Case Study: Dimensional Fund Advisors

1
Case StudyDimensional Fund Advisors

• Investments
• Melbourne Business School
• Ning Gong

2
DFAs Investment Philosophy

• Passive fund that still claimed to add value
• They agree with the efficient market hypothesis
  which claims that no one can consistently beat
  the market
• Do they perform fundamental analysis on the
  stocks they own?
• What happens to the trading costs?

3
Investment Philosophy (contd)

• But, they also believe in the value of sound
  academic research, and, in particular, the
  Fama-French Findings about
• Size effect (large vs. small)
• Book-to-market ratio (value vs. growth)
• They believe in the ability of skilled traders to
  reduce transaction costs and taxes.

4
DFAs Business Strategy

• Their investment philosophy is the foundation of
  their business strategy.
• Enhanced index funds, especially in the small-cap
  sector
• It seems to work well for them, because DFA funds
  outperformed the small stock indexes, but it also
  lagged behind the SP 500 index throughout the
  1980s and early 1990s.

5
Trading of Small Stocks

• Whats about the liquidity for small stocks?
• They are illiquid because of high bid-ask spread
  and therefore they demand liquidity premium in
  the market
• How does the DFA mitigate the illiquidity of
  their small stock holdings?
• On-the-market vs. block trades

6
Block Trades

• What problems and practical issues with privately
  negotiated block trades?
• Information asymmetry, i.e. the lemons
  principle
• Long-term relationship and reputation could
  reduce the lemons problem
• Diversification and the tracking-error
• Degree of the price discount.

7
Why isnt DFA more popular with investors?

• With stellar scholars on board, why isnt DFA one
  of the largest funds in the U.S.?
• Small stocks may out-perform than the large
  stocks, but there are additional, unspecified
  risks
• As stated in the case, there was an extended
  period of time that small stocks underperformed
  than the large stocks
• There is no reason to overload small stocks based
  on the CAPM.

8
Investors Concerns

• More importantly, what happens if an investor
  needs to sell his holdings???
• This point is mentioned but not focused in the
  case.
• In my opinion, DFA does not perform as well as it
  claims because of illiquidity for investors.
• It reserves the right to withdrawals in kind
  that is, by handing over shares in hundreds of
  stocks.
• Market gains vs trading gains See the article of
  The Only Game in Town.

9
Whats DFAs Future?

• After the internet bubble bursted, DFA is doing
  better.
• DFA wants to broaden its product line by offering
  tax-managed funds to boast after-tax returns to
  investors.
• Differential taxes for dividends and capital
  gains
• Realize losses not gains
• Reducing transaction costs
• Should DFA try to maximize its size?