Joe R. Hollen, a Reno, Nev., certified financial planner, is convinced that investing in index funds rather than actively managed mutual funds provides the best returns.
believer," he says of the giant mutual fund company that popularized indexing.
So why was he clearly excited to be attending a conference in Santa Monica, Calif. sponsored by
Dimensional Fund Advisors
, a much smaller and lesser known mutual fund company?
"The light went on and I just went, 'Wow,' " said Hollen. "This is something I can offer to clients they can't get themselves."
Indeed. Access to Dimensional funds is limited to individuals with $2 million in investment assets, investors of more modest means working with fee-only advisers and accountants who must pass muster with the company, and employees using 401(k)s at certain large companies, such as
It's all part of the philosophy and even the mystique of this lofty mutual fund family founded by academics and overseen by many of the nation's leading economic financial economists, including two Nobel laureates. The privately held Santa Monica firm, with a rapidly growing $53 billion under management, counts Governor Arnold Schwartzenegger among its minority owners since 1996.
Hollen was one of more than 100 select advisers attending the two-day conference at a swank hotel a block from Dimensional's headquarters overlooking the Santa Monica beach. While the sun shone gloriously outside, attendees listened earnestly to talk of asset classes and risk dimensions and squinted at columns of numbers and statistics.
The brain trust at Dimensional has used its more than 32 funds to test the ground-breaking economic theories formulated at the University of Chicago: diversification reduces risk; investors generally cannot outperform the market itself; and, over the long term, small companies have higher expected returns than large ones.
They also practice what's known as passive investing vs. actively managed portfolio investing, the method employed by most mutual fund managers. But their approach is not indexing per se, though it has jokingly been called "indexing on steroids."
Dimensional managers prefer to call what they do "structured asset management." They target a class of assets in which to invest, buy them as cheaply as possible and keep portfolio turnover low and investor expenses to a minimum, usually below 0.50% of money invested.
The firm specializes in small- and micro-capitalized companies in the U.S. and around the world, including emerging markets such as Chile, Turkey and Poland.
Recent returns on some of their flagship small-company funds have earned the professors high marks.
Paul Herbert, senior mutual fund analyst with Morningstar who follows several of Dimensional's funds, said the fund family is not the only one to model academic theories.
"But they've got the broadest lineup in distributing their funds," he said. "And they've had pretty good success.
"These are really outstanding results," he added, referring to Dimensional's
U.S. Small Cap Value Fund
or DFSVX. The fund, as of April 30, had an annual return of 62.25% and a five-year return of 17.57%, compared to 42.46% and 12.92%, respectively, for the Russell 2000 Value Index.
"There's something unique about these funds," he added. "No one else could run a $2.9 billion micro-cap fund." He was referring to the company's oldest fund, the
U.S. Micro Cap Portfolio
or DFSCX, established in 1981.
(Dimensional, by the way, as of Dec. 31, 2003, held about 4.84% of the outstanding shares of TheStreet.com (TSCM) , publisher of this Web site.
Dimensional manages the trick of continuing to buy small companies, without driving up their prices, Herbert said. The company's fund managers can do this because they buy and hold shares, have good liquidity and an established network of brokers willing to sell them large blocks of small-company stocks.
But that success has its downside. Some of Dimensional's funds are starting to overlap one another, failing to provide investors essential diversification, company co-founder, co-chairman and CEO David G. Booth told the advisers.
By the end of the year, the firm might have to close its U.S. small-cap funds to new investors because of overcapacity and expand its overseas and tax-managed funds, according to Kevin Hight, regional manager.
Meanwhile, the advisers basked in the comfort of having cast their lot with the smart money.
In the early 1960s, stock-picking was 100% art and 0% science, Booth told the group. But by 1975, when the first index fund was launched, there was empirical evidence that most investment professionals failed in the long run to outperform the market.
Even so, said Daniel M. Wheeler, Dimensional's director of global financial adviser services, most investors still "want to believe so desperately there's a Tiger Woods of money management."
Wheeler said that Warren Buffett, the greatest investor of our age, reportedly gets only three to four good investing ideas a year, compared to typical mutual fund portfolio managers who select hundreds of companies for their portfolios.
"We don't even have three or four good ideas," Wheeler said, and the crowd laughed at the self-deprecating joke.
Most people making investments get caught up in what's happening today, he said, when investing is really about the future, which is unknowable.
In the 1980s people rushed into gold, in the 90s it was Japanese funds and in 2000 it was the Internet and high technology, Wheeler said.
Advisers who use Dimensional funds can help keep their clients focused on diversification and the long term, he reminded his audience.
One of those advisers is a young woman named Helen Tsu, a newly minted certified financial planner from Newport Beach, Calif. She was pleased to be asked to join the Dimensional fold.
In trying to develop her own philosophy of investing, she found her favorite books were
Winning the Loser's Game
by Charles D. Ellis and
A Random Walk Down Wall Street
by Burton G. Malkiel.
"These writers had me convinced that passive investing is the only way to go," she said. "After that, I thought indexing was the only way to go. But it just seems too simple."
Then she got the reams of academic reading materials from Dimensional and felt she had found what she was looking for: "I'd been thinking there's got to be something better."
(Individuals who want to invest in Dimensional funds can try finding a fee-only adviser to assist them through the company's Web site at www.dfaus.com. Neither Dimensional nor the advisers receive fees for this service.)