"One Vanguard, Many DFAs"

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gkaplan
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"One Vanguard, Many DFAs"

Post by gkaplan »

The history of U.S. mutual fund indexing is Vanguard versus Dimensional Fund Advisors. In 1976, Vanguard introduced what was then called First Index Investment Trust, a fund that replicated the S&P 500. Five years later, DFA launched its U.S. 9-10 Small Company Fund. Every mutual fund indexing entrant since that time has been a historical footnote.

The companies are not only today’s two biggest mutual fund indexers (with Vanguard being substantially larger, of course) but also neatly encapsulate a key debate of indexing: Should indexers own the entire marketplace, on the theory that the wisest man is the man who realizes that he knows nothing and who therefore will not attempt what must surely fail? Or should they use academic research to shape their funds so that they hold some market segments but not others? ....

http://news.morningstar.com/articlenet/ ... ?id=747144
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Re: "One Vanguard, Many DFAs"

Post by Rick Ferri »

DFA did not--and has not--used the language of strategic beta to describe its approach, but that is what it does.
I wouldn't use it either. Morningstar coined the term "strategy beta" decades after DFA starting using quantitative strategies to invest in "additional betas" in the marketplace.

All indexes involve some element of active management. This is how any stock or bond gets in our out of an index, and how the index provider rebalances and reconstitutes the index as needed. Where the line is draw between passive and active is up to each individual investor. To me, if a index is passive if its designed to represent "the universe of investment options available to all public investors." It's not passive if the index is designed to outperform the universe in any way.

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nisiprius
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Re: "One Vanguard, Many DFAs"

Post by nisiprius »

I don't think you can have it both ways. Dimensional's funds can't both be index funds and not be index funds at the same time.

Whenever anybody gripes about Dimensional using an inappropriate benchmark, notably using the MSCI Emerging Markets index, rather than the MSCI Emerging Markets Value Index, as the benchmark for a fund named "Emerging Markets Value Portfolio," we get told that it doesn't really matter much because Dimensional funds do not "slavishly" track any index and shouldn't really be compared to an index, so who cares which index we shouldn't compare it to? One poster suffered criticism for saying that a Dimensional fund had "tracking error."

Whenever I've checked, their fund descriptions have used the vaguest of vague language:
The investment objective of the U.S. Micro Cap Portfolio is to achieve long-term capital appreciation.
Not only do they not use the word "index," they don't even use the word "passive" (except in contexts like "passive foreign investment companies). And they say things like:
As a non-fundamental policy, under normal circumstances, the Portfolio will invest at least 80% of its net assets in securities of U.S. micro cap companies.
It's not a "fundamental" policy for a small cap "passive" fund to invest in small-caps? Compare Vanguard. This is the kind of language an index fund use, and presumably Vanguard's lawyers are happy with it:
The [Vanguard Small-Cap Index] Fund seeks to track the performance of a benchmark index that measures the investment return of small-capitalization stocks.... The Fund employs an indexing investment approach designed to track the performance of the CRSP US Small Cap Index, a broadly diversified index of stocks of small U.S. companies. The Fund attempts to replicate the target index by investing all, or substantially all, of its assets in the stocks that make up the Index, holding each stock in approximately the same proportion as its weighting in the Index.
I think even Dimensional's staunch advocates would agree that they are not index funds. They only claim that they are "passive" funds, and they can only do it by creating a definition of passive that is noticeably different from what's generally understood, because everywhere else "passive" is defined as "indexing." Of course it is a pretty good answer to say "who cares about tracking error, given the errors have been pretty consistently on the upside."

Should "passive" imply "indexing?" Maybe you can make out a case that it shouldn't... but it usually does.
Passive Management
A style of management associated with mutual and exchange-traded funds (ETF) where a fund's portfolio mirrors a market index. Passive management is the opposite of active management in which a fund's manager(s) attempt to beat the market with various investing strategies and buying/selling decisions of a portfolio's securities.
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Taylor Larimore
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"One Vanguard, Many DFAs"

Post by Taylor Larimore »

Bogleheads:

John Rekanthaler, vice-president of research for Morningstar, has written an interesting article for those who like to compare Vanguard and DFA funds. The article is unusual because it does not use past performance for naive investors to emulate. These are excerpts:
A key debate of indexing: Should indexers own the entire marketplace, on the theory that the wisest man is the man who realizes that he knows nothing and who therefore will not attempt what must surely fail? Or should they use academic research to shape their funds so that they hold some market segments but not others?

