Long-time readers will know that I’ve written before about Dimensional Fund Advisors, an innovative investment firm that builds low-cost, widely diversified funds. I enjoy keeping an eye on DFA, because their strategies are based on academic research (there are a few Nobel laureates in the family) that all investors can learn from.
The one downside of Dimensional funds is that they’re not available through discount brokerages: the only way you can get them is through a small number advisors who have been schooled in DFA’s strategies. This helps the company control fund inflows and outflows from performance-chasing retail investors that would make executing those strategies impossible.
But that doesn’t mean Couch Potatoes can’t pop the hood on these funds and take a look. Just shy of a year ago, the firm launched the DFA Global Balanced Fund in Canada: it’s a fund of funds that includes the standard 60% equity and 40% bonds. [Note: This fund’s name has been changed to the DFA Global 60EQ-40FI Portfolio. There are now also versions with different allocations to equity and fixed income.] The I thought it would be interesting to compare it to my own Complete Couch Potato.
How DFA works
Before we do that, however, it’s worth taking some time to understand how DFA funds are built. They’re not index funds, and it’s not even accurate to say they’re passively managed, though there is certainly no stock selection, timing, or forecasting involved. The methodology is complicated, but in the broadest terms, it starts with the whole universe of stocks in a particular market and then gives added weight to smaller companies and those with value characteristics (specifically high book-to-market ratios). This strategy is based on the Fama-French Three Factor Model, which holds that small-cap and value stocks should deliver higher risk-adjusted returns over the very long term.
DFA uses this methodology even in their “Core Equity” funds, but the tilt to small-cap and value stocks is even stronger in their “Vector Equity” funds. All of the funds are hugely diversified: the Canadian Core Equity Fund holds more than 600 stocks, for example, while their International Core Equity Fund holds over 4,300. All of the funds have extremely low turnover, since they’re not tied to any third-party index that adds or deletes stocks.
Dimensional’s bond strategies get less attention, but again the funds are engineered to get broad exposure to specific risk factors—in this case, maturity and credit quality—with no attempt to forecast interest rates. The funds stick to the highest-quality bonds—no high-yield junk. Perhaps DFA’s most unusual fixed-income strategy is global diversification, something very few Canadian bonds funds share. (All of the currency exposure in the bond funds is hedged to the Canadian dollar, which is what investors should want.)
Let’s get naked
With that of the way, here’s what the DFA Global Balanced Fund looks like with its shirt off:
DFA Canadian Core Equity | 14% |
DFA Canadian Vector Equity | 6% |
DFA US Core Equity | 7% |
DFA US Core Equity (Hedged) | 7% |
DFA US Vector Equity | 5% |
DFA International Core Equity | 7% |
DFA International Core Equity (Hedged) | 7% |
DFA International Vector Equity | 5% |
DFA Global Real Estate Securities | 2% |
DFA Five-Year Global Fixed Income | 30% |
DFA Investment Grade Fixed Income | 10% |
You’ll notice the equity mix is about evenly split between Canadian, U.S. and international, just like the Compete Couch Potato. The international equity component (like the Vanguard Total International Stock ETF) also includes emerging markets. The total number of stocks in the DFA fund is close to 8,000, while the Complete Couch Potato has more than 10,000.
The main difference, of course, is that about one-third of the DFA equity portfolio gets the small/value tilt from the Vector funds. Another is that about a third of the foreign currency exposure is hedged. Partial hedging is also a technique used by many pension funds: it’s a sensible strategy for Canadians, but it’s expensive and a bit difficult to do with ETFs. I’ve left the Complete Couch Potato unhedged for that reason.
The two fixed income funds, as I’ve said, includes U.S. and international bonds as well as Canadian issues, and are confined to relatively short maturities. That makes them quite different from my Complete Couch Potato, which is all Canadian and has a longer duration. Also unlike my model portfolio, the DFA fund has no exposure to real-return (inflation-protected) bonds.
The final ingredient is the real estate allocation, which is also globally diversified, with just a tiny amount to Canadian REITs. (The DFA fund’s top holdings are similar to the iShares Global Real Estate Index Fund). I’m not sure I understand the logic of allocating just 2% to this asset class: such a small holding will have a negligible effect on the portfolio. For what it’s worth, the Complete Couch Potato includes 10% in real estate, all Canadian.
