Episode 351 – DFA vs Vanguard

24:43But in general, I agree. They've been super consistent, similar to Dimensional. I don't know if it's true that Dimensional has never closed a fund. I'd have to double check on that, but it's not a common occurrence for sure. Their oldest fund, for example, is still open, even though it has not beaten the market, which we'll talk about in a second. We have this big list of funds with past performance. Then the performance ends February 14th, 2025. That's when I prepared the data for this. When I posted the video on this on my YouTube channel, people joke that I spent my Valentine's Day collecting the data, but that's not true.

25:14Return data is always available as of the previous trading day. If I had data as of February 14th, I collected it on February 15th. Your wife was quick to point that out. I do think it's worth mentioning that this is not a case of combing through a database and finding funds with good past performance and then saying like, hey, look, we found funds with good past performance. That would not be that interesting. We are going to talk about funds that have not outperformed. Some funds are going to do well over any historical period, just due to luck. And so combing through the database or data mining those and saying, hey, look, I don't think that's super interesting.

25:45There's no reason to expect those funds to continue doing well in the future. Anybody should be super skeptical if they see someone touting, hey, look, this actively managed fund has performed really well in the past. Skepticism is warranted with what we're about to talk about here as well. But I think what's interesting in this case is that theory and evidence predicted that these funds would outperform the market in the long run many, many years ago. For the most part, they have actually done that. I think that's pretty interesting. David Booth would have told you in 1990, yeah, we expect this value in small cap thing to work out over the next 50 years.

26:18We don't have 50 years yet, I guess, if we started in 1990. We got a lot, a lot of years. Dimensional's first fund, which is the DFA US micro cap portfolio, it has underperformed the Vanguard 500 Index Fund, at least as of February 14th. That's since inception, going back to December 1981. Now, most of that underperformance, when you look at the chart, most of it comes in the last five years where US large cap growth stocks have just been on an unstoppable epic run. Will that turn around? I don't know. If you look at rolling periods, it doesn't look so bad. It has beaten the Vanguard Small Cap Index Fund since the Vanguard funds conversion from an active fund to an index fund in September 1989.

27:01If we look from that period, September 1989, the DFA fund, the micro cap fund has beaten not only the Vanguard small cap index fund, but also the Vanguard 500 index fund over that period. Shows how sensitive some of this stuff can be to start and end dates. The DFA US small cap portfolio, slightly larger in size than the micro cap portfolio, but we're still in the small cap space. It has underperformed the Vanguard 500 Index Fund, but outperformed the Vanguard Small Cap Index Fund since its inception in 1992, March 1992. The DFA US Large Cap Value Portfolio has trailed the Vanguard 500 Index Fund, but beaten the Vanguard Value Index Fund since the DFA Fund's inception in February 1993.

27:45DFA US Small Cap Value Portfolio has beaten the Vanguard 500 Index Fund and the Vanguard Small Cap Index Fund since the DFA Fund's inception in March 1993. Now, Vanguard did launch a Small Cap Value Index Fund in May 1998. And the DFA Small Cap Value Fund has beaten it by a pretty wide margin since its inception. We'll try and get the charts for all of these as I'm saying them into the video. And then both funds, the Vanguard Fund and the DFA Fund, have beaten the Vanguard 500 fund over that same period from May 1998 to February 14th, 2025. The DFA large cap international portfolio has outperformed the Vanguard total international stock index fund since the Vanguard fund's inception in April 1996.

28:32Now one note on the international, it's a bit of a quirk here. They're both called international portfolios. Vanguard includes emerging markets, dimensional doesn't. So it does muddy up the comparison a little bit. However, emerging markets actually outperformed developed over this period. If anything, that should make Vanguard look better, not worse. I could have tried to splice together some developed and emerging or tried to cut out somehow emerging markets, but it becomes really messy really quickly. Does Dimensional's international equity funds always exclude emerging markets or just this specific one?

29:07For the US listed funds, I think that they do exclude them. I haven't checked all of their funds to say that that's true, but the ones that I'm looking at here, they do exclude them. It's pretty confusing. If you're trying to understand past fund performance, the Canadian dimensional mutual funds, when they say international, they have international developed and emerging markets. Their US funds seem to have only developed, and then they have separate emerging markets funds. That's what I was going to ask. They don't roll them in together into the same fund. They have emerging markets funds, but you've got to buy them each sold separately as they used to say.

