DFA Case
Case Analysis: Dimensional Fund Advisors 1. Describe the philosophy of DFA. What sort of market behavior are they counting on?
DFA believes in three principles:
1. The Efficient Market Theory. That is, the stock market is efficient and no one has the ability to consistently pick stocks that will beat the market. Over any given period, some lucky investors will outperform the market while others will underperform. DFA felt that the market price of any firm’s stock incorporated all public information and therefore did not do any fundamental analysis on the firm in question.
2. The value of sound academic research. For example, DFA’s founders believed that small-stock investing could yield high returns to investors. They formulated this belief on the Ph.D. dissertation research of Rolf Banz of the University of Chicago, which showed that small stocks had consistently outperformed large stocks between 1926 and the late 1970s.
3. The ability of skilled traders to contribute to a fund’s profits even when the investment is inherently passive. DFA’s investment fund had a semi-active strategy between those of actively managed funds and those of pure index funds.
DFA counts on market behavior that reflects the following concepts:
1. The Beta is Dead. Stocks with high-beta do not have consistently higher returns than low-beta stocks. That is, greater risk does not guarantee greater reward.
2. The Size Effect (Small Minus Big). Based on the research that small stocks historically outperform large ones, DFA strategically built a micro-cap portfolio (9th and 10th NYSE deciles) and a small-cap portfolio (6th to 10th NYSE deciles). The company expanded this strategy to international markets such as the UK, Japan, Europe, and Pacific Rim. Regarding the liquidity problem of small companies, DFA engaged in block trading; DFA bought large blocks of illiquid stocks from sellers instead of bidding on the open market to buy stocks.
3. Value stocks outperform growth
DFA believes in three principles:
1. The Efficient Market Theory. That is, the stock market is efficient and no one has the ability to consistently pick stocks that will beat the market. Over any given period, some lucky investors will outperform the market while others will underperform. DFA felt that the market price of any firm’s stock incorporated all public information and therefore did not do any fundamental analysis on the firm in question.
2. The value of sound academic research. For example, DFA’s founders believed that small-stock investing could yield high returns to investors. They formulated this belief on the Ph.D. dissertation research of Rolf Banz of the University of Chicago, which showed that small stocks had consistently outperformed large stocks between 1926 and the late 1970s.
3. The ability of skilled traders to contribute to a fund’s profits even when the investment is inherently passive. DFA’s investment fund had a semi-active strategy between those of actively managed funds and those of pure index funds.
DFA counts on market behavior that reflects the following concepts:
1. The Beta is Dead. Stocks with high-beta do not have consistently higher returns than low-beta stocks. That is, greater risk does not guarantee greater reward.
2. The Size Effect (Small Minus Big). Based on the research that small stocks historically outperform large ones, DFA strategically built a micro-cap portfolio (9th and 10th NYSE deciles) and a small-cap portfolio (6th to 10th NYSE deciles). The company expanded this strategy to international markets such as the UK, Japan, Europe, and Pacific Rim. Regarding the liquidity problem of small companies, DFA engaged in block trading; DFA bought large blocks of illiquid stocks from sellers instead of bidding on the open market to buy stocks.
3. Value stocks outperform growth