Dfa basic slides 2013

• Equity Market(complete value-weighted universe of stocks)Stocks tend to have higher expected returns than fixed income over time.

• Company Size(measured by market capitalization)Small company stocks tend to have higher expected returns than large company stocks over time.

• Company Price(measured by ratio of company book value to market equity)Lower-priced “value” stocks tend to have higher expected returns than higher-priced “growth” stocks over time.

Value

Large

Small

Growth

Increased RiskExposure andExpected Return

TotalStockMarket

Decreased Risk Exposure and

Expected Return

Dimensions of Stock Returns around the World

Risk and Return Are Related

Eugene F. Fama and Kenneth R. French, “The Cross-Section of Expected Stock Returns,” Journal of Finance 47, no. 2 (June 1992): 427-65.Eugene F. Fama and Kenneth R. French are consultants for Dimensional Fund Advisors. This page contains the opinions of Eugene F. Fama and Kenneth R. French but not necessarily of Dimensional Fund Advisors or DFA Securities LLC, and does not represent a recommendation of any particular security, strategy, or investment product. The opinions expressed are subject to change without notice. This material is distributed for educational purposes only and should not be considered investment advice or an offer of any security for sale. Dimensional Fund Advisors (“Dimensional”) is an investment advisor registered with the Securities and Exchange Commission. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products or services described. ©2012 by Dimensional Fund Advisors. All rights reserved.

2

Precision in Portfolios

• Traditionally, “products” have been classified into rigid and sometimes arbitrary categories.

• Style boxes force crude strategic allocation.

• Using the three-factor model, the total portfolio is measured by factors that determine risk and expected return.

• Freedom from brittle definitions allows precisely tuned portfolios.

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Traditional Consulting Style Box

Large

Mid

SmallValue Blend Growth

Three-Factor Model Small

Growth Value

Large

3

Integrated Solutions Reduce Turnover

Annual: January 1989–December 2012.Russell components are Russell indices weighted according to Russell 3000 market value weights (buys and sells measured by the weight of each component).Estimated annual cost assumes transaction costs of 50 bps. Russell data copyright ©Russell Investment Group 1995-2013, all rights reserved.For illustrative purposes only.

• In effect, a component portfolio buys and sells from itself, generating needless costs and taxable events.

IC1450.7

R3000

3.4%

27.1%

33.5%

Russell 3000via ComponentsRussell 3000

Buys and Sells in Excess of Russell 3000

R2000

R1000

R2000G R2000V

R1000G R1000V

R200G R200V

R2000G R2000V

RMCG RMCV

4

Advancements in Research

Size

Small

Large

Relative Price

HighLow

Value Effect(1991)

Market

Single-Factor Model(1963) Size

Large

Small

Size Effect(1981)

Size

Large

Large

Small

Small High

Low

High

Low

Direct Profitability

Relative Price

HighLow

Expected Profitability (2012)

RR1255.1

5

Annual Index Reconstitution EffectsConsistency of Asset Class Exposure

Month-end values from January 2004-December 2012. Russell data copyright © Russell Investment Group 1995-2013, all rights reserved. CRSP data provided by the Center for Research in Security Prices, University of Chicago. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results.

• Over time, securities within an index can migrate from one asset class to another (such as from small cap to large cap)

• An index’s characteristics may be significantly different 11 months after reconstitution due to security migration.

• An index that purports to represent a certain asset class may not offer thorough, consistent exposure to the underlying risk factors.

LI1770.5

Percentage of Assets in Bottom 10% of Market

Russell 2000 Index

CRSP 6-10Index

June 30 Averages(reconstitution month) 96.30 96.61

May 31 Averages(11 months after reconstitution) 88.42 97.24

Jan 2004 Jan 2005 Jan 2006 Jan 2007 Jan 2008 Jan 2009 Jan 2010 Jan 2011 Jan 2012 Jan 201380%

85%

90%

95%

100%

CRSP 6-10 IndexRussell 2000 Index

Per

cent

age

of A

sset

s in

Bot

tom

10%

of M

arke

t

Structure Determines Performance

• The vast majority of the variation in returns is due to risk factor exposure.