29:42Yeah. In the US and then in Canada, they're combined. It makes it hard to compare past performance if you don't really dig into what's actually inside of the funds. Then Vanguard calling it international, but including emerging markets, that's also a little bit confusing. Fund names can often be very misleading. The DFA international value and small cap value portfolios have beaten the Vanguard total international stock index fund since the Vanguard Fund's inception in April 1996. Same thing with the emerging markets. They actually outperformed over that period, which would have helped Vanguard out a little bit.

30:14In emerging markets, the DFA Emerging Markets portfolio beat the Vanguard Emerging Market Stock Index Fund since the Vanguard Fund's inception in May 1994. Then Dimensional goes on to launch three more emerging markets funds, which have all gone on to outperform the Vanguard Emerging Markets Stock Index Fund. Then the last one I'll mention here is the DFA US targeted value portfolio. It has pretty seriously outperformed the Vanguard 500 index fund since the DFA fund's inception in February 2000. I mentioned the sensitivity to start and end dates earlier. If we look back in time now, we know that that was either the worst time ever to invest in US large caps or the best time ever to launch a small cap value fund.

30:55Take that for what it is, I guess. If you move that start date to 2010, I'm guessing you're going to get a different number, still over 15 years. That's exactly it. Yeah. Based on a comment on my YouTube video on this, I did look at rolling performance, rolling period performance over five-year periods. I don't have that data in front of me right now, but it was all very favorable. It was all over 50 % of rolling periods, typically well over 50 % that Dimensional was outperforming. You've compared a lot of these to the Vanguard 500, which tracks the S &P 500. And it's maybe worth stressing just how difficult that index has been to beat since its creation.

31:33But certainly in the last 30 years or so, anybody that can beat the S &P 500 with a US fund has done incredibly well and would be in a very, very small group. Yeah, that's very true. One thing that jumps out, I think, in those comparisons is that Dimensional's performance has generally been better in international developed and emerging markets than it has in the US market. I mean, that speaks to what you just said, Dan, that US large cap growth stocks or large cap stocks more generally have just been nearly impossible to beat for anybody. I was doing some research a while ago, just trying to look for really good managers that had major flame outs.

32:10And so many of the really interesting stories are value managers who over the last 10 or so years have just not been able to keep up and they end up closing down based on underperformance. It is well-documented. We talked about this briefly after we had Andrew Chen on. Andrew Chen basically says there are no more anomaly premiums in the US market when you account for costs. But there's other research showing that while that is true and that is fairly well-documented that premiums have been pretty muted in the US. Outside the US, they've actually been quite strong. We see that in the performance of Dimensional's funds.

32:47But to your point a second ago, Dan, it is still pretty impressive that Dimensional has had some outperformance in the US market over that period. Whether the factor premium thing, like whether the performance of US large cap growth and the underperformance of factor premiums in the US is a permanent structural change, which is what Andrew Chen argued, or is itself an anomaly that we're seeing anomalous high returns for large cap growth stocks. That's something we can't know. Time will tell. But it is interesting to look at the US market today. Valuations have come down a little bit since I wrote this, but valuations are still pretty high.

33:22But in the year 2000, when valuations were super high, we could have been having the same conversation, looking at how poorly value and small cap value had done relative to the market. And then as everybody knows that reversed fairly aggressively. I think overall, dimensional ideas are impressive and their implementation is impressive. and the fact that they've done pretty well by taking this academic research that says, hey, this stuff kind of should work and Dimensional is showing that it actually can and actually does. I think that's pretty cool and pretty interesting. It suggests, I think, that insights from academic finance are not just curiosities.

34:00They're practically useful to investors beyond the big insight that, hey, you can't really beat the market very easily, not without taking on more risk, but Dimensional is showing that there are maybe other risks you can take that can pay off in the long run. Then another insight I think is interesting that comes from these data is that whether it's dimensional or Vanguard, because keep in mind, Vanguard has these style funds too, tilting toward styles like value and small cap value can actually have merit. We've talked about this before, Dan. There are periods where factors suck for a long period of time, but there are periods where the market sucks for a long period of time too.