It’s a shame that DIY investors can’t get access to this fund, because it’s a one-stop solution that is probably superior to what 95% of Canadians hold in their portfolios. It’s also extremely cheap: the F-series MER is just 0.60%, though the advisor would add his or her own fee on top of that.
Would you by any chance know why DFA does not want maturities longer than five years?
It is also puzzling that they would not have some portion in real return bonds. Since real return bonds usually have longer maturities, maybe they just have a view that longer maturities in fixed income do not adequately compensate an investor? I wonder why or how they would come to this conclusion though? In your research on DFA were you able to find out why they do not hold real return bonds?
@Phillippe: Great questions. Regarding bond maturity, my understanding is that their research has concluded that going out longer adds volatility without an adequate tradeoff in higher returns. The same is true with credit risk: increasing credit risk beyond a certain point doesn’t compensate the investor. Remember too that the equity side of a DFA portfolio may be more volatile than the overall market, so it makes sense to balance that with low volatility on the bond side.
I have never been able to learn the specific reason for avoiding inflation-protected bonds, but I assume it’s because most of them have very long maturities. You could argue that the fixed-income side of a portfolio is not supposed to offer inflation protection: that’s what the equities are for. It’s a reasonable argument, though not everyone agrees. I still like RRBs for their low correlation to the rest of the portfolio.
For the bond side of the equation consider a ladder of GICs from deposit insured credit unions and the like. Look them up on CANNEX. Its simple, low duration, and the returns are on a par with corporates with less (zero) credit risk. Maybe add XBB. In an RSP hold real return bonds using an ETF. XBB will increase duration a bit and XRB will increase duration more.
@Andrew: I agree, a simple GIC ladder is really an underrated strategy. It may well be preferable to a short-term bond ETF—it certainly is if you’re using a taxable account.
Thank you Dan for your clear answers, they helped me understand the reasoning behind DFA’s choices with respect to fixed income. I also like RRBs for diversification/lower correlation with equities.
I do find some irony in the fact that DFA avoids longer maturities and RRBs. DFA is linked to Fama and French who are perhaps the strongest advocates (believers) in the
efficient market theory. Yet they avoid bonds with longer maturities… as you explained in your answer to my question, the return vs. volatility is not worth it. But how can they be so sure it will be in the future? Just wondering :)
@Philippe: I’m not sure that avoiding a particular asset class because is contrary to the idea that markets are efficient. (You could argue that gold and commodities should be avoided, too.) You also need to think about every asset class in terms of how it will affect the overall portfolio. DFA likes to move as much risk to the equity side of the portfolio and keep the fixed-income side safe.
The actually will change the duration of the portfolio a little depending on the shape of the yield curve (i.e. the difference between short-term rates and long-term rates). Here’s an explanation of the strategy:
http://www.dfaca.com/strategies/income.html
An interesting topic for a post might be a comparison between DFA’s returns and traditional indexes (and, perhaps given their “core” and “vector” split, a comparison to enhanced-alpha style Fama-French and/or fundamentally weighted portfolios). Just from a cursory glance at their website, it doesn’t look like they’re outperforming in many cases, even before taking into account the extra 1.0% of fees.
@Philippe V. Inflation is the worst ennemy to long term bonds. I like to keep the ave maturity within 5-6 years, the exception being RRBs for the very low coorelation with equities (but a small allocation).
Fair point Dan.
Avoiding longer term maturities reminds me a little bit of another discussion you had on your blog. You tried to be a peacemaker with dividend investors and (whole-market) index investors (https://canadiancouchpotato.com/2012/03/19/when-buy-what-you-know-makes-sense/). My conclusion of your post was that if an investor is comfortable with potentially lower returns but sleeps better at night then that is what’s best for him/her.
DFA adjusts their allocation based on the yield curve, but they purposefully avoid long term government bonds (very safe) that usually yield more than short term bonds. That’s why the strategy reminds me a little bit of you blog, buy what you know, even though DFA have rationalised it through math and risk adjusted return equations and having most of the volatility on the equity side.
@Eric, thanks for your comment. Actually to be clear, right now in my portfolio my maturity on the fixed income side does not exceed 5 years. Just like DFA it seems.