Eventually, I figure, Vanguard will offer Vanguard Total World Marketplace--a fund that indexes all of the globe's securities.

DFA taught its advisors--and thus ultimately, those advisors’ clients--to implement a viewpoint. Don’t own the market’s entire beta, to use the modern lingo. Own only the smart betas.

Fund marketers will express certainty that their betas are the smart ones, but fund owners should be warier.

DFA--as with fund companies that talk about the intelligence of their betas--promises that, by neglecting portions of the marketplace, its funds will outperform the naive, broad indexing strategy.

Vanguard believes that reweighting traditional market-cap-based indexes represents neither a ‘new paradigm’ of index investing nor a ‘smarter’ way to invest.

The invention of exchange-traded funds did open a door for BlackRock and State Street, but Vanguard is catching up there, as well.
Bogleheads can read the complete article here:

One Vanguard, Many DFAs

Best wishes.
Taylor

[this post merged into existing thread on same topic - moderator prudent]
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afan
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Re: "One Vanguard, Many DFAs"

Post by afan »

For Vanguard, this notion sounds suspiciously like those espoused by active managers.
This is not LIKE active management, it IS active management. But the summary is exactly right. To justify their existence, managers have to claim that their factor mix will outperform that of the cap weighted market. I have never seen any of them address whether they can beat the market on a risk adjusted basis when considering higher moments than variance. Since investors require higher compensation to hold negatively skewed portfolios, those portfolios tend to have higher mean and mean/variance returns. But perform the same when accounting for skewness- market efficiency at work.

But if you figure, apparently accurately, that few investors will pursue risk adjustment to higher moments, one can claim to be beating the market with a special sauce of factor blends. Given the level of noise in stock returns, there will always be some set of factors that, in retrospect, did "well"- again ignoring higher moments. Thus, not only will one be able to show the putative value of some factors looking backward, but one can have a series of funds with different factor mixes and always show good performance by some of them. This is the same as the Fidelity strategy with its stock picking funds.

Of course, the costs of all these factor bets exceed those of a cap weighted index fund by many fold.
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Re: "One Vanguard, Many DFAs"

Post by Solo Prosperity »

nisiprius wrote:Should "passive" imply "indexing?" Maybe you can make out a case that it shouldn't... but it usually does.
Passive Management
A style of management associated with mutual and exchange-traded funds (ETF) where a fund's portfolio mirrors a market index. Passive management is the opposite of active management in which a fund's manager(s) attempt to beat the market with various investing strategies and buying/selling decisions of a portfolio's securities.
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Defining DFA is very hard in the active versus passive debate. Using the Investopedia definition above of "Passive Investing", one could simply argue that their funds mirror a market index that has been created using the Fama/French Library. Essentially, they create their own market index for SCV stocks and then "passively" track it with their fund. Is that passive investing? I am sure to most no, but to some, yes. The debate will go on.

Ask yourself, if you invested in VBR, the Vanguard Small-Cap Value ETF, would you consider this an active or passive investment on your behalf? It is not a MC weighted index and not dissimilar to what DFA does for some of their strategies...however, I am willing to bet that deep down a lot of people would call the Vanguard fund passive and the DFA fund active.

What about those who invest in S&P 500 index funds? There are rules and guidelines that help select the companies that are included in that index...not very passive. But, the fund itself "passively" tracks that index. So if an index is active, but a fund tracks it "passively" (never try's to beat it, just matching it) is this an active or passive strategy??

In my personal opinion, I define passive investing by it's turnover. I know others will disagree and say anything besides a MC weighted index is not passive (which is fine...I will survive), but effectively, on some level, everyone one of us is an active investor (Unless you hold the entire global market cap weighted portfolio and never plan to re-balance...so sorry to whoever does that :D ). By my definition I actually consider Buffett to be mostly a passive investor...so obviously my definition will differ from most here, but it makes more sense to me to think about it like that as opposed to just meaning "blindly following an index".

