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DFA vs. Vanguard - Which is better?

I have been hearing for quite some time that the funds from Dimensional Fund Advisors (DFA) are superior to those of Vanguard. At the Bogleheads 8 conference, Ed Tower, an economics professor at Duke University, presented preliminary results from a study he coauthored with Zhang Yichong, a graduate student at Duke, that examined this topic, and a couple of others. Here's an overview of the findings from an updated version of the paper, and my take on this one issue.

Vanguard and DFA
Vanguard is probably familiar to you as the giant mutual fund family known for its low costs and passive indexing approach. It keeps costs low, in part, by paying no loads to those that distribute their funds.

DFA is also a low cost fund family that uses passive investing, and emphasizes small cap and value investing based on what is known as the Fama and French Three Factor Model. This model states that small cap and value investing have a greater return than large cap and growth stocks, but is compensation for taking more risk. DFA distributes its funds through advisers and cannot be bought directly by retail investors. In full disclosure, I am one of those advisers approved to sell DFA funds.

Over the years, I've often heard that DFA is a better way to passively invest than Vanguard, though I haven't seen any data to support those claims. As a matter of fact, this study is the first such data that I've seen on this subject.

The findings from the study
Tower and Zhang looked at equity returns of DFA and Vanguard funds from the end of 1982, when DFA data became available, until August 31, 2009. The findings surprised me.

The DFA equity portfolio has not consistently outperformed the Vanguard equity portfolio. Over the entire life of the DFA equity portfolio, its return is less than that of the Vanguard equity portfolio, even without adding in adviser and transaction fees for the DFA portfolio. However, for the period of the start of the growth stock bubble (end of 1995) through August 31, 2009, DFA, even with an adviser and transaction fee of up to 1%/year, out-returned the Vanguard portfolio.
Thus, according to the study, the answer is dependent upon which period of time is being studied. Ed Tower noted to me that the DFA portfolio showed less volatility, which is one measure of risk. The question of which is better remains unanswered, especially going forward.

My take
I'm a believer in the Fama and French Three Factor Model, yet I also agree with them that the higher expected return is compensation for taking more risk. Many DFA advisers noted how well DFA did during the 2000 - 2002 bear market, but this was a period when small cap and value shined. To imply that this would happen in every bear market is making a trend from one data point - it doesn't work. In actuality, small cap and value underperformed in the recent bear market. Value happened to be heavily weighted toward financials.

While I'm fascinated with this question of which is better between DFA and Vanguard, I happen to think it's the wrong question. Both are outstanding low-cost approaches to capturing as much return as the stock market has to give. One can get the very lowest costs by buying Vanguard directly, but there are also great low cost advisers that have access to DFA funds. One such adviser is Portfolio Solutions that uses various passive low cost funds, including Vanguard and DFA.

I happen to have both DFA and Vanguard in my portfolio, though I admittedly have much more of my portfolio in Vanguard than I do DFA funds.

As I said, the comparison of Vanguard to DFA funds is fascinating, yet I think a much better question to ask is will DFA and Vanguard likely outperform much more active and expensive mutual funds and ETFs. My answer is YES!


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