As a fee-only, independent investment advisory firm, we are free to choose any available investment option for our clients. For the past 18 years, we have relied mainly on funds from Dimensional Fund Advisors to construct our client portfolios. We use Dimensional funds because we believe they provide the greatest value for our clients, however, we periodically review our investment choices to see if any better options have become available.
Exchange-traded funds (ETFs) can be an attractive alternative to mutual funds. ETFs are baskets of assets, such as stocks, bonds, or commodities. Unlike mutual funds, which trade only once a day after the markets close, ETFs can be bought or sold, like stocks, throughout the trading day. Most ETFs passively track a standard stock or bond market index, although actively managed ETFs are also available. A new suite of index fund ETFs was launched by State Street Global Advisors last October. We were intrigued by these ETFs because of their ultra-low annual expenses, which range from 0.03% to 0.11%, with an average annual fee of about 0.05%. These funds, referred to as the SPDR Portfolio ETFs, are available to our clients with no trading fee on our TD Ameritrade Institutional platform. This represents an ultra-low-cost approach to constructing broadly diversified global stock and bond portfolios.
Dimensional funds have annual expense ratios that are well below the industry averages, but higher than the SPDR Portfolio ETFs. Are the Dimensional funds worth the added expense? The bar chart below, which compares the 15-year returns of leading Dimensional stock funds to all other available funds, should help us answer that question:
Each vertical bar in the above table represents all the funds within a specific asset class. The ranking of each Dimensional fund is designated by a black horizontal line. A common strategy among fund companies is to close poorly performing funds, which leads to higher reportable average returns among the surviving funds, referred to as survivorship bias. This bar chart eliminates survivorship bias by including the funds that have been closed, represented by the gold portion at the bottom of each vertical bar.
As denoted by the black horizontal lines, the Dimensional funds rank near the top of each asset class. Of particular interest are the white dots that appear on most of the vertical bars. These dots represent the average index fund returns within each asset class. Since the SPDR Portfolio ETFs are all index funds, it can be inferred that they are reasonably well represented by the white dots. Please note that the Dimensional funds have outperformed the index funds in every asset class for which average index fund returns were available, providing compelling evidence that the Dimensional approach has been remarkably effective over the past 15 years.
How has Dimensional achieved these index-beating returns? Since 1981, Dimensional has taken the best ideas from the world of academic finance and translated them into practical investment solutions. Their approach focuses on the drivers of expected returns, using advanced portfolio design and careful trade execution, while balancing risks, expenses, and other tradeoffs that may impact performance. For example, many of the Dimensional funds employ a momentum algorithm, based on research that has demonstrated a small momentum effect in stock prices. This allows Dimensional to hold off on selling a stock with upward momentum and accelerate the sale of a stock with downward momentum. Many of the Dimensional funds also use a profitability filter, in which the least profitable companies within each asset class are screened out. These enhancements have helped produce long-term index-beating returns, as shown in the bar chart.
Our conclusion is that Dimensional funds are worth their slightly higher annual expenses ratios compared to the ultra-low-cost SPDR ETFs. Their consistent performance near the top of each asset class over the past 15 years provides compelling evidence that Dimensional has delivered on its promise. We will continue to monitor the performance of Dimensional funds going forward and to seek other investment alternatives that can provide value to our clients.
Please feel free to contact me if you have any questions.
Jeffrey J. Brown, MD CFA
Principal, Shearwater Capital, LLC
jbrown@shearwatercapital.com
