Dimensional Fund Advisors’ Passive Fund Management Theory

Most investors have not even heard of Dimensional Fund Advisors, Inc. (DFA). The company doesn’t have any TV commercials or splashy magazine ads touting the benefits of their funds. Dimensional focuses more on pension funds and endowments, rather than individual investors, since their funds aren’t even directly available to investors. Investors must go through financial advisors to purchase the funds and usually require a $100,000 minimum investment. 

Dimensional Fund Advisors, Inc. is based in Santa Monica, CA and has $69 billion in mutual funds. The company was founded twenty five years ago by David Booth and Rex Sinquefield. Both men are former graduate students of Professor Eugene Fama, who taught economics at the University of Chicago. Professor Fama, who now serves on the board of Dimensional, coined the term “efficient markets.” Efficient markets are just what Dimensional is counting on to produce results for its various funds.

Their fund management is based on the theory that without expensive research or rare talent it is very difficult to pick winning stocks. The company eschews active fund management that relies on market timing or stock picking. DFA uses a passive management theory to structure funds that will capture the returns of an entire asset class, rather than just mirror a selected index. Backed by academic research, they identify small stocks and value stocks that return a better value over a longer period of time.

DFA’s broad range of stocks, favors small and value stocks because they feel the market discounts these stock prices to reflect the fact that they may not be as strong or carry more risks than “hot stocks” that mainstream investors are seeking. DFA appeals to investors who focus on a long-term upside potential.

Another key to DFA’s fund management theory is minimizing trading costs and taxes to achieve the best total returns. Many funds eat into their total returns with high transaction and management costs. Dimensional’s fund managers avoid trading at a premium and negotiate buying large blocks of shares at discounted prices.

Aided by a strong rally in small stocks over recent years, DFA has performed well, but not all industry experts agree with their investment theory. Critics argue that the advantage of small or value stocks will eventually be corrected by the market, leaving more traditional index-based funds ahead of DFA.