Interested to see where the A v. P debate continues to go over the next decade as ETF's continue to blur the lines of active and passive strategies.
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Re: "One Vanguard, Many DFAs"

Post by KyleAAA »

"(Eventually, I figure, Vanguard will offer Vanguard Total World Marketplace--a fund that indexes all of the globe's securities. Such is the logical ending place for the agnostic indexer. Don’t favor one individual security over another, or a region, or an industry, or an asset class. Just hold what the world holds. Stocks, bonds, warrants, convertibles, partnerships, whatever. It can all be done through a single fund.)"

Yes, please.
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Re: "One Vanguard, Many DFAs"

Post by lack_ey »

KyleAAA wrote:"(Eventually, I figure, Vanguard will offer Vanguard Total World Marketplace--a fund that indexes all of the globe's securities. Such is the logical ending place for the agnostic indexer. Don’t favor one individual security over another, or a region, or an industry, or an asset class. Just hold what the world holds. Stocks, bonds, warrants, convertibles, partnerships, whatever. It can all be done through a single fund.)"

Yes, please.
I would rather not have tax-exempt bonds in the same fund as taxable bonds but maybe that's just me.
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Tax Exempt and Taxable Bond.

Post by Taylor Larimore »

I would rather not have tax-exempt bonds in the same fund as taxable bonds but maybe that's just me.
lack_ey:

It is not just you. Tax-exempt bonds are designed specifically for higher-income investors in taxable accounts. Taxable bonds are for the rest of us and best in tax-advantaged accounts. Mixing the two means that one or the other is probably in the wrong type account.

Best wishes.
Taylor
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Re: "One Vanguard, Many DFAs"

Post by patrick »

nisiprius wrote: Whenever I've checked, their fund descriptions have used the vaguest of vague language:
The investment objective of the U.S. Micro Cap Portfolio is to achieve long-term capital appreciation.
Not only do they not use the word "index," they don't even use the word "passive" (except in contexts like "passive foreign investment companies). And they say things like:
As a non-fundamental policy, under normal circumstances, the Portfolio will invest at least 80% of its net assets in securities of U.S. micro cap companies.
It's not a "fundamental" policy for a small cap "passive" fund to invest in small-caps? Compare Vanguard. This is the kind of language an index fund use, and presumably Vanguard's lawyers are happy with it:
The [Vanguard Small-Cap Index] Fund seeks to track the performance of a benchmark index that measures the investment return of small-capitalization stocks.... The Fund employs an indexing investment approach designed to track the performance of the CRSP US Small Cap Index, a broadly diversified index of stocks of small U.S. companies. The Fund attempts to replicate the target index by investing all, or substantially all, of its assets in the stocks that make up the Index, holding each stock in approximately the same proportion as its weighting in the Index.
Vanguard's lawyers have also used similarly vague language:
Vanguard's prospecuts for Small-Cap Index wrote:The Funds‘ board of trustees, which oversees each Fund’s management, may change investment strategies or policies in the interest of shareholders without a shareholder vote, unless those strategies or policies are designated as fundamental. Under normal circumstances, each Fund will invest at least 80% of its assets in the stocks that make up its target index. A Fund may change its 80% policy only upon 60 days’ notice to shareholders.
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Re: Tax Exempt and Taxable Bond.

Post by Leif »

Taylor Larimore wrote:
I would rather not have tax-exempt bonds in the same fund as taxable bonds but maybe that's just me.
lack_ey:

It is not just you. Tax-exempt bonds are designed specifically for higher-income investors in taxable accounts. Taxable bonds are for the rest of us and best in tax-advantaged accounts. Mixing the two means that one or the other is probably in the wrong type account.

Best wishes.
Taylor
Yep, asset location. That is the same issue I have with all-in-one funds. Simplify down to what makes sense, but don't hurt yourself.
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Re: "One Vanguard, Many DFAs"

Post by nisiprius »

QuietWealth wrote:...that their funds mirror a market index that has been created using the Fama/French Library. Essentially, they create their own market index for SCV stocks and then "passively" track it with their fund. Is that passive investing? I am sure to most no, but to some, yes. The debate will go on.
My understanding is that, no, that is not what they do. It's all a little hard to disentangle, and I can't find this on their U.S. website, but: DFA's Australian site says
By not adopting an index approach, Dimensional can practise patient trading, focusing on price rather than time of execution, which can mitigate the effects of momentum and lead to lower trading costs.
Similar statements pop up in other places, although as I say I can't actually find them on Dimensional's own U.S. website. This one is typical: Dimensional advantages
The goal of an index-based strategy is zero tracking not return enhancement. Index-based strategies often pay liquidity premiums to minimize tracking error, especially around reconstitution dates. The reconstitution cost can be well over 1% per year for small cap index-based strategies. Dimensional avoids reconstitution costs by not tracking indexes...
Similarly, a document that's from their own U.S. website, but dated 2009, refers to "flexible and patient trading."

