The following originally appeared in Issue 218 (Issue 17 - 23, May 2004) of IFA Magazine. Reproduced and republished with the permission of InvestorInfo Ltd. All Rights Reserved.
A Different Way of Looking at the Benchmark
By Matthew Smith
IFA Magazine
May 2004
Most portfolio managers believe participants belong to either the active or indexing camp. Andrew Cain, Dimensional Fund Advisors director and portfolio manager, doesn't see the world that way. He says "passive" investing is very different to indexing and should not be considered under the indexing label.
"We consider ourselves to be strong proponents of passive. It is wrong to describe us as an index manager because index managers contract out their investment decisions."
Dimensional manages three passive funds that cover small cap, large (top 100) and value asset classes. He says the argument for passive investing has to do with the fact much out performance has more to do with the asset class than it has to do with the manager's stock-picking capabilities.
"Skill and timing is only part of the story. If you're investing in small companies versus large companies, straight away there is a big difference in the returns and risk you are exposed to," he says
"Consultants and researchers have only just come to grips with that concept."
Dimensional bases its investment approach on a body of academic and empirical evidence relating to stock market behaviour that considers the different returns company size and value attribute to a portfolio.
"Typically active managers will take a view. They work on forecasting about the economy, the sector and the companies and they will take an active position based on that. In the passive approach, we're not making a forecast, we're just saying we want exposure to a particular segment of the market.
"We don't say this is better than that, we invest in the whole asset class on a weighted basis making a broadly diversified portfolio."
Dimensional has a buy-and-hold strategy that keeps investments until they are no longer considered to be in that asset class.
The manager defines value by comparing book-to-value with market value.
Cain believes the stock market is efficient, which is what index managers rely on to provide investors with exposure to the market while mitigating risk.
"We believe the index is not as an investment vehicle, it is a measuring tool. We define our own index, we don't follow the index, we create our own," he says.
Dimensional Australian small, large and value passive funds have returned 47.2 per cent, 22.7 per cent and 34.3 per cent before fees for the year to the end of March 2004 respectively. Over three years the same funds returned 13.8 per cent, 7.2 per cent and 16.8 per cent to the end of March this year. Since its inception in November 2000, the small companies fund returned 10.7 per cent; the large companies fund returned 5.7 per cent since inception in October 2000; and the value fund returned 13.55 per cent before fees since it started in July 1999.