34:32If your goal is to try to access those factors and implement them in your strategy, I would argue you're better off going with dimensional than you are with Vanguard style funds, for example. Dimensional, whatever your preference is, market cap weighting versus factors, it's pretty hard to argue that this is a company that takes implementation of these ideas extremely seriously and they do a phenomenally good job in doing it. If you are going to see, say, underperformance in a dimensional fund compared with a cap weighted benchmark, you're not going to see it because of or implementation. You're going to see it because the factor premium didn't show up during that period.

35:11That's not something you can say about any fund company. Yeah. I mentioned that idea of index funds trading into stuff that has low expected returns and out of stuff that has high expected returns, kind of around the edges of the market when the composition of the market changes. Marco Salmon has this paper showing that that costs index and requires some explanation, but that costs index investors, they find between 32 and 81 basis points relative to what is the question. The way that they measure that is that they have an index fund strategy that rebalances in the same way that an index fund would, so quarterly on a calendar basis.

35:45Then they compare that to an index fund that delays rebalancing. It rebalances daily with a rolling look back period, and the look back period determines how long they'll wait before implementing changes to the market composition. If there's an IPO, if their look back period is a year, they're not going to add that IPO until after a year. They compare the real life version of an index fund, like the quarterly calendar rebalancing to these various look back periods. They find that the longer you wait to implement those changes to market composition, the higher the returns of the index fund are.

36:19All that to say, just on implementation, Dimensional does have a total market fund that is designed to not give you any factor exposure. It's designed to give you the US market return, but they implemented the way that they would implement any other dimensional fund. So it's flexible. It doesn't track an index. It doesn't rebalance on a specific day, which can have effects on the price that you pay for securities and that you sell securities at, and it doesn't jump into IPOs, all that kind of stuff. And so because I was looking into this topic, I looked at the performance of that fund versus VTI.

36:51The dimensional fund has a nine basis point fee. VTI has three basis points. But since it listed as an ETF in, I think it's March 2021, and it's outperformed by about 35 basis points annualized over that period, which is almost exactly what Marco's paper predicts. That's probably noise, but it's kind of neat. It's interesting noise though, isn't it? I've had this discussion with clients and people who are more into the theory of it. I think it's important to remember when indexes were created, they were not created as an investment strategy. They were created as a benchmark of the overall market, and they did an extraordinarily good job at that.

37:31It was only much later that people looked at them and said, hey, what if we bought the market? And if you're going to buy the market, what do you do? Buy all the stocks in the index in the same proportion. And so there are some frictions based on that. And those are real for sure. Now, I mean, I think you would argue compared to the costs of most active management, compared to the high costs of most other alternatives, the index fund is the best of the bunch. But in theory, if you could take all of the good things about the index fund and tweak at the margins to get rid of some of their faults, which is exactly what you're saying Dimensional is trying to do.

38:13If you can do that successfully, it wouldn't surprise me if you saw some modest outperformance. The danger is, I can't think of a specific example, but there are definitely bun companies who have tried to do this. I'm going to start with an indexing premise, but I'm just going to make a few tweaks here and there and they backfire. So you have to be very careful about what those tweaks are going to be. If you are skilled at it and you work on the right things and you trim in the right places, it wouldn't surprise me very much if you got a little bit of outperformance at the margins. I would love to see other fund companies, see Marco's research, hopefully get some traction and see that maybe we don't have to exactly follow the index.

38:58Why don't we just build a fund that is a total market fund, but not an index? Track something like the total market, but implement a little bit differently, which is what Dimensional has done. I guess there's not a lot of margin in it because as soon as you add margin for the fund company, all the benefits go away. Exactly. You could pay somebody to do all that work and that's going to have to detract. And then at what point does it become counterproductive? I don't know. For most funds, it is counterproductive. Exactly. I've written most of that topic, so we'll do a future episode on that. That'll be a fun one too.

