Perspectives on Factor Investing

Written by Dimensional Fund Advisors.

March 2019

Dimensional Fund Advisors launched the first factor based fund in 1981 – the US Microcap Portfolio. Since then financial factor research and products have mushroomed. Academic papers have identified over 400 equity factors. There are currently 130 open-end mutual funds and over 600 ETFs that are factor based.

The primary reasons for this radical change are the low cost of ownership and return attribution. In a diversified stock portfolio, academic research (as well as own internal studies) have shown that 90%-99% of return variability can be explained with just five financial factors: Beta, company size, relative value, profitability, and momentum. This fact has profound implications for investors because the research shows where the overwhelming majority of equity investment returns (and premiums) come from. It also means focusing on other issues such as individual stock selection, active manager selection, and market timing are unnecessary and very likely counterproductive. It then begs the question how does an investor put together a portfolio of equity factors designed to have the highest probability of success? The answer rests on four primary considerations:

A rigorous portfolio implementation based upon this historical evidence and rules-based portfolio management should provide an investor with greater confidence in pursuing a positive investment experience.

Choosing an Index Provider

There are many index providers that apply various sorts of factors weighting.

Among professional advisors, Dimensional Funds is one of the more favored providers.

There are several reasons for this:

The table below shows a sample of eight US Large Cap Value indexes. As of 6-30-2018, the DFA US Large Cap Value index had a higher return than all the other providers over 5, 10, 15 years and common inception dates.

dfa 03 2019 chart