Would you invest in DFA?
Yes due to steady returns provided by the company and as investors are generally past performance chasers, one has no reason not to invest in DFA. The company was founded on a sound investment style based on its core belief in sound academic research, passive fund management. Until almost the end of the 20th century DFA had found a way to make money actively with a passive investment strategy. But looking forward, according to me it needs to evolve with the times and look for questions regarding its own strategy and its evolution with the times and the questions facing the financial future. As highlighted by the boom in the I.T sector towards the end of the last century that DFA missed out on completely, DFA on principle is always poised to miss out on new technology companies, as they intrinsically have low book to market value. Also my another objection to DFA’s selection of small cap stocks only is that these category of companies are among the worst hit companies during a financial crisis because of their limited access to credit and most of these companies don’t survive a major recession. Even some proponents of the efficient market hypothesis have argued that due to DFA and similar companies investing in this particular style, this style’s edge had been eroded. Lastly many prominent academicians and financial institutions have called into question the efficacy of the efficient market theory due the financial bubble created in the financial markets. That fact that market price of a stock represents the fair price has been called into question. Most of the big banks now act as quassi-exchanges and execute trades within themselves without needing to inform the stock exchange, in which case the market may not posses sufficient information.
What do you think of DFA as a business?
Does it add value for investors?
DFA’s fees tended to be lower than those of most actively managed funds but higher than those of pure index funds. Because of the diversified nature of their funds i.e lower risks and higher returns that the funds experienced over the last years make DFA a value for money. DFA has a competitive advantage and is a market leader in small cap stocks investing segment while keeping the transaction costs low. DFA managed funds yielded steady returns over the decades for its clients. Note: numbers from Exhibit 8 for past returns
How did they convert the notion of market efficiency and conclusions from optimal portfolio theory into a business?
DFA rejects stock-picking, market timing and utilizes enhanced indexing to design portfolios and limit trading costs by a passive investment strategy . To reduce risk of its funds, DFA diversified the portfolio of the fund as much as possible until the stocks fit the DFA criteria. DFA believes in market efficiency and used Fama and French (FF) three factor model as an alternative explanation for the ongoing arguments on asset pricing. These included stocks with small market capitalization and stocks with high book to price (market value). Since these stocks yielded higher return than market, FF commented that such phenomenon is explained by the existence of size as well as value premium in addition to the market risk premium as posited by traditional CAPM.
B. Value/Size premium
What is the value and size premium?
How much is the size premium? Any trend? What could be the cause? How much is the value premium?
What do you think can be the cause?
Can a mutual fund like DFA earn the value premium?
In his Phd. Dissertation, Rolf Banz of the University of Chicago, found that small stocks had consistently outperformed large stocks over the entire history of stock market from 1926 through the late 1970s. Fama and French in their paper commented that value stocks, over time, produce better returns in the US, and that this effect applies to most of the other countries as well; the same evidence is found for size effect....
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