How Dimensional delivers high returns over the long term—and why it’s in a class by itself.
One puzzle with respect to the success of Dimensional Fund Advisors is that nobody has tried to imitate its business model. “What they do is not all that secret,” says Jack Gould, Steven G. Rothmeier Professor and Distinguished Service Professor of Economics. “But nobody has effectively competed with them.”
Chairman and CEO David Booth, '71, thinks that’s because it’s harder for others to believe as firmly as Dimensional does that markets work well, that is, that stocks trade at fair prices. It just isn’t worth spending the time and money to try to outperform the market by finding mispriced stocks. By dispensing with the idea that money managers can consistently pick winners, Dimensional is free to focus on ways that truly add value for their clients, which is translated into higher returns over the long term.
Dimensional’s U.S. small cap value product, for instance, has gained an average of 12.5 percent per year since its inception in 1993, compared with only 10.99 percent for the benchmark Russell 2000 Value Index. Its U.S. micro cap fund has been around since 1981, and that has increased 12.21 percent per year compared with the Russell 2000 index’s 10.52 percent.
Thus, while Dimensional favors a “passive” rather than an “active” style of managing investments, the way it runs its business as a whole isn’t passive at all.
Gould thinks Dimensional’s innovative quality is what sets the company apart. “It’s always changing and adapting,” he says. Dimensional follows a continuous “feedback loop” that brings together science and practice. It begins by taking academic research and using those ideas to engineer portfolio strategies. New products are introduced and strategies are fine tuned as research advances, often with the help and advice of the academics themselves. Dimensional maintains close ties with an impressive group of scholars, many of them affiliated with the GSB. Clients are also an important part of the process and Dimensional works hard to understand what they want through dialogues, which lead to questions from clients, more research on Dimensional’s part, and further refinement of its products.
A big part of Dimensional’s success is being able get clients to understand the company’s long-term investment approach and, in particular, to view the world through the lens of efficient markets. It’s a message that Dimensional has gotten good at telling over time, and its list of followers has grown rapidly in the past 27 years.
Most of this growth comes through a select group of intermediaries called registered investment advisors (RIAs). Dimensional offers funds directly to institutional investors only, but RIAs allow the company to reach a huge number of individuals—something that would be costly for Dimensional to do on its own because talking with clients is a key part of their strategy. RIAs are paid by their clients, not by Dimensional. This removes conflicts of interest that might arise if RIAs were instead paid by Dimensional on commission.
Today, Dimensional manages about $120 billion in assets for RIAs and institutional investors.