Six years ago, Montreal-based financial adviser Sonny Wadera packed his bags for Texas. He wasn't giving up on the investment business for a stake in a Lone Star oil operation. He was simply going back to school for a couple of days. His goal was to build better portfolios for clients at Kelson Financial using indexes created by Dimensional Fund Advisors (DFA).
To add such products to client accounts, advisers need to attend a two-day educational conference (at their own cost) in Austin, Tex., or Santa Monica, Calif. Mr. Wadera felt it was time he did so. "I was getting tired of the industry. If I wanted to, I could have gone out to lunch every day of the week with a different wholesale provider, schmoozing me to buy their brand of mutual funds."
He knew picking actively managed mutual funds for clients wasn't beneficial. Funds with strong one-, five- or 10-year track records rarely continue their winning ways. Index funds offered a better solution – with DFA, perhaps, offering the best option of all.
Most mutual fund companies aim to beat their benchmark indexes. To do so, they hire fund managers to try and pick winning stocks. DFA board member and 2013 economics Nobel Prize winner Eugene Fama suggests individual stock picking is far too inconsistent and a poor way of trying to beat the market.
DFA, unlike most index fund companies, doesn't try equalling market returns. It aims to beat them by tilting its emphasis toward smaller-cap and value companies. Historically, such stocks have outperformed the market.
"Think of water getting poured into an ice tray," explains Mr. Wadera. "The tray represents the entire market of stocks, but DFA tilts the tray slightly to one side, increasing the weightings of small cap and value stocks."
Has tipping the ice tray worked? According to Morningstar, over the past 15 years, 75 per cent of DFAs funds outperformed their benchmark indexes. Over the past five years, 80 per cent have done so.
Many investors think mutual fund expense ratios are the only fees they pay. This isn't true. All mutual funds experience turnover, relating to the amount of buying and selling done by fund managers. Those trading extensively can cost investors up to an extra 1 per cent per year. So, a fund with an expense ratio of 2.4 per cent could actually cost 3.4 per cent. Because DFA sells indexes, fund turnover is low. So when DFA lists its F Class Canadian Core Equity Fund with a 0.38 per cent expense ratio, investors are assured they aren't paying high, hidden additional costs for the fund manager's trading.
The company gives advisers the foundation for explaining to clients the importance of staying in the investment game, advising them that speculating on the next hot fund or market sector is a poor strategy. And it costs more money.
When investors sell funds, fund managers must sell stocks to meet cash redemptions. If enough investors sell, managers may be forced to sell stocks below their purchase prices. This isn't just bad for those selling. It affects every one of the funds' investors. This is exactly the kind of thing DFA vice president Brad Steiman hopes educated investors can eliminate.
And it appears to be working. The U.S. Investment Company Institute measures mutual fund investors' cash inflows and outflows. Since 2008, such transactions for the typical mutual fund look like a roller coaster. Investors added $60-billion (U.S.) more than they withdrew between 2008 and 2009. Then, they withdrew $50-billion more than they added during the first three quarters of 2010. Data for DFA funds, in contrast, exhibit no such fluctuations.
There's also a striking contrast between net inflows of DFA funds versus others. U.S. mutual funds experienced $535.5-billion in net cash outflows between 2008 and 2013. DFA added $33-billion. Although these figures are U.S.-based, Mr. Steiman suggests the trends are likely similar in Canada.
Now for the downside: Investors can't walk into their local financial service institution and ask them to build portfolios of DFA funds. They're only for advisers who have undertaken the pilgrimage to Dimensional-land. DFA advisers also charge additional fees for financial planning. Expect to pay roughly 1 per cent of a portfolio's assets each year. To keep costs low, DFA also insists on a minimum $10,000 initial investment per fund. So, young investors starting from scratch won't have access to them.
Are the fees and restrictions worth it? For those who qualify, I think so. Advisers learn at the knee of financial academics without Wall Street or Bay Street bias. The wisdom gets passed down to investors, which makes plenty of dollars and sense.
Editor's Note: An earlier online version of this article incorrectly spelled Mr. Steiman's name. This version has been corrected.