Who is Dimensional
Fund Advisors?

“People at Dimensional care much more about getting the right answer than defending their answer.”

Kenneth French – Professor, Dartmouth College. Dimensional Director, Consultant, and Co-Chair of the Investment Research Committee

Dimensional Fund Advisors (DFA) is the only fund manager founded on the basis of obtaining a return from the market by applying decades of academic research and experience. They apply an investment strategy which provides the investor with the market return without guessing the market.

Ethos and mission 

DFA was founded in 1981 by academics David Booth and Rex Sinquefeld of The University of Chicago’s School of Business. It uses academic research to formulate investment strategy and has formal associations with prominent financial economists such as Eugene Fama who was awarded the Nobel Prize for Economics in 2013, and with Professor Kenneth French who has conducted decades of research into the empirical analysis of stock market returns.

Financial research identifies the sources of investment returns and Dimensional provides the tools and experience to target these sources and help investors achieve the return that they want. DFA do this by scientific asset allocation, diversification, reducing cost, managing risk, and applying proven trading strategies. This is quite unlike most other fund managers who guess the market and who are regularly shown to be wrong. Traditional investment approaches strive to beat the market by taking advantage of pricing “mistakes” and attempting to predict the future. Too often, these approaches prove costly and futile. Predictions go awry and managers may hold the wrong securities at the wrong time, missing the strong returns that markets can provide. When you invest with DFA your investment is no longer speculation and it becomes simply a method for consistently obtaining the market return. Guided by a strong belief in markets, DFA works to implement compelling ideas in finance for the benefit of clients. An enduring philosophy, strong client commitment, and deep working relationships with the academic community underpin their approach.

Their investment philosophy has been shaped by decades of research. They believe that security prices reflect all publicly available information as intense competition among market participants drives prices toward fair value.

They use the information in market prices, combined with fundamental data, to systematically identify differences in expected returns among securities. They seek to add value by building portfolios that target higher expected returns in a cost-effective manner. By integrating a dynamic, market-driven process with a flexible trading strategy, they manage the trade-offs that matter for performance— balancing competing premiums, diversification, and costs. This approach is applied consistently across a full suite of global and regional equity and fixed income strategies, allowing them to help meet the diverse needs of investors worldwide.

What is factor investing? 

At its most basic level, factor-based investing is about systematically following a set of rules that builds a diversified portfolio of stocks sharing certain well-defined traits/characteristics that are associated with the drivers of investment returns, and avoids (or even sells short) a diversified portfolio with the opposite characteristics. 

Factor investing grew in popularity after the Global Financial Crisis, which gave way to the longest bull market on record, with single-factor strategies attracting considerable inflows. However, more recently they have struggled to deliver market-beating returns. Factor-based investing remains a much more reliable way of delivering long-term returns than market-cap weighted strategies – but only if it is done correctly. According to Dimensional:

“Factor investing as a systematic way to design and implement investment strategies to pursue higher expected returns than the market. It’s a rules-based approach that takes some of the emotion out of investment and replaces it with rigorous research and efficient implementation.”

While many investors often choose a passive or active investment style, a systematic factor-based investment approach offers the potential for market-beating performance without manager-specific risks.

Although factor investing has become more mainstream in recent years, it is important to note that it is a style of investing rooted in academia and backed by extensive research. A factor is a purely academic construction that you can’t invest in directly, which is important because it's a long way from thinking about a factor in an abstract academic sense, and using it to invest.

Investment factor models started emerging in the 1970s and 1980s, with the first – the Capital Asset Pricing Model (CAPM) – explaining why stocks that moved with the market outperformed those that did not.

After that, academics started to identify other factors such as size, which the CAPM model did not explain, as academics found that the smaller the company, the higher the expected returns.

In the early 1980s, when this research around the size factor came out, Dimensional founder and executive chairman David Booth wanted to bring it to the market, and that is essentially where the idea of systematic investing started.

