3. They Try to Predict the Future
โI have a proven system for picking winning stocks.โ
โThe market is primed for a retreat.โ
โThat sector will continue advancing through next year.โ
4. They Act on Impulse
โI canโt take this bear market - Iโm getting out!โ
โEveryoneโs making money - I want a piece of the action.โ
5. They Bet on Tips and Hunches
โI heard it on cable news. Iโd better sell!โ
โI got a hot tip from my neighbor. Itโs a slam dunk.โ
โMy friend works in the industry - heโs got the inside scoop.โ
6. They Are Swayed by the Media
โHow to Reach $1 Millionโ
Money, 08/2012
โThe Death of Equitiesโ
Business Week, 08/13/1979
โThe Crash of โ98 Can the US Economy Hold Up?โ
FORTUNE, 09/28/1998
โRetire Rich โ A Simple Plan to Have it Allโ
FORTUNE, 08/16/1999
7. They Rely on Unreliable Track Records
โI donโt just pick average fundsโ
โI carefully examine the winning fundsโ
โI only invest in 5 star fundsโ
8. They are Plagued by Emotional and Psychological Distractions
Claiming Losses Who to Trust
Sunk Cost Fear
Hindsight Bias Greed
Fooled by Randomness Overconfidence
12. Why Flip a Coin?
Academic Research Provides Many Answers
13. Most of the Advancements in Finance Have Come from Academia
Eugene Fama
Nobel Laureate, 2013
Kenneth French
Dartmouth College
Robert Merton
Nobel Laureate, 1997
Robert Novy-Marx
University of Rochester
William Sharpe
Nobel Laureate, 1990
Merton Miller
Nobel Laureate, 1990
Myron Scholes
Nobel Laureate, 1997
Peng Chen
Cornell University
14. Illustration based on voluntary participation at client event hosted by a financial advisor, August 2013. Results audited by advisor.
Together, We Know More Than We Do Alone
Participants were asked to estimate the number of jelly beans in a jar.
Range: 409-5,365
Average: 1,653
Actual: 1,670
15. In US dollars. US equity trades: Trade data from consolidated trade feeds and includes securities listed on the NYSE, AMEX, Nasdaq, and Regional exchanges. Source: Better Alternative Trading System (BATS) Global Market Systems. US fixed income trades: Trade data provided by Federal Reserve Bank of New York, Municipal Securities Rulemaking Board, and FINRA TRACE. Source: Securities Industry and Financial Markets Association (SIFMA).
Markets Reflect the Combined Knowledge of All Participants
US Markets Trading in 2013
Equity
Fixed Income
Average Daily Volume
$223 billion
$810 billion
16. Prices Incorporate All Available Information
Book Equity
News about
Cash Flows
Risk
Considerations
Book Equity
Expected Cash
Flows
Discount Rate
Price
21. Source: Mutual Fund Landscape, Dimensional Fund Advisors 2014. Mutual fund data is from the CRSP Mutual Fund Database, provided by the Center for Research in Security Prices, University of Chicago.
Funds are identified using Lipper fund classification codes and are matched to their respective benchmarks at the beginning of the sample periods.
Conventional Investment Methods
Mutual funds that survived and beat their index for 10 years, ending December 31, 2013
19%
15%
Stocks
Bonds
23. Indexing
Measurement tool not intended for investing
Allows commercial index to determine strategy
Attempts to track the benchmark
Accepts lower returns, reduced flexibility, higher trading costs
24. Indexing Attempts to Track a Commercial Benchmark
Holds a basket of securities represented in the index.
Buys and sells the same securities at the same time as all other funds tracking the index.
INDEX LIST
Market
25. Portfolio Engineering
Applies insights about markets and returns from academic research
Structures portfolios along the dimensions of expected returns
Adds value by integrating research, portfolio structure and effective implementation
27. Viewing the Market in a Different Dimension
Higher Expected Return
Market
Lower Expected Return
28. Portfolios Can Be Structured along Dimensions of Expected Returns
Overweight
Underweight
Market
Higher Expected Return
Lower Expected Return
29. Dimensions of Expected Returns
Sensible
Persistent across different time periods
Pervasive across markets
Cost-effective to capture
Statistically large and significant
30. Dimensions of Expected Returns
1. Relative price is the price of a security as it compares to another.
2. Operating income before depreciation and amortization minus interest expense scaled by book.
31. Do profits today contain information about profits in the future?
Profitability Research
32. Identifying a Persistent Measure:
Include all major costs of doing business Exclude nonrecurring items of profitability Be comparable across sectors
34. Dimensions of Expected Returns
US Stocks
Size (Market Cap) 1928-2013 Small Large Premium
12.33% 9.78% 2.55%
Relative Price
1928-2013 Value Growth Premium
12.62% 8.94% 3.68%
Profitability
1964-2013 High Low Premium 12.98% 8.26% 4.72%
Source: Dimensional Fund Advisors
35. Dimensions of Expected Returns
Non US Developed Stocks
Size (Market Cap) 1970-2013 Small Large Premium
15.07% 10.06% 5.06%
Relative Price
1970-2013 Value Growth Premium
15.11% 9.16% 5.95%
Profitability
1992-2013 High Low Premium 9.03% 3.88% 5.15%
Source: Dimensional Fund Advisors
36. Dimensions of Expected Returns
Emerging Markets Stocks
Size (Market Cap) 1989-2013 Small Large Premium
12.78% 11.11% 1.68%
Relative Price
1989-2013 Value Growth Premium
15.08% 10.06% 5.02%
Profitability
1996-2013 High Low Premium 10.63% 4.23% 6.40%
Source: Dimensional Fund Advisors
38. Critical Components of Net Returns
ENGINEERING
+
+
+
+
+
EXECUTION
AND
+
EXPENSES
REVENUE
-
+
=
Beta (Market)
Size Large - Small
Price Growth - Value
Profitability More - Less
Index Tracking Flexibility
Style Drift Limits
Momentum
Expense Ratio
Securities Lending
Fund Return
-
Less tax impact
Taxable Accounts
41. Dimensional Fund Advisors Putting Financial Science to Work for You
Strategies based on academic research Many firsts with the market #1 choice among professional advisors Worldwide leader adding value through trading Available only through select advisory firms
42. Focus On What You Can Control
Let science work for you.
Let markets work for you; Capture returns.
Diversify intelligently.
Control expenses, taxes and turnover.
Stay disciplined.