D-F-A are three letters that, put together, have meant little to most individual investors. That's changing, and odds are rising fast that if you talk with a financial adviser, you'll hear about DFA. Short for Dimensional Fund Advisors, DFA is a California firm whose office overlooks the Pacific from a neat perch on the bluffs at Santa Monica. It's filled with a flock of efficient-market types, including the University of Chicago's Eugene Fama, who first proposed the efficient markets hypothesis (that is, that stock prices swiftly and correctly reflect information, making attempts to beat the market the work of fools).
DFA manages most of its $32 billion for such giant investors as pension funds. It won't deal with you and me, at least not directly. But its business with some 500 independent financial advisers, who funnel money from individuals to DFA, is surging. These assets now come to more than $12 billion. To the right ears--those on anyone who doubts the value of stock picking or market timing--DFA is an easy sell. It holds that portfolios built with DFA funds and tilted toward the small-cap and value stocks that Fama and other researchers favor offer the best risk-return trade-off. As Gregg Fisher, president of Manhattan financial planners Gerstein, Fisher & Associates, put it, "Hearing Eugene Fama speak, it's like watching Babe Ruth play baseball."
Despite its passive approach, DFA follows no index. So, for example, its small-cap portfolios are traded daily according to DFA's own criteria for what makes a good small-cap stock, such as market value and liquidity. Not having slavishly to track, say, the Russell 2000 index gives it flexibility to keep a sharp focus on the small-cap end of the market. DFA also slices markets in any exotic way that allows it to grab a portion--emerging markets value stocks, for instance--whose risks and returns seem to differ from every other portion. These distinct asset classes then can be put together in portfolios of varying levels of risk. As it happened in the five years ended Sept. 30, a 15-fund DFA portfolio, 60% in global stocks, 40% in global bonds, would have returned an annual average of 3.3%. By contrast, a benchmark with a 60-40 mix of domestic stocks and bonds returned 2.3% a year.
What's the hitch? First, consider that just because small-cap and value stocks have done better before is no guarantee they will again. "There's no reason to suspect that any one segment of the market will do substantially better than any other part," Vanguard Group's indexer-in-chief, Managing Director Gus Sauter, told me. Also, individuals can't buy DFA except via an adviser. That means extra annual fees. A hypothetical DFA portfolio might cost 1% of assets a year--far less than the average mutual fund, yet far higher than other options (table). While DFA suggests its long-term returns will outstrip an adviser's fee, any do-it-yourselfer with discipline might approximate a DFA portfolio more cheaply.
The key word is discipline. Fisher said his big challenge is convincing clients that once you create an asset allocation, it's best to do nothing. Do your portfolio moves seem too frequent and leave you queasy? Then D-F-A may spell relief.
Copyright 2002, by The McGraw-Hill Companies Inc. All rights reserved.
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