39:31We've made this all sound pretty rosy that these academic ideas work and dimensional is outperformed in the long run. That all sounds pretty good, but there's an important downside to dimensional funds, which is that they're going to perform differently from the market over time. We talked about this a bunch in the AMA episode, Dan. They're exposed to different risk premiums. Different risk premiums pay off at different times. I mentioned that a minute ago as a benefit, which I think it kind of is in the long run. It's reasonable to expect a small benefit for taking on those risk exposures, but just like there can be periods of outperformance, there can also be periods of underperformance, like as we just mentioned, the recent history in the US market, where tilting toward value and small cap value really sucked.

40:10Over the last 10 years, again, this is ending February 14th, the DFA US small cap value portfolio has trailed the Vanguard 500 index fund by 4.5 percentage points annualized for 10 years. It's a big gap. That's no joke. It takes a very patient investor to endure something like that. We all know how impatient most people are, most investors are. They lose the confidence in a strategy that is quote unquote, not working after a year or two, let alone 10 and 10 by pretty significant margin. So you need to be in it for the long haul and don't underestimate how difficult it is to hang on to that strategy when it underperforms for 10 years.

40:59Now that has happened before, worse even. So from its inception in 1993 to February of 2000, the DFA US small cap value portfolio trailed the Vanguard 500 index fund by 6.3 percentage points annualized. So I guess it's not quite as long, seven years, but more underperformance on an annualized basis. Now, in that case, David Booth used to joke that, he probably still does joke, that they have a knack for launching products right before they go out of favor. They launch the small cap value portfolio and then it just gets smoked for seven years. But in that case, things did turn around for small cap value.

41:35When the dot-com crash happened, small cap value stocks went on to deliver annualized returns over 9 % annualized through the so-called loss decade in the US, while the US market was effectively flat. Periods of pain, but then we get a decade of basically a 9 % excess return. Now, it is important to remember that while they've struggled in the US value and small cap value, they've still performed relatively well in markets outside the US in recent history. Over past periods of small cap value, outperformance in the US, at least in the data presented earlier in this video, dimensional funds have been able to capture more of the premiums than Vanguard funds with similar styles.

42:14To your point earlier, Dan, when these premiums do deliver, and it's not just implementation, Dimensional also has more exposure, like they own smaller and cheaper stocks. A DFA and a Vanguard small cap value fund are almost not even comparable because Dimensional has so much deeper tilts. That's just a product decision. Then the implementation is another piece of that. They do that efficiently, but it's also just much different risk exposures. So I think if you want those risk exposures, Dimensional does a really good job delivering them. Now, I can't tell you how the current period of US underperformance is going to play out.

42:48We do know that despite those two historical periods that we just talked about, pretty extreme pain for extended periods of time, the US small cap value portfolio has beaten the Vanguard 500 index fund over its lifetime. No pain, no gain, I guess, but it is pain. It's not a joke. They're called risk premiums for a reason. Sometimes it sucks to pursue them. That's kind of it. Dimensional and Vanguard are these two fund companies with really connected histories that I think is pretty interesting that stem from the development of the first ever index fund. Vanguard's market cap weighted index funds have been nothing short of revolutionary.

43:22I don't think that's hyperbolic at all for investors. They've become synonymous with sensible investing for good reason. Dimensional took implementing the ideas from academic finance a few steps further than Vanguard did. They're lesser known. That's partially their own doing. They don't really market much. I guess Vanger doesn't really either though. But lesser known, they've got this impressive track record, but nobody knows who they are unless you're a finance geek. Through a lot of Dimensional's history, the funds were only available to institutions. They started out as an institutional manager or to retail investors through financial advisors.

43:54That was their next iteration. They said, okay, we'll move away from institutions, but we're only going to go through advisors. That at the time was to limit cash flow volatility going into and out of their funds. They didn't want to deal with managing portfolios with performance chasing behavior from investors. They thought advisors could shield them from that. They started launching ETFs in the US market in 2020, and they've now got a full suite of their strategies available as US listed ETFs. Then of course, Avantis also launched ETFs in 2019, also US listed. They do sub-advise some funds from Annualife that have ETFs here in Canada.