It's not just a question of following a specially-constructed index. There are a fair number of mutual funds that actually do this, and say so. Dimensional's funds are not simply index funds that happen to track the Fama-French indexes.
Ask yourself, if you invested in VBR, the Vanguard Small-Cap Value ETF, would you consider this an active or passive investment on your behalf?
Personally, yes, assuming that the only "management" is rebalancing to fixed allocations on a predetermined basis, in my opinion that would be a passive strategy.
It is not a MC weighted index and not dissimilar to what DFA does for some of their strategies...however, I am willing to bet that deep down a lot of people would call the Vanguard fund passive and the DFA fund active.
I can't speak to others. To me, even though I don't tilt, a tilted portfolio that constantly rebalanced to fixed-percentage allocations of index funds, such as the Coffeehouse Portfolio, are passive.
What about those who invest in S&P 500 index funds? There are rules and guidelines that help select the companies that are included in that index...not very passive. But, the fund itself "passively" tracks that index. So if an index is active, but a fund tracks it "passively" (never try's to beat it, just matching it) is this an active or passive strategy??
Passive.
In my personal opinion, I define passive investing by it's turnover.
Morningstar is showing Vanguard Small Cap Value Index fund, VISVX, 16% turnover; DFA US Small-Cap Value fund, DFSVX, 9% turnover. So, yes, in this case Dimensional has lower turnover. I think those are both very low numbers.

For a "core holding," Vanguard Total Stock, VTSMX, turnover 3%; DFA US Core Equity, 4%. I won't claim there's any real difference.
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Solo Prosperity
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Re: "One Vanguard, Many DFAs"

Post by Solo Prosperity »

Nisiprius,

Thanks for the feedback.
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Re: "One Vanguard, Many DFAs"

Post by msi »

Or should they use academic research to shape their funds so that they hold some market segments but not others?
If only academic research could predict future investment returns.
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Re: "One Vanguard, Many DFAs"

Post by Rick Ferri »

nisiprius wrote:
QuietWealth wrote:"What about those who invest in S&P 500 index funds? There are rules and guidelines that help select the companies that are included in that index...not very passive. But, the fund itself "passively" tracks that index. So if an index is active, but a fund tracks it "passively" (never try's to beat it, just matching it) is this an active or passive strategy??"
Passive.
Yes and no. If the strategy is cap weighted and meant to represent the value of the marketable universe and used for multiple purposes (economics, valuation, benchmark), then it is passive. I would put the S&P 500 under this domain even though there are rules. John Bogle calls these traditional index funds. I would them market index funds. Another name would be benchmark index funds.

On the other hand, if a index is specifically designed NOT to represent a market, such as RAFI, then it's a strategy index. It doesn't matter if an index is formed from the active strategy first and then the fund tracks, the strategy itself is intentionally designed NOT to track a market and is thus and active strategy.The key is these indices have no purpose except as a product. Strategy indexes exist only for the purpose of managing money against them.

Clear as mud. Yes?

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Re: "One Vanguard, Many DFAs"

Post by MN Finance »

I don't know why anyone cares, since clearly any allocation to either company will, with a coin flip of who's on top, outpace the other 98 of the top 100 options.

The S&P 500 is just as 'active' as a passive, non-'indexed' DFA fund. The arithmetics of passive investing apply to the made up S&P just as they do the made up dfa funds.

If Vanguard is so altruistic then they should just have 3 or 4 funds options, they dont.
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S&P 500 Index Qualifications

Post by Taylor Larimore »

Bogleheads:

I copied this from Investopedia:
To qualify for the S&P index, a company must have:

a market cap of $5.3 billion
its headquarters in the U.S.
the value of its market capitalization trade annually
at least a quarter-million of its shares trade in each of the previous six months
most of its shares in the public’s hands
at least half a year since its initial public offering
Four straight quarters of positive as-reported earnings
Best wishes.
Taylor
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