merton and Myron Scholes, who both won a Nobel Prize in Economics for their work on option pricing, Eugene Fama, a Nobel favorite due to his work on market efficiency and involvement in creating the Efficient Market Hypothesis, and Ken French, Fama’s constant collaborator famous for his work in asset pricing.

Such a dependence on academic research is not surprising, considering that co-founders David Booth and Rex Sinquefield were both students of Fama. In fact, Fama’s work on the Efficient Market Hypothesis is perhaps the theory that most influences DFA money management strategies. DFA assumes that the stock market is efficient, but based on research conducted and developed by Fama and French, certain types of stocks (specifically small-cap value stocks) will perform the best over long periods of time.

In addition to seeking out value stocks over growth stocks, and small-cap stocks over large-cap stocks, DFA also tries to gain an edge by keeping expenses low. Trading costs are kept to a minimum by ensuring that the each portfolio is constructed to encourage low turnover, and the focus on low fees appears to be working; out of over 70 investment offerings (excluding those with less than a one-year track record), the highest annual expense ratio is only 0.89% for a Global Equity Portfolio, while the lowest annual expense ratio is 0.11% for the US Large Company portfolio. Most of the funds have an expense ratio less than 0.5%.

Despite the fact that DFA manages over $225 billion, making it somewhere around the 15th largest mutual fund company in the United States, many investors have never heard of this company before. DFA, surprisingly, doesn’t mind. DFA keeps costs low by not heavily marketing themselves, and by relying on a network of professional financial advisors to promote the funds. In fact, DFA is so choosy that you can only invest in one of their funds through certain fee-only financial advisors.

Dimensional Fund Advisors is certainly one of the most unique money management firms in the United States, creating an alternative to both index management and active management. If you are an investor who believes in the theory of the Efficient Market Hypothesis and are looking for a mutual fund to suit your ideas, DFA may be just the right fit.