A recent article from InvestmentNews describes the popularity of Dimensional Fund Advisors (DFA) mutual funds with financial advisers:

For the third time in four years, Dimensional Fund Advisors tops the list of mutual fund companies best positioned to increase its share of assets with financial advisers… The Austin, Texas-based mutual fund company, best known for its factor-based investing philosophy and high barriers to entry (for the mutual fund world, at least), scored 25% higher than bond megashop Pacific Investment Management Co. LLC, which came in second. The Vanguard Group Inc., the world’s largest mutual fund company, finished third.

Why do advisers prefer DFA funds? Three reasons come to mind: exclusive access, smart beta, and superior performance. The first reason is the same as the “high barriers to entry” mentioned in the above quote — the DFA funds cannot be purchased directly by individual investors, but only through qualified advisers. This means advisers can position themselves between inexpensive index-like vehicles and investors’ assets, thus improving the justification for an advisory fee.

The second reason emphasizes characteristics that make DFA funds supposedly different from regular index funds. For example, DFA Core Equity funds skew towards small-cap and value stocks:

Increased exposure to small and value companies may be achieved by decreasing the allocation of the portfolio’s assets in large growth companies relative to their weight in the US universe. Securities are considered value stocks primarily because a company’s shares have a high book value in relation to their market value (BtM).

However, this tilt is well known through Fama-French research and can be achieved through other means, including specialized factor exchange-traded funds (ETFs).

The third reason requires more scrutiny. While it is true that most DFA funds earn above-average ratings in their respective categories according to Morningstar, how does the performance of these funds look like from the Alpholio™ perspective? Let’s analyze the first DFA fund on the US Core Equity list, the US Core Equity 1 Portfolio (DFEOX). Here is the cumulative RealAlpha™ chart for the fund:

Cumulative RealAlpha™ for DFEOX

The chart clearly shows that on a truly risk-adjusted basis, the fund did not generate any alpha in the past seven years. This is further supported by performance statistics:

DFEOX Statistics

Similar results are observed for all of the DFA US Core Equity funds since their inception:

Name Ticker Annualized Lag RealAlpha™
US Core Equity 1 Portfolio DFEOX -0.38%
US Core Equity 2 Portfolio DFQTX -0.27%
US Vector Equity Portfolio DFVEX -0.64%
US Social Core Equity 2 Portfolio DFUEX -0.02%
TA US Core Equity 2 Portfolio DFTCX -0.03%
US Sustainability Core 1 Portfolio DFSIX -0.13%

These data indicate that an individual investor would realize better risk-adjusted returns from substitute portfolios of ETFs than from these DFA funds, while in the process gaining intra-day liquidity and full control of investments. Alpholio™ provides composition of such substitute portfolios on an ongoing basis. Thus, the three reasons for preference of DFA funds, in particular the exclusive access, no longer hold.

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