Study after study indicates that virtually no one – not even the experts, fund managers or sharebrokers – can successfully and consistently forecast economic events, interest rates, exchange rates, or pick the right bonds, properties, or shares/ stocks, year in and year out. However overall costs can typically be 2% to as high as to 3.5% p.a.
Asset Class Investing
Asset class investing has been proven by decades of rigorous academic research and the science of investing. One of the founders is Eugene Fama, a Professor of 30 years from Chicago University, who won the inaugural Onassis prize for services to global finance in 2009.
He doesn’t forecast or stock pick either, but he has co-designed an investment method that works better than most – the DFA funds.
The Advantages of the DFA Funds
No big teams of expensive fund managers
Low costs overall
Two low cost bond funds
Clever core share funds
Low trading costs
No forecasting or stock picking so no expensive mistakes
Avoids the index slave problem
Adds value with momentum trading
Can be tilted towards value and small shares that average 2-3% p.a. more than large shares
Since they don’t forecast or stock pick, they don’t need to employ a big team of expensive managers – hence the DFA asset class funds are lower cost funds.
Eugene Fama designed a solid bond fund strategy that does not forecast interest rates. It is very very low risk yet has returned over 7% pa. since 2004.
In theory the DFA shares funds own all the eligible shares in each asset class but in practice they first apply a “common sense quality filter” and only buy shares that pass through that filter. E.g. shares must be in a politically stable country, a properly regulated stock market, not in a market with excessive trading costs or taxed at source, no new issues, and the shares must be actively traded (fully liquid).
Small company shares
Over the long term small companies shares have outperformed large company shares by a margin of 2% to 3% pa. DFA offer low-cost small company Global and Australian funds.
A value share is a share in a company that was performing well, but now the company has encountered problems and its share price has fallen markedly. E.g. Michael Hill Jewellers shares when they tried to sell shoes and The Warehouse when they went intoAustralia. Their share prices fell sharply and, when they eventually got rid of the loss-making divisions, their share prices rose sharply.
Over the long term value companies shares have outperformed large company shares by a margin of 2% to 3% pa. DFA offer low-cost value Global and Australian funds.
DFA pay close attention to minimising trading costs. Often a small company will become a large company, a value company will become a large company and a large company can become a small company. By operating three separate funds, costs could be incurred when a share moves from one fund to another.
By combining all three (large, value and small) into one core fund, a lot of trading costs are eliminated – a simple and clever solution that reduces costs further.
DFA offer a Global Core Fund holding about 5,000 shares, and an Australian Core Fund holding about 300 shares.
DFA do some “engineering” where shares have momentum. Often a share can get very popular and rise far above its “fair value”. If they see that trend emerging, they will hold that share longer before taking profits.
DFA’s internal research indicates that their momentum “engineering” adds up to 2% p.a. to returns.
DFA are not “Index Slaves”
Index funds have to hold the index e.g. theASX300 Australia Fund must hold all the shares in the top 300. From time to time a company will grow and displace another that is shrinking. The market usually knows this in advance so the index fund must sell the company that is shrinking (out of favour) and sell at a loss. Conversely they must buy the growing company (in favour) at a high price.
This is a worst case scenario – being forced to buy at high prices and sell at low prices.
DFA are not index slaves so when, and if, a share passes through the “filter” and is due to be bought or sold they do it “at their leisure”. They take their time and avoid most of the sharp rises and falls.