44:28Not crazy about them, but they are out there. Then of course, they have their mutual funds in Canada, and those are still only available through advisors for the time being. I would definitely say it's not worth paying a financial advisor's fee for access to dimensional funds. We've gotten that call a few times where someone's like, hey, I want to pay you either your normal fee or a discounted fee or whatever just to invest in dimensional funds, and we reject them every time because it just doesn't make sense. Based on our expected returns for the factor tilts, they're not huge. I think it's like 40 basis points or something.

44:59If you're paying even 30 basis points in fees to own that, it's not going to make a whole lot of sense. The actual fees on dimensional funds, their 60-40 global portfolio based on the most recent MRFP is down to 28 basis points, which is pretty good. Comparable to the asset allocation ETFs by iShares, Vanguard, BMO, same ballpark. I wouldn't pay an advisor just for dimensional funds, but I think it is worth finding one that either uses or could use dimensional funds. If someone comes to you, Dan, you know the literature. I mean, you guys have access to dimensional funds if you wanted to, but you have the knowledge base that a dimensional advisor would have.

45:38And I think that's really what investors should be looking for when they seek out financial advice. Like anything else, you're going to want your advisor to understand the investment strategy and the products that they use really well. If you were able to access dimensional funds through an advisor who just saw them on a huge menu that included a lot of other garbage, it's the wrong fit. I'm sure there's no sort of exclusivity contract, but if you're an advisor who is kind of on the approved list, my guess is you're using dimensional funds, if not exclusively, pretty close to exclusively because you just believe in the strategy and it's not like I'm going to make this 5 % of my portfolio.

46:19I'm going to use it as my core strategy. If you're going to do it, you need to understand the details and then you need to just carry it out with confidence because otherwise you as an advisor end up being in the performance chasing category here where you say, hasn't worked for five years. I'm switching gears. That doesn't help anybody. I agree with all that. Should we move on to the after show? Yeah, let's do it.

46:49So I got a quick cancer update. I went for CT scans. They injected iodine into my blood, so they could see tumors better, but they were all clear, which was great. I just got that news last Thursday. It feels like I got the news a long time ago. I don't know. It feels like my whole life changed and I felt just a weight off my shoulders, but only a week ago that I found that out. So that was good news. So basically like the surgery got the cancer that was in there out and there was no sinus spread when they did the surgery. And then these CT scans have confirmed that there is no spread as of now.

47:20That's fantastic news. I think I can speak for everybody in the audience when I say that that's excellent news. So I know from talking to you before, it was like the uncertainty is the hardest part to deal with, right? And now, yes, you got some news and it's about as good as it could have been. So that's excellent. It kind of felt like everything was on pause until I knew what was going on there. Definitely a weight off my shoulders. There is still this cycle now of blood work every three months, CT scan every six months for the next year, because there is still a 15 % chance of recurrence based on the type of cancer and stuff like that.

47:54If that does happen, then I would still need chemotherapy, which would be highly effective. They order it this way. I could have elected to do chemo, but they recommend, they call it active surveillance because if it does recur, chemo is still just as effective later as it would be now. So it's like, I've got this 15 % chance of recurrence for the next five years. But if it does recur within that window, I can do chemotherapy and it would still be just as effective as if I did chemotherapy now. So very little or no benefit to doing it proactively. Exactly. Well, that's not something anybody wants to go through unless they have to, right?

48:31No, it's dreadful. That sounds great. They give the option because I guess some people want and just be done with it. They also explained that some people for whatever reason are not able to do active surveillance because they live far away from a medical center, for example. That's what I'm doing. I'm doing active surveillance, keep an eye on it for the next five years. And then after that, I'm considered a regular person again. Excellent. I did want to touch base, Dan. It's been six months. We talked about this briefly in the intro. Six months since you started co-hosting the podcast. What do you think?

49:01Are you enjoying it? What are your thoughts? It is really great to be back behind the mic and to be able to speak to a much wider group of investors than I'm able to do on my own. I still communicate with investors when I hear from them directly, but obviously the numbers have slowed down as I have not been creating any content the way I used to. Your listeners will know. I mean, I had my own podcast there, the Canadian Couch Potato podcast for, geez, I can't even remember how many years. It wasn't very long. I did about 24, 25 episodes. And this was going back 2015, I think we launched, which 10 years ago, the podcast universe was a lot smaller than it is today.

