Dimensional Fund Advisors (DFA) is an investment firm based in Santa Monica, California. It was founded in 1981 by David Booth and Rex Sinquefield. It is a different investment firm which think differently and push the frontiers of innovation. The firm had close working relationships with academics such as Eugene Fama and Kenneth French who introduced the Fama & French three factors model. Fama has worked in DFA since very early days, now he is the director of research department of DFA. He is known for his work on portfolios and asset pricing. This report is going to discuss the business strategy of DFA, issues relating to Fama & French Three Factor Model such as variables being used also the performance of DFA. DFA’s business strategy:
The overall strategy of DFA is passive but still claimed to add value. In 1981, DFA launched its first business strategy which was to invest mainly in small cap stocks; they also believed two principles: the value of sound academic research and the ability of skilled traders. DFA encouraged academic researches and reward the professors who can contribute sound investment strategies to the firm. DFA believed that by combining these principles would make it successful among investment companies. In 1983, by applying Eugene Fama’s term structure research, DFA launched its second strategy which was to invest in a short-term fixed income portfolio. In 1989, DFA began to managing money for wealthy individuals, before that DFA’s clients were mostly major institutions such as corporate, government, union pension and charities. Because the direct accounts with individual investors were intolerably expensive, DFA created a limited number of investment and accounting firms known as registered investment advisor (RIAs). RIAs contributed to DFA’s core beliefs which are lower transaction cost, low turnover and diversification. Lower cost enabled DFA to charge fewer fees to the client. All these factors benefited DFA, its assets under management grown rapidly over time. In my opinion, the business strategy of DFA was successful according to the strong performance of asset growth. It also reflects a strong belief in the principles of modern finance and the efficiency of capital markets. While DFA was founded, it was dedicated to the principle that stock market was “efficient”. As it believed no one could consistently pick stocks right and make money from it. Besides, DFA was not simply an index fund manager; it was still a proponent of index funds. Fama & French findings:
According to the article, in 1992, Fama and French published “Cross-section of Expected Stock Returns” which contained a number of findings which could be summarised as follows: 1. Stocks with high beta (risk) did not always perform better than low beta (risk) stocks, which conflict with CAPM (1963)’s theory that stocks with higher beta (risk), should receive greater return. 2. Book to market ratio was the most powerful scaled-price variable for estimating stock returns. Stocks with high ratio of book value of equity to market value of equity (BE/ME) exhibited consistently higher returns than stocks with low BE/ME. 3. The stocks of smaller companies produced higher returns than those of the larger companies. The findings was reasonable as high BE/ME stocks (value stocks) were stocks had low prices and despite high asset values on book, these companies usually had poor performance and were more likely to become distressed. Risks associated with these value stocks were higher than those of growth stocks (low BE/ME stocks). Similarly, smaller companies in general have a greater opportunity to grow compared to large companies, but they also had a wider dispersion and the annual returns on their stocks usually had greater variability. Therefore, Fama and French’s findings did make sense because returns for value stocks and smaller stocks were higher in order to...