Imagine an investing strategy so intelligent, so sophisticated, that it's difficult to explain to anyone who doesn't have an afternoon to spare.
That is the challenge facing Dimensional Fund Advisors, a firm with a couple of Nobel Prize winners on its payroll. For decades, the Austin, Tex.-based company sniffed at the notion of letting just anyone buy its funds. It answered the door only for institutional investors and a select group of financial advisers trained in its proprietary approach.
Beginning this week, however, anybody with a few dollars to spare will be able to buy products in Canada that at least somewhat resemble a DFA fund. Manulife Financial Corp. has launched four exchange-traded funds (ETFs) designed by the high-powered intellects at the Texas firm. The new products, which trade on the Toronto Stock Exchange, cover a quartet of categories – large Canadian stocks, large U.S. stocks, mid-sized U.S. stocks and stocks in the developed world outside of Canada and the United States.
The ETFs will appeal to investors educated in financial theory. But one big question is how many of those people are out there.
Manulife's John Hancock unit introduced a similar line of DFA-designed ETFs in the United States beginning in late 2015. So far, they've failed to attract large amounts of money.
The lack of popular excitement may reflect how difficult it is to explain exactly what it is that DFA does. Even for people used to market jargon, it can be a head scratcher.
DFA is a company that lectures you at length about how tough it is to beat the market, but then sets out to do exactly that. It denies being a passive investor, but also says it's not an active manager in the usual sense of trying to forecast winners.
However you describe it, DFA has long been a favourite among investing geeks. The company's leadership group includes not only a pair of Nobel laureates – Eugene Fama and Myron Scholes – but also a profusion of other big names in finance theory. Their collective star power has helped turn DFA into a real-world success. With $460-billion (U.S.) in assets under management, it is one of the fastest-growing money managers in the world.
At the heart of DFA's strategy is the efficient-markets hypothesis put forward by Prof. Fama in the 1960s and 70s. He argued that markets function like highly efficient machines. They absorb the available information about stocks and bonds, then reflect that input in prices.
Believers in the efficient-markets gospel argue investors will find it difficult, if not impossible, to beat the market by consistently picking stocks better than other people. Anyone who attempts to do so is going up against the intimidating amount of collective wisdom embodied in market prices.
In line with this thinking, most of the efficient-markets crowd are staunch advocates for using low-cost index funds to cheaply harvest whatever the market delivers.
DFA, however, argues you can do better than indexing. It claims it can beat market benchmarks by constructing baskets of stocks that are weighted toward certain factors associated with higher performance.
This, too, is a notion that emerged from academia. Prof. Fama and Ken French, a renowned Dartmouth professor who also serves as a DFA director, discovered in the 1990s that small stocks and value stocks produced better returns than the broad market. While this finding might have seemed to violate the efficient-markets theory, Prof. Fama and Prof. French argued the extra returns were actually compensation for the extra risk embedded in these categories. The market, in their view, was still being efficient, but in a way that could be exploited by nimble investors.
DFA has built its strategy on the possibility that you can reliably harvest such factors for extra returns. Rather than following a predetermined market benchmark, its portfolios tilt in the direction of smaller value stocks. It also uses smart trading strategies designed to avoid the inefficiencies caused by sticking to an index designed by someone else.
How has all of this theory worked in practice? Depends who you ask.
Larry Swedroe, a financial author and director of research at Buckingham Strategic Wealth, a Missouri-based investment-advisory firm, calculates that DFA funds outpaced low-priced index funds from Vanguard between 1998 and 2016, often by a percentage point or more annually. In contrast, Edward Tower and Yichong Zhang of Duke University looked at DFA funds' performance from 1982 to 2009 and found they did not consistently beat Vanguard's offerings.
To make matters more complicated, a growing swarm of companies now offer approaches that resemble DFA's. Known as smart beta, these new strategies also attempt to identify factors linked to higher performance.
Adam Butler, chief executive of ReSolve Asset Management, a Toronto firm that uses ETFs to build global portfolios, says DFA deserves credit for its pioneering work, but adds its products no longer necessarily stand out as exceptional in what has become a crowded area.
DFA's greatest strength has been its adviser network, Mr. Butler says. Well trained and fiercely loyal, those advisers have been exceptionally good at keeping investors true to the DFA approach through even the worst market gyrations.
Do-it-yourself investors who buy Manulife's new ETFs won't have that psychological support. In addition, because of the limitations of the ETF structure, the new products aren't guaranteed to produce performance exactly like DFA funds.
All of that makes Manulife's new offerings an intriguing bet on an unusually brainy approach to investing. The good news is if the market is truly efficient, the ETFs should wind up attracting exactly as much attention as they deserve.
Manulife's DFA-style ETFs
Here are Manulife's four new exchange-traded funds, followed by tickers (unhedged version/hedged version):
- Manulife Multifactor Canadian Large Cap Index ETF (MCLC/n.a.)
- Manulife Multifactor U.S. Large Cap Index ETF (MULC.B/MULC)
- Manulife Multifactor U.S. Mid Cap Index ETF (MUMC.B/MUMC)
- Manulife Multifactor Developed Int’l Index ETF (MINT.B/MINT)
Source: Manulife Financial Corp.
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