Texas Fund Firm Out-Vanguards Vanguard

DFA figures that over long periods, its smaller stocks will prevail. The aim is to lag slightly in downturns, while outperforming by wider margins in upturns.

Besides focusing on smaller stocks, DFA seeks to gain an advantage from the methods it uses for trading and structuring portfolios. These differ considerably from the approach taken by Vanguard and other conventional managers of index funds.

For its portfolio, Vanguard Small Value aims to track the MSCI U.S. Small Cap Value Index by holding about 1,000 stocks. The portfolio is weighted according to market value. So bigger stocks account for a large percentage of assets in the fund.

DFA doesn't aim to track a standard benchmark. Instead, the company starts with stocks that are in the smallest 10% of those traded in the U.S. Of those, it emphasizes stocks that account for the cheapest 25% of assets in the group. The final portfolio includes up to 1,600 names. DFA portfolio managers don't weight their holdings according to market values or any fixed standard. Instead, they aim to emphasize shares that are cheapest to trade.

Say two stocks each are around the same size and price. But one is expensive to trade because there is a wide spread between the bid and ask prices -- the amounts that buyers are willing to pay and sellers will accept. To make the purchase, the DFA trader would have to raise his price. To limit costs, the trader would buy the cheaper stock and postpone bidding on the expensive one, perhaps waiting weeks or months until more favorable conditions appeared.

Diehard proponents of index funds question the DFA approach, saying it fails to deliver pure exposure to asset classes. DFA managers argue that their trading strategy holds down costs. That can boost returns for investors who have the patience to hold over the long term.

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