Rob Harvey, Dimensional

And we opened up a search for a new asset manager. And one of the people that we talked to was Dimensional. So the asset managers that came in the door, obviously, the first question that we're asking every single one of them is, what do you think the Fed's going to do? And where do you think rates are going to go? How are you positioning your portfolio accordingly? And everybody had an answer and everybody had a story except Dimensional. Because their answer was, we don't think predicting what the Fed is going to do is a worthwhile exercise. So we don't do it and we don't think you should do it either. Okay, now you got my attention because I haven't heard that response before. So I was curious about it.

I wanted to learn more about their approach. I flew down to Santa Monica to attend one of their conferences there where I got to see Eugene Fama and Ken French presenting some of their research and talking about their relationship with Dimensional. And I was just blown away. When you're in the front row seat, and Ken French is talking to you about the three-factor model, it's like being in the front row seat of a Journey concert. It is an incredible experience. And I was sold. So when I went back to the Bay, I had advocated that we, use Dimensional as that asset manager that was missing. I don't know that it was a good fit for the way that everybody views the world.

But for me, at least, I had sort of a moment of introspection where I'm like, listen, if I like these guys so much and I want to put my money with them, why don't I go work for them? So I did. And so I had wrapped up my MBA and I moved down to Austin, Texas, and I've been with Dimensional ever since.

You like them. You tell your family. They learn something new maybe about how their investments can be run, maybe an approach that they didn't realize was out there before. Then they're interested and they talk to their financial advisor. And the financial advisor piece is critical because we're very supportive of the advisor community. We don't have in-house advisors ourselves. We partner with advisors and that's because we think the best way for investors to reach their financial objectives is by leveraging their financial advisor and listening to their advice. So it's a very strong relationship that we have with advisors that's, paid off quite well, both in the sense that we've all been able to benefit, right?

Investors have had a good experience. Advisors have grown their business. Dimensional has grown their business. But it's because we're all playing on the same team. We all want the same thing. And it's not about pushing whatever is hot today. It's about thinking what's going to make sense, what's going to drive long-term returns over the next 10, 20, 30 years. And there's a lot of ways you can support advisors, right? It's not just about product. It's about you turn on the TV. There's a lot of news out there. There's a lot of noise out there, too. How do you cut through that? How do you, stay relevant to your clients that you only see four, eight times a year and have them stay focused on that plan when they're constantly being bombarded with all this other stuff?

That's part of a responsibility that we're picking up, too. And we're saying we want to help you with that. So it's content. It's messaging. It's thinking about succession planning for the business. It just there's a lot that goes into that. And we're really plugged into the advisor ecosystem in that sense. It's not just great investment solutions, but we do that, too. Yeah.

We have, well over 100 products now that we offer. One of the ones that's important and very relevant for the advisor community is ETFs. As you said, we didn't have ETFs in 2018. It's a relatively new space for us to be in when you think about the longer history of dimensional. But we're the number one active ETF issuer in the market. So we came at a point where we knew that we could be successful based on that partnership with advisors. And we have been. And we've seen that market share grow over time actually as well. So it's not just a, an early advantage that slipped away. We're actually, picking up steam in the active ETF space as well.

And you mentioned before that some of the approach of dimensional has changed. And that's absolutely true. If you wanted to buy a dimensional mutual fund, you had to go through a process and still do actually of understanding how we view the world. Because we think that's really important. If you're going to be invested in something like micro caps, you need to understand that micro caps aren't going to outperform large caps every day or even every year. That's part of the experience. And so if we care about helping investors achieve their long term objectives, and it's clear that we do, right? That was one of the first things that I said. You have to also make sure that long term expectations are set properly.

So there's sort of an educational period where we share the research, we share what we're doing in the portfolios, we talk about some of the messaging that can be effective for advisors. So that's all part of buying the mutual fund. And we still have that, even with ETFs. We want to work with advisors. We want them to partner with us and go to our conferences and speak to us and, sort of share thoughts on what would be effective. But you obviously don't have to do that with an ETF. You can just go out and buy it. So we haven't walked away from that investor education piece. But with ETFs, they're just more open. But, I think we're also being more aggressive with meeting people where they're at and making sure that the education is accessible to them.