• After fees, traditional management typically reduces returns.

sensitivity to market[market return minus T-bills]

sensitivity to size[small stocksminus big stocks]

sensitivity to BtM[value stocksminus growth]

randomerrore(t)

++ + +=average expected return[minus T-bills]

average excess return

THE MODEL TELLS THE DIFFERENCE BETWEEN INVESTING AND SPECULATING

Priced Risk• Positive expected return• Systematic• Economic• Long-term• Investing

Unpriced Risk• Noise• Random• Short-term• Speculating

Structured Exposure to Factors explain 96% of return variation

Unexplained Variation is 4%

• Market• Size• Value/Growth

THE MODEL TELLS THE DIFFERENCE BETWEEN INVESTING AND SPECULATING

7

Total Equity Risk

Company Risk

Industry Risk

Market Risk

Unsystematic

Systematic

Capital Asset Pricing ModelWilliam Sharpe: Nobel Prize in Economics, 1990

Beta measures volatility relative to the total market. A beta higher than the market’s beta of 1 implies more volatility, and a beta lower than the market’s implies less volatility.

Unsystematic

• Specific to firm or industry (lawsuit, fraud, etc.)

• Diversifiable

• No compensation

Systematic

• Marketwide, affects all firms (war, recession, inflation, etc.)

• Non-diversifiable

• Investor compensation

• Measured by beta

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http://www.uwants.com/overture_ss.php?srchtxt=music

http://www.uwants.com/overture_ss.php?srchtxt=music

Dimensions of Higher Expected Returns

1. Credit premium data (1973–2012) provided by Barclays Bank PLC.Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.Equity premiums provided by Fama/French. Maturity premium data provided by © Stocks, Bonds, Bills, and Inflation Yearbook©, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield).

Annual Average US Premiums: 1927–2012

1 2 3 4 5

8.05%

3.58%

4.80%

2.52%

0.85%

Market PremiumAll Equity Universe

minus T-Bills

Size Premium

Small Stocks minus

Large Stocks

BtM PremiumHigh BtM

minus Low BtM

Maturity PremiumLT Govt.

minus T-Bills

Credit1 PremiumInt. Corp.

minusLT Govt.

9

VALUE MINUS GROWTHTop 30% – Bottom 30%

SMALL MINUS LARGEBottom 50% – Top 50%

Average Premium (%)

Standard Deviation (%)

Average Premium (%)

Standard Deviation (%)

Jan 1926–Dec 2012 4.77 16.60 4.53 16.08

Jan 1946–Dec 2012 4.56 13.83 3.04 13.67

Jan 1975–Dec 2012 3.55 14.53 3.35 12.83

Historical US Value and Small Cap Premiums

Data provided by Fama/French.

Annual

RR1221.5

The Risk Dimensions Delivered

Periods based on rolling annualized returns. 739 total 25-year periods. 799 total 20-year periods. 859 total 15-year periods. 919 total 10-year periods. 979 total 5-year periods.Performance based on Fama/French Research Factors. Securities of small companies are often less liquid than those of large companies. As a result, small company stocks may fluctuate relatively more in price. Mutual funds distributed by DFA Securities LLC.

July 1926–December 2012

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Value beat growth 100% of the time.





US Value vs. US GrowthOVERLAPPING PERIODS

In 5-Year Periods

In 10-Year Periods

In 15-Year Periods

In 20-Year Periods

In 25-Year PeriodsValue beat growth 100% of the time.





US Small vs. US Large

Small beat large 97% of the time.