49:44It was great. I loved doing it, but it was just an extraordinary amount of work. When I started doing it, it was, I want to say totally a one-man team, but it was close in that I took a different approach than you do. I wrote the scripts word for word. So I was booking interview guests myself. I was writing all of it. I was recording it myself, sending the files off to a producer who edited and added the music and that. But to produce a 45-minute podcast probably took me 10, 12 hours. And I was doing it on the weekends because I just don't have time to do that during the workday. And it was taking its toll for sure.

50:26And it got to the point where even though I loved doing it, and I think it had a pretty loyal audience, it was not practical for me to continue. And I remember, I mean, you and I talked about this, we were at a dinner and you'd basically said, look, if you could do it without all of that prep work, are you still interested in the idea? And I said, absolutely. And you know, here we are. It's such a tight ship here. I mean, it's such a great team in front of the mic and behind the scenes. So much amazing research and prep that goes into it. It makes my job relatively easy. And my role, I feel it's share my experience, share my whatever wisdom I may have gained in the trenches over the years.

51:09And I really enjoy it. I hope listeners feel I'm adding something to it as well. You definitely are. I've loved having you on and we hear from listeners. I know you don't go on social media as much, but we definitely hear a lot from listeners that you've been a great addition. Excellent. Thank you. Yeah, it's good. Should we do some reviews? Yeah. I'll start. Best finance podcast, super interesting and informative. This podcast, as well as Ben's YouTube channel, led me to question the financial advice I've been getting for most of my adult life. Became a PWL client last year, and I couldn't be happier.

51:40Keep up the good work by B. Smith from Canada. Very nice. All right. Here's another one that's titled, Great Way to Learn. Been a regular listener to every episode for the past two years, and AMA number four was my absolute favorite. I'm getting close to retiring and I love the discussions on factor investing and sequence of return risks. Thanks for your expertise and entertaining discussions from Cordoniera in the United States of America. Nice one. Fantastic. I mean it. That's good. I'm glad they actually meant it. I cannot recommend this podcast enough to anyone interested in seeing how the sausage is made in practical terms.

52:18Having listened to every episode at least twice over the last few years. Wow. That's a lot of listening. It's given me the confidence to save, invest for retirement and get my financial house in order and keep it that way. Probably most impactful thing from these episodes was the understanding and confidence of how employer matching slash fund selection can impact employee retirement. Based on the education provided within, I approached my company HR about our 401k funds to have access to better options. In an interesting turn of events, I'm now on the 401k committee and we've recently gotten lower cost index and target date funds approved for everyone in the company.

52:53You have literally impacted thousands of people in a positive manner and I can't thank you enough for the work that you do. That's from Mike from the United States. That's pretty cool. That's an amazing story because I've heard this a lot. People will say, talk to your HR department and see if you can get them. And I'm thinking that's never going to work. I don't know what kind of an audience you're going to get with the people who make these decisions. And you could make some argument that isn't really going to resonate with them. This is fantastic. A real example of someone who actually did it successfully.

53:23And got on the committee. Good for Mike. Credit goes to Mike for pulling that off. Not just us. I'm going to start giving that advice again. I stopped doing it because I thought it was futile, but apparently not. That's excellent. So, all right. Our last one here just says, top tier podcast, excellent discussions on financial topics with sometimes too much research and evidence to back it up. Fair enough. Love nerding out over super niche topics and getting into the nitty gritty details. The AMAs are a good opportunity for you all to dive into more regular everyday people issues, which is a good break from some of the super specific topics that are only applicable to high income individuals or corporations.

54:02Been listening for around a year and trying to catch up on the backlog. Keep them coming from RTE 2001 in Canada. Very nice. Good feedback. Yeah, good feedback. We always appreciate the reviews. I think last time we recorded, we didn't have any maybe. And so I said, hey, why don't you leave a review if you haven't yet? And then we got all these new ones. Excellent. Hopefully we have some more next time. All right. Anything else? No, I think we're good. All right. Thanks, Dan. And thanks everyone for listening. Thanks. See you next time.

54:42Thank you.