When you think about moving away from what the market portfolio looks like, you better have a good reason for doing that. Because if you don't have a good reason, you should just, just hold everything at market cap weight, basically. But we do have good reasons. And the reasons really is sort of that academic heritage that we're well known for, which is the greatest minds in modern financial theory, like Eugene Fama, Ken French, Robert Novy-Marx, Myron Schultz, have chosen to work with us to help us improve our understanding of where returns come from. And then actually build portfolios around capturing that. So we have an enormous research team here with dozens of PhDs in it who take that research from academics and apply it in these portfolios.

Again, systematically, meaning the bets that we're making on smaller securities, for example, doing better than larger securities, are there in all of our equity portfolios and are there every day. So if you believe in what we're putting out there, if you believe in the research, we're not switching from it. We're sticking to our guns over time. So there's a consistency aspect to that. Now, it doesn't mean, again, that they're going to outperform every day. But I think that consistency and approach gives investors more confidence because they know what they're going to see when they pick up the account statement. If value got crushed last year versus growth, you should expect to see a value strategy underperform. That is part of your, that's part of the experience that you should anticipate, right?

It'd be weird if you picked up your account statement and your value fund outperformed the market when value didn't do well. So part of that, I think, is also just about setting expectations, like I said. Yeah.

Isn't that interesting? There's some differences in returns here. We could do something with that. And there's always new research coming to light. There are hundreds of factors or premiums, whatever you want to call it, that are out there in the market. You need a team to vet all of those to say, are these worthwhile? Like, should we be pursuing these? And I think that deep bench of, PhDs and researchers is incredibly important. My boss, Marlena Lee, is a PhD who worked with Eugene Fama at University of Chicago. She's very well equipped to have some of these conversations and has many times over the years and sort of evaluating this research. So there's a high bar for something coming into the portfolio.

We're not chasing the flavor of the week. We need a lot of data and a lot of confidence that it's going to work. But we evolve. And there's a lot of evidence of that, too. You think about profitability, for example, coming into our portfolios in 2012. We were doing small value for years and years and years before that. Profitability comes along and we vet it carefully for a long time and say, this is worth it. We should be implementing this. There's little tweaks. There's big tweaks. But you should always be moving forward. So what we look like today is going to be similar, I expect, to what we look like 10 years from now. But I also expect there to be developments and improvements. So that's the research piece.

The product piece is also important. If we found ways to improve the micro cap portfolio a little bit here, a little bit there over time, that's great. But we're not necessarily serving the investors, our investors, our clients as well as we could. If we know that we can also do things in other areas of the market that are also value add. So you've seen not just in the product wrapper, like ETFs, like you mentioned, but also where are you going to be positioning yourself? Like, and what do you position yourself against? Historically, dimensional has been very much a component of the market. Those are our flagship funds, like a value strategy or a small cash strategy. we do have market-wide strategies, but we're known for component strategies.

Some of our most popular ETFs are low tracking error, high degree of overlap, market-wide portfolios with good implementation and very light tilts towards the premiums. People like that. And that's new for us. And we're not saying there's a right or wrong answer. It's all about risk preferences and, how much tracking error or volatility you're interested in taking. But you can build portfolios that still incorporate those good ideas in just different flavors. You're just turning the knobs a little bit differently. And that has continued to evolve, and I fully expect that I see that going forward as well. We are not done. You will see more ETFs. You will see more mutual funds launched in the future.

And we just talked about the fact that since last week, we've had an incredible amount of changes out there in the market that you should be paying attention to. So there's just a fundamental principle of how often would you expect your asset manager to be doing their job, which is looking at the portfolio and making sure that it's staying on track. I would argue it has to be every day. It has to be. So right off the bat, indexing, I think I've got some problems with that. But then on top of that, also, indices don't incorporate the research that's out there effectively on where investment returns are coming from. And that is also problematic.

There's money that's being left on the table by sloppiness and implementation. There's money that's being left on the table by doing the same thing that everybody else is doing at the same time and by only doing it once or twice or four times a year. But then there's another aspect, which is why wouldn't you want to incorporate what these academics who have spent their entire lives devoting to understanding where returns are coming from? Why wouldn't you want that incorporated? You should. And we have a phenomenal track record of outperforming index funds on a net of fees basis or indices, I should say, on a net of fees basis, which also means we outperform the index funds that are tracking them. So we've got the proof statement, too.