The Risk Dimensions Delivered

Based on rolling annualized returns. Rolling multi-year periods overlap and are not independent. This statistical dependence must be considered when assessing the reliability of long-horizon return differences. International Value vs. International Growth data: 157 overlapping 25-year periods. 217 overlapping 20-year periods. 277 overlapping 15-year periods. 337 overlapping 10-year periods. 397 overlapping 5-year periods. International Small vs. International Large data: 217 overlapping 25-year periods. 277 overlapping 20-year periods. 337 overlapping 15-year periods. 397 overlapping 10-year periods. 457 overlapping 5-year periods. International Value and Growth data provided by Fama/French from Bloomberg and MSCI securities data. International Small data compiled by Dimensional from Bloomberg, StyleResearch, London Business School, and Nomura Securities data. International Large is MSCI World ex USA Index gross of foreign withholding taxes on dividends; copyright MSCI 2013, all rights reserved.

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International Small vs. International Large











International Value vs. International GrowthOVERLAPPING PERIODS

In 5-Year Periods

In 10-Year Periods

In 15-Year Periods

In 20-Year Periods

In 25-Year Periods Value beat growth 100% of the time.





January 1975–December 2012 January 1970–December 2012

12

Performance of the S&P 500 Index

Performance data for January 1970-August 2008 provided by CRSP; performance data for September 2008-December 2012 provided by Bloomberg. The S&P data are provided by Standard & Poor’s Index Services Group. US bonds and bills data © Stocks, Bonds, Bills, and Inflation Yearbook™, Ibbotson Associates, Chicago (annually updated work by Roger G. Ibbotson and Rex A. Sinquefield). Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Dimensional Fund Advisors is an investment advisor registered with the Securities and Exchange Commission. Information contained herein is compiled from sources believed to be reliable and current, but accuracy should be placed in the context of underlying assumptions. This publication is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. Past performance is not a guarantee of future results. Unauthorized copying, reproducing, duplicating, or transmitting of this material is prohibited. Date of first use: June 1, 2006.

Daily: January 1, 1970-December 31, 2012

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Total Period Missed 1 Best Day

Missed 5 Best Single Days



One-Month US T-Bills

Annualized Compound Return 9.94% 9.66% 8.84% 7.47% 6.33% 5.30%

$58,769

$52,702

$38,212

$22,191

$13,999

$9,195

Gro

wth

of $

1,00

0

13

Perils of Market Timing

Returns are from market-close to market-close. Indices are not available for direct investment; their performance does not reflect the expenses associated with the management of an actual portfolio. The S&P data are provided by Standard & Poor’s Index Services Group. Dow Jones data provided by Dow Jones Indexes. Russell data copyright © Russell Investment Group 1995-2010 all rights reserved. Mutual fund universe statistical data and non-Dimensional money managers’ fund data provided by Morningstar, Inc. Nasdaq Composite Index data provided by The Nasdaq Stock Market, Inc. KBW Bank Index data provided by Keefe, Bruyette & Woods, Inc. (KBW). Past performance is not a guarantee of future results.

A Case Study of Q1 2009

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-12.4%

-24.7%

16.4%

-11.0%

-24.6%

18.1%

-14.9%

-31.0%

23.4%

-2.7%

-19.3%

20.5%

-35.8%

-55.3%

43.8%

Dow Jones Industrial Average

S&P 500 Index

Russell 2000 Index

Nasdaq Composite Index

KBW Bank Index

Negative Return Period1/1-3/9

Q1 2009 Returns1/1-3/31

Positive Return Period

3/10-3/31

• March 9 was the low closing date for four of the five featured indices year-to-date.

• The Dow Jones Industrial Average rose 5.8% on March 10, 2009.

• Looking at daily returns, it’s difficult to tell if a recovery is occurring.

Return excluding March 10, 2009

9.6%

6.3%

-0.6%

All US Stocks Excluding the Top 10% of Performers

Each Year

Excluding the Top 25%of Performers

Each Year

Compound Average Annual Returns: 1926-2012

Missing Opportunity

Results based on the CRSP 1-10 Index. CRSP data provided by the Center for Research in Security Prices, University of Chicago.

• Strong performance among a few stocks accounts for much of the market’s return each year.

• There is no evidence that managers can identify these stocks in advance—and attempting to pick them may result in missed opportunity.

• Investors should diversify broadly and stay fully invested to capture expected returns.

LT1395.5

Dfa basic slides 2013

Economy & Finance

Transcript of Dfa basic slides 2013