The financial services industry spends millions of marketing dollars every year trying to convince investors that the key to financial success is picking the right stocks (or mutual fund) or correctly timing the market.
Yet study after study over the past four decades has shown that most actively-managed mutual funds under-perform their benchmarks. For example, only 27% of actively managed large-cap core funds, or 239 funds, out-performed the S&P 500 index in the first half of 2014, according to a new report from S&P Capital IQ. That’s the lowest level of active managers to beat the index since 2011, when only 19% beat the S&P 500 index for the full year. And this under-performance by active managers applies across asset classes (large cap, small cap, value, and growth) and across markets (US, developed international, and emerging markets).
Yet at least one fund manager has been able to generate consistent long-term out-performance, without resorting to the futility of active management.
More than 75% of its funds have beaten their category benchmarks over the past 15 years, and 80% over five years, according to Morningstar – impressive for what some investors incorrectly categorize as index investing.
The philosophy behind Dimensional’s success is the theory of efficient markets, first developed by Professor Eugene Fama (University of Chicago) in 1965. In 2013, Fama was awarded the Nobel Prize in Economics for his academic work.
DFA’s funds are all build on the same conceptual foundation – that it’s very hard to beat the market, and virtually impossible to do it consistently, by stock-picking or market-timing. However, there are various so-called “factors” that can be introduced into an investment portfolio to generate market-beating returns. These factors, combined with a focus on tax-efficiency, low expenses, and a sophisticated trading strategy, have led to Dimensional’s success.
What sets DFA apart from every other mutual fund company is their commitment to integrating leading-edge, rigorous academic research in financial economics into their investment process. DFA’s co-founder David Booth met Fama while a Ph.D. student at the University of Chicago in the fall of 1969. Booth graduated in 1971, and 10 years later, along with Rex Sinquefield, another student of Fama’s, launched DFA from his apartment in Brooklyn. Sinquefield served as chief investment officer until 2005, when he left to devote more time to his political causes.
Dimensional’s director of investment strategy is Kenneth French, an economist and professor at Dartmouth College, and a collaborator with Fama for nearly 30 years. The Fama-French “three-factor” model is the root of Dimensional’s strategy, and their ongoing work has informed the development of new strategies and products for decades.
Fama and French are not the only academics on Dimensional’s board, and Fama isn’t even the only Nobel Prize winner. Myron Scholes of Stanford University, who was awarded the prestigious prize in 1997 for the Black-Scholes method for valuing derivatives, lends his expertise to the funds’ board. Also on the board is Roger Ibbotson, the founder of research firm Ibbotson Associates.
You can read the entire January 4, 2014 Barron’s profile here.