Dimensional Fund Advisors (DFA) is a renowned investment firm known for its unique dimensional investment philosophy and approach. DFA’s investment philosophy is grounded in academic research and emphasizes market efficiency, diversification, and long-term investing. Some core concepts of the dimensional approach include targeting asset classes with higher expected returns, diversifying broadly, minimizing costs, and maintaining discipline. In this article, we will review the key tenets of DFA’s investment philosophy, examine the academic evidence supporting it, and discuss how dimensional investing is applied in practical portfolio construction.
Efficient markets and passive investing as core beliefs
DFA believes markets are mostly efficient and securing higher returns is largely about exposure to risk factors with higher expected returns. This leads them to build passively managed funds targeting dimensions like size, value, and profitability. They tilt portfolios towards small caps, value stocks, and high profitability firms to capture long-run premiums rather than attempting to pick individual winners.
Broad diversification across dimensions
Dimension funds hold thousands of securities across many countries and sectors. By diversifying broadly, they reduce unique risks and aim to isolate factor returns. This wide exposure increases the reliability of capturing premiums over long periods.
Focus on costs
As passive investors, DFA focuses on minimizing trading costs and fees. They trade patiently to reduce transaction costs. Fund expense ratios are also kept low. DFA believes cost control is vital for returns as expenses compound over time.
Adherence to process
Dimensional portfolios follow rules-based processes. They stick to asset class dimensions despite periods of underperformance. This discipline is key for earning long-run rewards from factors. Chasing recent returns can hurt factor investing.
In summary, the dimensional approach of DFA emphasizes market efficiency, broad diversification across factors, keeping costs low, and strict discipline. This philosophy is grounded in financial research and has led to long-term success for many Dimensional funds.