Does DFA hit its benchmarks?

(MoneyWatch) Many investment strategies appear to show value added before expenses, but the big question is if they actually deliver what they promise. Today, we'll look at whether the passively managed asset-class funds of Dimensional Fund Advisors, which has well over $200 billion in assets under management, have delivered the returns of the asset classes in which their funds invest.

According to its website, DFA touts its ability to "capture what markets have to offer." Thus, it should be able to produce fund returns comparable to appropriate benchmarks. As you review the results, remember that indexes have no costs, but funds do. We should generally expect to see a fund underperform its benchmark by at least its expense ratio, plus some additional amount related to the costs of turnover. Also, we'll also take a look at each fund's securities lending revenue, which helps offset the fund's expenses. (Please note that the revenue figures are for the fund's latest fiscal year, which ends in October, so they don't exactly align with the fund's returns as presented.)

Domestic

We'll start with DFA's domestic funds, looking at five funds versus appropriate benchmarks. The time period for all these funds is inception through June 2012.

The evidence is clear that DFA has been able to earn the returns of the asset classes its funds invest in, outperforming benchmarks by an average of 0.68 percent. Even if we exclude the large value fund as perhaps an outlier, the average underperformance of the remaining four funds was just 0.10 percent. Note that the average expense ratio is 0.36 percent. However, once we add in the securities lending revenue, the average "effective" expense ratio falls to 0.24 percent.

International

Next, we'll see how DFA's international funds have performed. This time, we have four funds to examine:

The four international funds outperformed their benchmark index (something the vast majority of active funds fail to do) by 0.77 percent, overcoming the drag of their expenses. The gross expense ratio averaged 0.50 percent. However, once we consider the securities lending revenue, the "effective" expense ratio falls to 0.32 percent.

Emerging Markets

As you review the evidence, keep in mind that the emerging markets are probably the most expensive to operate in. We have three funds to examine:

DFA's three emerging market funds were able to outperform their respective benchmark indexes by 3.46 percent, overcoming a gross expense ratio that averaged 0.67 percent. After accounting for the securities lending revenue the "effective" expense ratio was 0.55 percent.

The bottom line is that whether we look at domestic stocks, stocks of other developed markets or stocks of emerging markets, DFA has demonstrated that a well-designed and well-run passively managed fund can meet the objective of investors -- to earn the return of the asset classes in which they want to invest. Case closed.

Larry Swedroe's firm, Buckingham Asset Management, primarily uses DFA funds in the construction of client portfolios.

*The start date for DFISX is October 1996, but data for the best benchmark for this fund starts January 1999, so the data used in this comparison starts in January 1999.

Image courtesy of taxbrackets.org

[VFR6500]

Hi Larry--One problem smaller investors have with the DFA funds is that they must go through an authorized financial advisor to purchase the funds due to DFA's high minimum buy-in. Typically, these advisors charge a flat fee of about 1.25%. Doing simple math on the examples you gave, the return for small investors would range from -1.01 to -.7% below bwnchmarks. Would you agree with this assessment? Thanks--- VFR6500

[Paula_Hogan_CFP_CFA]

Hello VFR6500, Whether the advisory fee provides good value depends on what you are purchasing from the adviser. I agree that a 1-1.25% advisory fee is high for simply putting your portfolio into a diversified selection of mutual funds, even with the high quality of investment management offered by DFA. However, if the advisory fee includes comprehensive financial planning, and if you want personally tailored advice on your whole financial picture, then an advisory fee of that magnitude combined with the expense and benefit of a DFA type portfolio is a compelling value proposition.

[VFR6500]

Thanks Larry

[twisi]

Hi Larry, this being the case with Dfa funds being transparent,liquid and capturing the market benchmarks is there a way to compare say a DFA 60/40 or 70/30 portfolio to a typical university endowment portfolio using the so called "Yale" endowment model.
Thanks-

[LarryswedroeCBS]

Twisi, first there is no such thing as a "DFA 60/40" portfolio. DFA simply provides building blocks for investors to use to design their own portfolios based on their unique desire for exposure to the various asset classes. Having said that one can look at any asset allocation and then implement it using DFAs funds. Further, the most efficient way to use their funds is to use their core funds as much as possible as they not only have lower internal costs, but they reduce internal trading costs by reducing turnover, which also improves tax efficiency, and they also allow you to rebalance using other investors money (saving fees and taxes) instead of your own money.


Hope that is helpful

Best wishes
Larry