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Back in the 1980s, when Dimensional Fund Advisors launched its first mutual funds, it didn’t so much have investors as it had devotees.
DFA’s funds were among the earliest quantitatively run factor-based funds that focused on value and small-cap investing, starting with the 1981 launch of its DFA U.S. Micro Cap Portfolio (ticker: DFSCX).
Initially, DFA funds were only available to large institutional investors; in 1989, the firm allowed financial advisors to purchase them for clients, but only after those advisors took a two-day academic course on the firm’s investing methodology and underwent a vetting process by Dimensional. For decades, retail investors couldn’t directly buy the funds. Despite its rather exclusive business plan, the firm has grown to $514 billion in assets, making it the fifth-largest mutual fund firm.
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That’s why DFA’s plan to launch three exchange-traded funds—Dimensional US Core, Dimensional International Core, and Dimensional Emerging Markets Core—in the next few months marks the end of an era.
“Oftentimes when you hear people talk about the history of DFA, they talk about the fact that over the years it’s developed an almost cult-like following,” says Ben Johnson, Morningstar’s Director of Global ETF Research. “That’s been a deliberate effort on the firm’s part. They want to make sure, to their credit, that their investors understand their philosophy and strategies, and use them well.” ETFs, by definition, trade on an exchange and therefore are available to anyone with a brokerage account.
Depending on whom you ask, the motive for launching ETFs is either opportunity or desperation. “The ‘Why now’ part falls under that umbrella of two things converging for us,” says Dave Butler, DFA’s co-CEO. “One was an ETF rule that was put into place at the end of 2019. Secondly, we’ve been having multiple client conversations with the financial professionals we work with. Those conversations have led to greater interest in having Dimensional’s investment philosophy in an ETF vehicle.”
Unlike traditional passively managed index funds, which rigidly adhere to their benchmarks by rebalancing portfolios when their benchmarks do, DFA’s funds—though similar in design to factor indexes—have a flexible, active approach to trading so that they don’t overpay for stocks they’re buying or sell stocks too cheaply. That has added to their performance over time.
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We felt that the timing was good for us to be able to answer the question, can we add value? And our emphatic answer is, ‘Yes.’
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Yet because of the way ETFs have been historically designed, such customized trading was difficult to do. Trades had to be executed in standardized baskets representing a fund’s entire portfolio. Intraday trading of individual stocks that were attractively priced in such predetermined stock baskets wasn’t possible.
That changed with the Securities and Exchange Commission’s adoption of Rule 6c-11 last September. According to the SEC: “An ETF relying on rule 6c-11 will be permitted to use baskets that do not reflect a pro-rata representation of the fund’s portfolio or that differ from the initial basket used in transactions on the same business day (‘custom baskets’).”
Butler says the rule change will allow DFA to run its ETFs with the same flexible trading style as the mutual funds. “We felt that the timing was good for us to be able to answer the question, can we add value? And our emphatic answer is, ‘Yes, we can in an ETF space given this new rule.’ ”
Not everyone buys DFA’s explanation. Financial advisor Rick Ferri of Ferri Investment Solutions used DFA mutual funds for 18 years before selling his asset management firm in 2017 to launch his current one, which only provides advice charged by the hour. He began asking DFA to launch ETFs in 2006 after Eugene Fama and Kenneth French, the legendary finance professors and DFA…
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