Why We Choose to Invest Using DFA Mutual Funds

At PFS, we have been using Dimensional Fund Advisors (DFA) mutual funds as the primary investment vehicle for our clients–and ourselves–since 1999.  We do not receive commissions or any compensation from DFA for using their funds.   We simply believe that their funds are based on a sound investment philosophy, have a strong performance record, and are well-suited to help us facilitate a successful investing experience for our clients.  In a prior post, we discussed how Morningstar, the investment industry’s premier research firm, ranked DFA funds very highly in its annual analysis of mutual funds, but recently the Wall Street Journal (WSJ) also featured two articles highlighting DFA–specifically, its innovative investment philosophy and its firm foundation in academic-based research. 

“DFA … is built on the bedrock belief that active management practiced by traditional stock pickers is futile, if not an absurdity.”

DFA believes that spending time, money, and effort researching the prospects of individual stocks and trying to pick the winners and avoid the losers for a given time period is not only ineffective but actually hurts investment results.  They believe that the optimal way to invest is to buy every stock in a given asset class.  They follow a passive strategy, but one that is more nuanced than just tracking an index.  Unlike index funds, they are patient in trading stocks that move in and out of the target asset class, waiting for opportunities to trade with eager buyers and sellers who are willing to pay above or accept below market prices.  They also earn additional returns by lending out securities that sit in their funds.  The practice of securities lending is common but the fact that DFA passes on 100% of the proceeds to their investors is very uncommon.  In this way, the majority of DFA funds (82% over the past 15 years) outperform their comparable benchmark, while index funds (e.g. the Vanguard 500 Index Fund) usually underperform their benchmark index by a few basis points each year, primarily due to fees.

“DFA is the sixth-largest mutual fund manager … [growing] at a time when investors are fleeing many other firms.”

DFA is not as well-known as other major mutual fund managers because they only allow institutional investors and investors working with a select group of financial advisors to buy their funds.  This is one of the ways that DFA keeps the cost of its funds low and protects the investors in their funds.  Since individual investors are working with advisors, they are less likely to react to changes in the market by buying and selling, thereby driving up the number of transactions and associated costs for the funds (as well as taxable distributions to fund holders).  DFA’s nuanced passive investment strategy (discussed above) also significantly contributes to the relatively low cost of its funds.

“What really makes Dimensional different is they think through the scientific process like nobody else…. They are ruthless about the truth. [Their directors] don’t [care] about any vested interests or incentives or marketing.  They only care about the data.”

DFA bases its investment strategy on academic research, especially that of economists from the University of Chicago, such as Nobel Prize winner, Eugene Fama, which emphasizes the “dimensions” of investment returns.  This research shows how certain types of stocks–namely, those of small companies, those trading at low prices relative to their asset values, and those with above-average profitability–outperform their counterparts in the long run.  Therefore, DFA tilts its funds (and we tilt client portfolios) toward the asset classes that have been shown to produce higher returns over a long investment horizon.  (Of course, there is no guarantee that these higher returns will continue in the future.  As the lawyers make us say, “Past performance is not a guarantee of future investment returns.”)

When PFS began using DFA funds in 1999, DFA managed $34 billion in assets.  Now, it manages $445 billion.  We believe this growth reflects an increased awareness of the futility of active management as well as an increasing realization that DFA truly provides a recipe for investment success that is a cut above its peers in the mutual fund industry.