Can You Get Past the Bouncer?

DFA sells a very useful mix of targeted index funds. Unfortunately, it’s a hassle to buy them.

By Thomas Easton
JUST LIKE ANY OTHER consumer products company, fund sponsors slug it out for attention: Meet Mr. Top Return. Hear Ms. Emerging Markets. If you had only put $10,000 with us back when, you’d have enough to send your child to college. Send us a check. Now.

The carnival atmosphere is missing from a handful of fund families. The frugal Vanguard Group, for example, scarcely advertises at all; it counts on investors who like low-cost funds to beat a path to its door.

Dimensional Fund Advisors, a Santa Monica, Calif.-based sponsor with $9 billion in fund assets, takes this aloofness a step further. Beat a path to DFA’s door, and you may find it slammed in your face.

Who would want to get in? The same sort of people who like Vanguard. DFA runs passive index funds and near-index funds. Their fees are fairly low, their frictional costs from trading are low, and they don’t pay out much in taxable capital gains. A passively managed fund is almost never going to top the charts in any given year, but it can easily beat out most actively managed funds over long holding periods—10 or 20 years, that is.

Like Vanguard, DFA has a very low cost fund to track the S&P 500 index. It has 19 other passive funds, some specializing in foreign stocks, some in small stocks, some in bonds. A few of the funds are modified index funds: They follow investing themes, such as value stocks or small-company stocks. But the stock selection is always mechanical.

The themes come from academia—for example, the theory that stocks selling at low multiples of earnings and book value beat growth stocks over time. The eminent finance professors Merton Miller, Myron Scholes and Eugene Fama sit on the boards of the DFA funds.

The other part of the DFA formula is transactional dexterity. The 22 people managing DFA’s portfolios are all traders. By making markets in many of the thousands of stocks that populate the funds, DFA claims, it enjoys negative transaction costs. Suppose a small over-the-counter stock is quoted at 20 bid, 20 3/4 asked. Even if DFA wants the stock, it may hold off buying until some trader puts in a big sell order, say, for 200,000 shares (to be spread among funds and institutional accounts). DFA may offer to take the block for 18 or 19. When the DFA traders sell a thinly traded stock, in contrast, they dribble the shares out a few hundred at a time.

It works well enough. Look at DFA’s U.S. 6-10 Small Company Fund, which mechanically buys stocks that are ranked in the bottom 50% in market value on the New York Stock Exchange. This fund has outperformed Vanguard’s comparable Small Capitalization index fund by a fraction of a percent over the three years of its existence.

Intrigued? Be prepared for a battle to get in. Originally an institutional manager with a $2 million minimum, DFA in 1989 lowered its account minimum to $25,000. But it accepts only money referred by financial advisers. And not just any adviser will do.

Consider the experience of Abner Oldham, a Chattanooga, Tenn. investment adviser. Other fund sponsors write, call and even visit him, begging for business. He found DFA himself while doing a computerized screen. In response to calls, DFA sent a binder the size of a telephone book describing what it does. He had to read it, report back, then drive 300 miles for a two-hour meeting in a hotel lobby, then go to a more distant city for a conference on how to use DFA’s funds.

“My wife said she couldn’t believe I was flying anywhere to get a mutual fund,” says Oldham. “Everyone else is willing to come to us.”

Why does DFA play hard to get? One reason: to screen out hot money. A flood of new purchases, followed a few months later by a rush of redemptions, would wreak havoc on DFA’s efforts to keep trading to a minimum. The funds would be chasing after stocks one day and unloading them at distress prices the next, says Rex Sinquefield, a founder and cochairman of DFA.

There’s also a paternalistic motivation. Sinquefield wants his investors to balance holdings among several different passive funds. By lecturing the advisers he can get that result.

No carnival barkers at DFA. The only ones jumping through hoops are customers.

Consider the volatile DFA Japanese Small Company Fund: It took off in the 1980s, and then skidded in the 1990s. “It’s probably been the worst investment in the galaxy recently,” says Sinquefield. “Suppose an individual wanted to put all their money into that? We wouldn’t want to be responsible.”

If you want in, find a financial planner to make an introduction. Oldham charges 0.25% to place anything over $500,000. That’s a bargain if you really need advice, but what if you have selected the funds and all you want is for the planner to stick a check in an envelope? If you hunt long enough, you might find an adviser who will charge by the hour. Call 888-333-6659 to get a directory of planners from the National Association of Personal Financial Advisers in Buffalo Grove, Ill.

Dicing the world into cheap slices

Low turnover, low fees, low profile.

Fund 3-year annua-
lized total
return
Assets ($mil) Weighted average Median market cap ($mil) Annual exp. per share Portfolio turnover
P/E price/ book
Fixed Income
Five-Year Government 3.8% $164 NA NA NA $0.28 398%
Global Fixed-Income 7.1 152 NA NA NA 0.46 130
Intermediate Government Fixed-Income 4.6 97 NA NA NA 0.27 41
One-Year Fixed-Income 5.2 909 NA NA NA 0.20 81
Two-Year Global Fixed-Income NA 297 NA NA NA 0.32 NA
Stock
Continental Small Company 8.5 315 22.1 2.1 $325 0.74 10
DFA Real Estate Securities 5.5 56 22.9 2.0 690 0.82 1
Emerging Markets NA 143 18.2 3.4 1,822 1.58 8
International High Book to Market 8.5 228 27.1 1.9 8,974 0.68 10
International Small Cap Value NA 352 31.2 0.9 NA 0.91 10
International Value NA 287 28.3 1.8 7,051 0.65 10
Japanese Small Company -2.0 345 44.8 2.5 493 0.74 8
Large Cap International 5.1 76 29.4 3.6 20,925 0.57 24
Pacific Rim Small Company 4.9 199 23.2 2.4 309 0.83 6
United Kingdom Small Company 13.1 166 18.6 3.4 204 0.72 8
US 6-10 Small Company 12.9 290 23.0 3.0 299 0.49 21
US 9-10 Small Company 15.9 1,181 22.4 3.2 113 0.62 25
US Large Cap Value 14.9 443 15.1 1.8 7,857 0.42 29
US Large Company 17.5 158 22.2 4.6 23,659 0.24 2
US Small Cap Value 14.4 1,150 20.3 1.8 274 0.64 21

* Through Oct. 31. NA: Not available or not applicable.
Source: Morningstar, Inc.


“Our deepest fear is not that we are inadequate. Our deepest fear is that we are powerful beyond measure. It is our light, not our darkness that most frightens us. We ask ourselves, Who am I to be brilliant, gorgeous, talented, fabulous? Actually, who are you not to be? Your playing small does not serve the world. There is nothing enlightened about shrinking so that others won't feel insecure around you. We are all meant to shine. And as we let our own light shine, we unconsciously give others permission to do the same. As we are liberated from our own fear, our presence automatically liberates others.” ~Marianne Williamson