Understanding Dimensional’s Value Proposition, Part 4 of 7: Exclusivity
By Peter C. Thoms, CFA
March 13, 2015
In the U.S., virtually all mutual funds and other publicly traded investments are open to anyone who wants to invest. Mutual fund companies are rightfully very eager to make their funds known to and readily available to everyone.
There is one big exception to this trend: Dimensional. Dimensional Fund Advisors (DFA) restricts access to its funds by only making them accessible to the clients of independent investment advisors with whom it wants to work. Admittedly, this can be frustrating for those who want to invest with Dimensional but do not work with an advisor who is a DFA partner. However, the walled-garden nature of the Dimensional investor community actually does benefit those investors on the inside because it protects them from the costly high turnover (frequent buying and selling) that is so rife among other funds and so detrimental to long-term returns. DFA’s low-turnover philosophy has undoubtedly contributed to the firm’s strong long-term performance record.
Despite the fact that Dimensional is one of the largest and fastest growing firms in the country (it is the seventh largest mutual fund company in the U.S. and has assets under management of approximately $400 billion), the company has grown to this size by doing virtually no public advertising and severely restricting access to its funds.
How is this possible and why has this happened?
Our series of articlesof which this is the fourthendeavors to explain Dimensional’s strategies in plain terms. It describes why we believe Dimensional funds offer the best value proposition in the industry and are therefore worthy of consideration by all investors. We encourage those interested in Dimensional to read each piece in this series to gain a more in-depth understanding of the firm’s evidence-based investment strategies.
Read Part 1 of 7: Value Tilt, here.
Read Part 2 of 7: Small Cap Tilt, here.
Read Part 3 of 7: Profitability, here.
As a professional investor for the last seventeen years, I have, through phone calls, emails and lunch invitations, been pitched hundreds of different investments by smart, well-spoken, convincing sales people from hundreds of investment firms. In my career, there is only a single firm that wanted me (!) to jump through hoops before it would give me access to its funds: Dimensional. In fact, in addition to passing an interview, I had to complete a lengthy and rigorous syllabus that explains the findings of the research underpinning Dimensional’s investment strategies. I studied for many hours over several months before Dimensional granted my firm (and therefore my clients) access to its funds.
Dimensional makes its funds accessible only to independent fiduciaries that can:
1 Pursue their clients’ financial goals without conflicts of interest, and
2 Understand Dimensional’s investment strategies and explain them to clients.
Dimensional wants like-minded advisor partners to ultimately put like-minded investors into its funds. Only about 6% of all financial advisors in the U.S. have access to DFA funds.
If everybody in a sandbox is throwing sand and you are not, you still get hit with sand! If no one is throwing sand, no one will get hit. This sandbox analogy pertains to trading. In mutual funds, excessive trading (throwing sand) kills returns and is one of the main reasons that the active mutual fund industry, broadly speaking, has such a dismal performance record. (For a detailed report, please download your copy of the Mutual Fund Landscape here.) It’s one thing for a portfolio manager of a fund to trade too much in an attempt to capture short-term moves of stocks or markets. However, trading is often driven by the activity of the underlying investors in the fund, and this type of trading can be even more damaging. Many fund investors trade way too much, buying and selling shares while all fund investorseven those not doing any tradingsuffer the consequences.
When you manage a mutual fund, as I did before starting my own investment firm, each day you come into work to see if there have been inflows or outflows of client assets from your fund. If there are inflows you need to put that money to work by making investments. If there are outflows you may need to sell some positions to raise cash to meet the redemptions. The worst-case scenario is that the market is down sharply and nervous investors panic and all sell their shares at the same time. In this case, even those investors standing fast will suffer as the fund’s holdings are liquidated at sub-par prices to meet redemptions. Even if you are not throwing sand, you will still get hit when other people do!
This is why Dimensional limits access to its funds to a select group of investment advisors. It expects its advisor partners to educate their clients about the benefits of minimizing trading while maintaining a consistent investment strategy through good times and bad. Dimensional wants to be in control of who is in its sandbox.
By allowing only like-minded long-term investors into its sandbox, DFA confers an advantage on these investors: it shelters them from unnecessary and damaging turnover and trading costs. Dimensional investors (like me) can be confident that DFA portfolio managers will adhere to the firm’s low-turnover philosophy and that their fellow investors in these funds are also long-term investors who understand that minimizing trade and transaction activity is one of the keys to successful long-term investing. If nobody throws sand, everybody benefits.
For information and performance details about any particular Dimensional fund, please visit www.dfaus.com and click on “Strategies.”
To learn more about DFA funds and how we employ them to construct low-cost, tax-efficient, value-focused portfolios for our clients, please visit us at: www.orionportfolios.com
Peter C. Thoms, CFA
Orion Capital Management LLC
1330 Orange Ave. Suite 302
Coronado, CA 92118
Tel: 619.435.1701
Email: [email protected]
About the Author:
Peter C. Thoms, CFA, is the founder and managing member of Orion Capital Management LLC, an independent Registered Investment Advisor based in Coronado, California. The firm manages assets for individuals, families, trusts, corporate pension plans and non-profit organizations.
Disclosure:
This document is for informational purposes only. Nothing in this report is to be construed as a specific investment recommendation. This document does not constitute the provision of investment advice, which is only provided by Orion Capital Management LLC under a written investment advisory agreement and only in states in which Orion Capital Management LLC is registered or is exempt from registration requirements. Orion is not a tax advisor and does not provide tax advice. For tax advice individuals should consult their CPA.