That early factor research inspired the launch of the world’s first micro-cap strategy in 1981 and it is still running today. Further research in the decades since, notably by Dimensional Directors, Gene Fama and Ken French, has identified value, profitability, and asset growth as valuable factors.

More than 600 factors have been proposed since the 1980s, but many are simply too far away from anything you could implement in the market.

Remaining disciplined 

One of the challenges of a systematic factor-based approach is remaining disciplined, particularly when markets become more volatile.

Because of the nature of risk, and the virtual certainty that factor strategies will experience long periods of underperformance (and, with them, the behavioral problem of negative tracking variance), factor investing is hard. It requires a strong belief system that can provide the discipline needed to ignore the stress created by near-term negative performance (or relative underperformance) and allow investors to stay the course. If factor investing were easy, everyone might do it;

Changing your investment approach, by adding different types of stocks when market conditions change, can harm investors’ portfolios.

If you believe in a factor, then you should stay invested in it, even during periods when it is volatile. Otherwise, you may miss out.

A lot of so-called value funds ended up being growth funds in disguise during the decade where the value premium was not as impressive as its historical average. And that lack of discipline meant they ended up underperforming when the premium rebounded more recently.

However, investors may want to invest with a consistent portfolio manager and a firm that understands the importance of remaining disciplined when markets are more volatile. One thing that we strongly believe in is diversification. It has been called the only free lunch in finance, and it helps capture premiums because we do not know which securities will deliver on any given day.

Ultimately, investors must judge whether their managers are delivering what they promised, which is easier with a systematic approach.

Any manager can look phenomenal if they are lucky and manage to pick the right stocks or hit the market at the right point in time. And they can also look bad if they are unlucky.

While the performance itself is an important aspect of judging a manager, investors should focus on consistency of performance as that is a sign that a manager is following a process; a lack of consistency could reveal inefficiencies or the lack of a well-defined approach.

You need to judge a manager holistically, from their research to the design and management of their portfolios. Are they doing everything they can to maximise performance and minimise risk?

Shared core investment principles: 

1. Capital markets work: investors are consistently rewarded for investing their capital in the market
2. Risk and return are related. An investor should aim to obtain the market return without taking unnecessary risks
3. Diversification is essential to minimise risk and achieve the market return on investment
4. Costs must be minimised and eliminated where possible to increase investment net return
5. Portfolio asset allocation is the key determinant of investment return
   a. Equity return is determined by market, size, value, and profitability
   b. Fixed Income return is determined by term and default risk
6. An investor’s behaviour has a significant effect on investment return

You can read our investment philosophy in full, here.

10. Focus on what you can control 

A financial adviser can offer expertise and guidance to help you focus on actions that add value. This can lead to a better investment experience.

Costs of trading 

In addition, the costs of trading are minimised and almost eliminated, and this could potentially reduce costs by another 1% or 2% a year. The removal of this ‘hidden’ cost means that Dimensional funds can be cheaper than most other funds because of their lower AMCs in combination with their very low trading costs. We believe that the total cost reduction of Dimensional funds in comparison with many active funds could be as much as 3% per annum.

Funds are only available through advisers because of the belief that advice is important. Research has shown that investors who do not take advice get consistently lower returns over time because of poor investor behaviour. Dalbar (www.dalbar.com) has been following investor returns since 1994 and they have consistently shown that investment results are more dependent on investor behaviour than on fund performance. They show that the average unadvised investor receives over three percent per annum (over 3% p.a.) less by making the wrong decisions and taking those decisions at the wrong times.

Dimensional vs. Vanguard 

Both are great, have strengths and weaknesses, and are better than what 99% of international investors are invested in.

If I could wave a wand and move all the trillions of dollars sat languishing in low-interest deposit accounts with banks, toxic structured products or poorly performing active funds portfolios - to either of these, I would. Pick either one and you’ll likely have made a good choice.

However, there's a deeper explanation I'd like to get into to better explain how they are individually set up to capture returns. You can read it here.