Dimensional Fund Advisors: Diversified Passive Investing
Just when you were about to get out of international stocks, international markets have outperformed US so far this year as highlighted in Barron’s. My firm adheres to a strict discipline of global diversification. Removing the emotion and rebalancing into asset classes that seem to be “dead” has helped provide clients with a more consistent investment experience.
While Dimensional Fund Advisors might have been a secret to many investors, our clients at CJM have known for some time now the significant advantage of following the DFA investment philosophy which utilizes a passive approach based on very specific ideologies: markets work, diversification is key, risk and return are related and portfolio structure explains performance. Because it is impossible to time stock and bond market changes the strategy that has paid off for Dimensional Fund Advisors has been diversification.
The ongoing dispute between passive and active managers gained fuel with last year’s winners and losers regarding asset classes and active managers. Pimco’s Bill Gross is still licking his wounds since admitting his mistake in betting against US government debt. Here is the manager of the world’s largest bond fund. Bruce Berkowitz, founder of Fairholme Capital Management, joined Bill Gross in having his worse year ever, last year. Actively managed mutual funds recorded $8.6 billion in outflows last year. Investors pulled a monstrous $33 billion form the Growth Fund America alone. This fund peaked at roughly $202 billion in 2007, and unfortunately for American Funds, this outflow shows the increasing shift from actively managed funds to passive index funds. They have lost about 15% of their assets since the end of 2007. Lastly, hedge fund manager John Paulson lost more than half of the capital in one of his firm’s biggest funds, the Advantage Plus Fund in 2011. The fund ended the year down approximately 52%.
According to an Investment News article, “Even if you subtract American Funds Growth Fund and its $33 billion outflows from the equation, actively managed funds still trailed passive index funds by nearly $38 billion of net inflow, according to Morningstar data”. In each of the last 10 years, more than half of all active equity managers have beaten their benchmarks only four times, and in none of those years did more than 63% beat their benchmarks. Over the past five years, only 48% of active equity managers have had better total returns than their benchmarks, according to Lipper, Inc.
Active managers generate higher turnover, transaction costs and taxes due to speculative trading. Index managers actually accept high transaction costs and turnover in favor of tracking. Alternatively, Dimensional Funds minimize costs and enhance returns through portfolio design and trading. They will never buy a high-priced popular stock of the day just to ensure that they continue to mirror whatever index they are tracking. Instead, they have a patient and price-conscious buy and hold approach to trading that is designed to minimize costs which work to the client’s advantage.
Dimensional Funds are not generally available directly to individuals. They work exclusively with advisors who share their belief that broad diversification, low costs, risk/return characteristics, managing taxes and a strict discipline are the key ingredients in long-run investment success. They will only give this privilege to advisors who go to great lengths to help their clients develop financial plans for each stage of their lives-and strive to help keep those clients on track to meet their goals. One of our worst tendencies as investors is to chase “hot” stocks, sectors and asset classes. Unfortunately, the historical evidence shows that we often end up buying yesterday's winners (after their great performance has already fun its course), and sell yesterday's losers(after all the losses have occurred). Tuning out exterior influences such as the news or market swings and staying the course based on the investor’s individual needs and goals is the value that CJM adds to their clients.
About Charles Massimo
Recognized as industry expert and guest speaker at national industry conferences, Charles Massimo is a published author and media subject expert on topics ranging from wealth/asset management to investment and financial planning for high net worth families.