As a longtime passive investing geek, there is no company I hold in higher regard than Vanguard, and no businessperson I admire more than its founder John Bogle. A handwritten note from Mr. Bogle is framed above my desk. I am a proud “Boglehead.”
So when I say that I prefer Dimensional Fund Advisors (“Dimensional”) to Vanguard, know that this is not a statement I make lightly.
First, a reminder: given Geometric’s independent structure, we are free to invest our clients’ money – and our own – in whatever mutual funds or ETFs we believe to be the best. We are not beholden to any fund company, and never will be.
Our investment philosophy allows us to sift through the vast wasteland of mutual fund and ETF companies, immediately eliminating most because they have excessively high costs, trade too frequently, or are not diversified enough.
Nearly all of the remaining options are “traditional” index funds or ETFs, which have the mandate to track an underlying benchmark. While there are several good index fund and ETF companies (Fidelity Spartan, Schwab, iShares, etc.), we believe that Vanguard is the best, lowest-cost and most reliable. The market agrees, as Vanguard has experienced record inflows making it the world’s largest mutual fund company. This is great news for investors everywhere.
Traditional index funds sit atop the huge pile of available mutual funds and ETFs, and Vanguard sits atop the smaller group of traditional index funds. But we believe that Dimensional sits even higher. There are several reasons for this:
• Academic grounding. Dimensional was founded by leveraging the research of Nobel Laureate Eugene Fama (who coined the term “efficient market”) and his partner in academia, Kenneth French. Other top academics (such as Nobel Laureate Robert Merton) remain on staff, while others (such as Nobel Laureate Myron Scholes) serve as directors. Dimensional’s investment methodology is subject to a level of academic rigor that no other firm can match.
• Passive, but not indexed. Dimensional mutual funds and ETFs are “passive,” in that they recognize that markets are largely efficient and that trying to pick winning stocks is fruitless. However, they are not tethered to any specific benchmark (e.g. S&P 500 or Russell 2000). Traditional index funds attempt to mimic these benchmarks as closely as possible. By definition, this goal restricts their flexibility in fund construction and requires trading stocks that are affected by benchmark “reconstitution” (elimination of some companies and addition of others), which has proven to be a disadvantageous time to trade. By electing not to strictly index, Dimensional is free to construct their mutual funds and ETFs in a manner that allows them to capture the returns of a given asset class without the necessity of trading the underlying stocks on the same day as everyone else, thereby reducing trading costs.
• Minimizing costs. Unlike most fund families, Dimensional actively promotes the importance of minimizing investment costs. They walk the walk by offering mutual funds and ETFs with low annual expense ratios (as of this writing, the Dimensional mutual funds and ETFs we own for clients have expense ratios ranging from 0.12% to 0.45% – slightly higher than Vanguard’s, but much lower than the industry average) and by carefully controlling costs within the fund (by trading patiently and infrequently).
• Small Cap and Value tilting. Informed by the evidence-based concepts that small cap stocks should outperform large cap stocks over time and that “value” stocks should outperform “growth” stocks, Dimensional mutual funds and ETFs are intelligently designed to capture these risk premiums. Dimensional makes it easy for advisors to “tilt” their clients’ portfolios towards small cap and value stocks – holding disproportionately more than a traditional market cap-weighted portfolio.
• Securities lending. Mutual fund managers have the option to lend their stocks to short-sellers, and receive a tiny lending fee for doing so. This fee can either be retained by the fund company or passed on to the funds (thereby increasing the return to fund holders). Most fund companies do some combination of the two. I know of only two that pass all of their net lending fees to fund holders: Dimensional and Vanguard.
• Smarter bond funds. Dimensional’s bond mutual funds are similarly “passive” in not attempting to pick winning individual bonds, while also not tracking a benchmark. This framework allows Dimensional to employ an evidence-based “variable maturity” bond strategy, holding longer maturity bonds only when investors can expect to be reasonably rewarded (i.e., when the yield curve is steep). When the yield curve is flat or inverted, Dimensional shortens the duration of its bond funds.
If Dimensional is so great, you may be asking, why haven’t you heard of it? The answer is that Dimensional does not market its mutual funds or ETFs directly to individual investors. It used to be that their mutual funds could only be purchased by investors working with advisors who have demonstrated expertise in the implementation of evidence-based investment strategies. However, they’ve since released many of their investments in an ETF format that can be purchased directly by retail investors. That said, Dimensional believes that passively-minded advisors – stewards of much of the investing dollars in their funds/ETFs – do a good job keeping their clients disciplined. Knowing that its fund holders are focused on the long-term allows Dimensional to implement all the desirable strategies described above.
Beliefs aside, we don’t have the option to buy Dimensional mutual funds or ETFs in every client account. For example, few 401(k) plans offer Dimensional mutual funds or ETFs. When Dimensional is not an option, we are perfectly comfortable owning traditional index funds – specifically Vanguard funds. And in rare circumstances, we prefer Vanguard to Dimensional for specific clients in specific situations. While Dimensional remains our default choice, we own whatever makes the most sense for the client’s needs.
If you’d like to read more about Dimensional’s story, we highly recommend this 2014 Barron’s cover story. If you would like to learn more about the historical fund performance of Dimensional’s mutual funds, including how they stack up to Vanguard’s, please contact us.
Lastly, while this post reads as a glowing endorsement for Dimensional, remember that it simply reflects our preferences, not any formal ties or allegiances to the firm. Our loyalty is only to our clients. If at any point we believe that a different fund company offers a better option for our clients, we would excitedly incorporate it.
In the meantime, we feel fortunate to be able to invest our clients’ money – and our own – in Dimensional mutual funds and ETFs.