You can do better than indexing. It's a drum that we've been banging for some time now because it's hard to get people to look beyond an expense ratio, but it's important. There's a lot more that's there. And by the way, when we talk about a dimensional fund, you're not paying much more. it's fairly close to an index fund. But look, if you want to have your portfolio be looked at every day, you've got to pay someone to do that. And so that's going to cost you a little bit more, but it is absolutely worth it.

But one thing that we've heard from investors is, hey, I like what you guys do on the implementation side a lot. I like the flexibility in trading. I like, the fact that you're considerate about what's going into the portfolio. I don't know if I want heavy tilts. A little bit is fine. But I'm kind of trying to find a replacement for an index fund. So I want low tracking here. I don't want to look too different from the market. Great. DFAI is for you. DFAI is, again, as I said, sort of broad market capitalization coverage. It has thousands and thousands of names. In fact, it has thousands more names than you'll find in the MSCI World X US, which is a very popular index to track for various funds that are out there in the developed international space.

And the reason that we have all these names that you don't have in an index is because index funds and indices don't include a lot of micro cap securities in them. And that's because it's very difficult for index funds to actually go out there and buy them. If everybody's trying to buy the same micro caps at the same point in time, it's going to get expensive. So index funds don't want that because it's going to mess with their tracking error, right? It's going to drive up their costs. So indices just don't include them. Well, the juiciest returns in the market come from micro caps. So you should expand your investment universe to include them. And we do because we don't have to trade four times a year.

We trade every single day. And in a way that we feel can be very cost effective to pick up some of those micro cap securities. So DFAI, just from a construction standpoint, is different from the market. You've got better coverage. One of the things I always hear investors talk about and sort of lament is, oh, there's no good small cap companies anymore. Everybody's staying private for longer. Nobody's IPOing. Like if you buy the same stocks that everybody else is buying through an index fund, that is probably true. But it doesn't mean that there's not great companies out there that look like private equity a lot of the time based on, they're starting up their business. They're brand new. The profitability is not there.

But man, there's a lot of potential for those. Those are in the micro cap space. So that's important. So from a construction standpoint, there's that. But then just the implementation, as I talked about, just making sure that when you go to market, you're smart about the way that you do it. And maybe you don't want to hold everything out there in the market, too. There's a lot of junkie small cap companies. And there's companies that have, in the past openly declared bankruptcy and stayed in indices. Because nobody took the care to remove them. So there's just some basic fundamental principles that can be adhered to and should be that give you the edge. And when you look at DFAI's performance, it's been phenomenal over the last three years.

It's outperformed its benchmark on an NFE's basis by a substantial margin. And we would kind of expect that from this portfolio. you're talking about, somewhere between, I don't know, 50 basis points to 100 basis points a year. Outperformance net is a great figure to put up for this fund. And again, the tracking error and the expenses are not very high. So very successful fund so far. And it's a great example of what we can do in other areas of the market as well.

That might just be a dead industry from now on. And we said, don't worry. We're not. And the reason is because of momentum, right? Momentum tells you that stocks that are getting crushed and massively underperforming their peers, you probably want to stay away from those because the tendency is that they're going to underperform over time. So that's a nice way for us to avoid value traps, for example. So that's kind of a different, sort of the same side of, or the different side of the same coin. And then you look at other stocks out there right now. What's doing really well in Europe? What's doing really well in DFAI? Defense stocks. They're doing really well. Those are momentum up. So if you have a portfolio that's focusing on smaller, deeper value, higher profitability securities, which is what we know drives returns in the equity space, but you're holding a defense stock that's in the top 5% in terms of performance for the rest of the international market, you might want to hold on to that one a little bit longer, right?

So there's just sort of, it's not as rigid as looking at only the premiums. Momentum is a nice way of incorporating real world information into how did this stock get to where it is now? And what does that mean for what it's returns look like over the next 2, 3, 4, 5, 6 months? Yeah.

Broad market coverage. You can do that with DFAI in a vehicle that has achieved the outperformance, which just helps boost the overall, performance of the fund that it's a component of. So I think DFAI is really meant to be a replacement of the core part in international funds. Yeah, no, I would agree.