By: Frank Armstrong
By: Frank Armstrong, CFP, AIF
Index funds are the lowest cost, lowest risk, and lowest tax cost solution to reliably capture the performance of the world’s markets.
Using institutional class index funds to provide a broad global diversification, we can effectively and economically provide exposure to most traded securities of the world’s attractive markets. The total cost executing our strategy cost is remarkably low, in many cases less than the cost of true no-load mutual funds. But, cost is only one of the benefits of a relationship with Investor Solutions.
A key advantage to using an Advisor is the access to institutional funds, like those of Dimensional Fund Advisors (DFA). In addition to low costs, access to global markets and tax efficiency, the DFA funds maintain very targeted investment strategies.
For sophisticated investors, do it yourself investing is not a viable solution. For a variety of reasons, we think that everyone ought to seriously consider a professional manager for his or her investments. Investor Solutions has a number of advantages that retail investors do not. First, we have access to much better targeted funds than Vanguard offers.
Most do it yourself investors that identify with an indexing philosophy often consider the Vanguard family of funds as a fair substitute to the DFA institutional funds. They are not!
Vanguard has no foreign value, foreign small, foreign small value, emerging market small, or emerging market value. Of nine major asset categories, Vanguard cannot supply three at any price and terms. Nor are they able to supply two sub categories of emerging markets. These categories are potentially the most valuable in terms of increasing returns, and reducing risk.
In three other categories, the domestic small, small value and large value funds, the Vanguard funds offer a weak imitation of the DFA Funds. For instance, the DFA small company fund has much smaller companies than Vanguard’s. Vanguard’s value funds are only slightly less growthy than the market, while the DFA funds we use are a deep value index. The Vanguard funds simply fail to capture the majority of the expected return premiums that are expected from these risk dimensions.
The DFA Emerging Market portfolios have radically different design from the Vanguard Emerging Market Index Fund. The DFA funds are equally weighted rather than capital weighted, substantially reducing individual country risk within the portfolio.
In short, the funds available to us are far better building blocks to an efficient, well-diversified portfolio.
On another front, DFA’s second and third generation tax-efficient index funds family does a remarkable job of reducing ongoing taxes below the already efficient nature of index fund operation. This can make a dramatic difference in net return after taxes for investors with accounts subject to taxes.
DFA vs. Vanguard
Both DFA and Vanguard offer low-cost, passively managed funds. But, while Vanguard funds are available to the general public, DFA funds are only accessible through a select group of fee-only advisors. Vanguard’s funds are designed to track popular domestic and international indexes but DFA funds are designed to capture the returns of “academically defined high cost of capital asset classes around the world.”
Academic research by Eugene Fama and Ken French has determined that 95% of the differences in average returns for equities can be explained by three factors, Beta, Size and Value (as measured by Book-to-Market). There is a risk premium involved with multi-factor investing. The higher the loading of these factors, the higher the expected return. The most critical difference between Vanguard and DFA index funds is how strongly each fund loads on the risk factors.
The tables below summarize some of the most important design characteristics. See current prospectuses for up to date data.
|Availability of Asset Class||DFA||Vanguard|
|US Large Value||X||Sub-optional|
|US Small Value||X||Sub-optional|
|Foreign Value||X||Not Available|
|Foreign Small||X||Not Available|
|Foreign Small Value||X||Not Available|
|Emerging Value||X||Not Available|
|Emerging Small||X||Not Available|
|Matters of Style||# of Companies||WTD Avg Mrt Cap $MM||Median Mkt Cap $MM||Wtd Avg Book/Mkt||Median Book/Mkt|
|US Small DFA||2,662||230||70||0.66||0.73|