But I can not help but wonder if my avoidance of long term government bonds is not my assumption of a forecast on inflation? Maybe I just sleep better at night not owning low yielding (in my opinion) long term government bonds (20 years+). But I try to be mindful that in the future maybe the yield curve will send short term rates even lower and long term rates higher, who knows? Long term government bonds are great protection in a portfolio and they usually yield a bit more than short term bonds. So I challenge myself, why not buy some? I canot right now though :)
This is why I originally asked Dan these questions on why DFA avoided long term maturities. Anyway, my answer is getting long and I do not want to belabour the point so I’ll stop here.
Its really too bad that the Dimensional funds are not available without an advisor. I know of several situations (such as a relatives RSP which is a bit of a mess) that would be perfect for the balanced fund discussed here. Longer term accounts such as RESPs, TFSAs and RSPs are sometimes balanced fund “set and forget” affairs with the only changes being annual contributions. Dimensional is missing out on this market because their policy means the advisor fee will be a significant drag on compound returns over decades long periods.
Also what is the value proposition from the advisor for 40 basis point drag (assuming thats it) over 20 years when they are just advising the initial conditions and perhaps taking a phone call when markets drop 10% or more?
A better model would be a flat hourly fee for the initial consultation to get into the right fund. After reading up on these funds I would definitely consider them for certain situations but this advisor fee will keep me away.
Hi everyone – I just wanted to clarify that the DFA Investment Grade Fixed Income Fund does in fact invest in longer term bonds – as of December 31, 2011, approximately 25% of the fund was invested in long term Canadian federal and provincial government bonds. The majority of DFA’s corporate bond holdings are short term – this is most likely intentional, as short term corporate bonds have historically resulted in both higher returns and higher risk-adjusted returns in a portfolio (relative to short term government bonds). By combining the DFA Investment Grade Fixed Income Fund with the DFA Five-Year Global Fixed Income Fund, you’re looking at an average maturity of about 5.2 years (compared to iShares DEX Short Term Bond Index Fund, with an average term of 2.8 years).
Just wondering, is there a short term global fixed income ETF that you would recommend? Is there reason to look outside Canadian bonds in the couch potato context?
@Phil: Unfortunately there is no global fixed income ETF listed in Canada. There are a couple of US-listed ETFs, but these would exposure you to currency risk, which you do not want on the fixed income side of a portfolio:
https://canadiancouchpotato.com/2012/03/01/ask-the-spud-should-i-hold-us-bonds/
Thanks for the input:)
I didn’t see this elsewhere so I compared the ‘packaged’ fees to the fees of the underlying funds. Based on the maximum fees that DFA has in its current prospectus (which will be updated soon), there isn’t much of a premium being charged for the fund of funds packaging (14 basis points for F series; 11 basis points for A series). Those shouldn’t drift much higher once the fund’s MER caps are lifted. That said, there are some very competitively priced and popular actively managed balanced funds that pay financial advisors pretty standard commissions. So, this is another example of where the passive alternative doesn’t have an obvious material cost advantage.
While DFA is unlikely to open up to DIY investors (let alone non-disciples), they have compromised on their practices before. If memory serves, in the U.S. they don’t pay commissions of any sort. But given the nature of the Canadian market, they launched funds paying trailing commissions out of the gate in Canada. And they’ve launched a lot more products than I would have initially expected them too – i.e. their line up is getting crowded – given their so called passive approach. So there is always hope but I suspect opening up to DIY crowd is one stance that won’t be compromised.
@Dan H: I agree that there are a (small) number of actively managed balanced funds that offer broad diversification at quite low cost, and in the hands of a disciplined DIY investor or responsible advisor, I’m sure they are very good choices, too. Mawer’s balanced fund comes to mind. Beutel Goodman, Leith Wheeler, McLean Budden, and PH&N are all probably competitive here as well.
I suspect the main issues here (and DFA advisors are certainly not immune) is whether an advisor will be able to retain a client with just a single balanced fund. Any of the funds we’ve mentioned are extremely well diversified and would probably be just fine as a single holding for almost anyone, assuming a 60% equity allocation was appropriate. Yet I’m sure that clients would start pushing back at the advisor and asking, “What do I need you for if you’re just going to put me in one fund and leave it alone?”
This goes back to something Andrew said above about the role of an advisor. I think a good advisor needs to be able to make a value proposition that goes way beyond “I can pick good funds for you.” It’s all of the other things that add value: risk management, financial planning, tax management, goal setting, controlling bad behavior, etc.
It’s unfortunate that Canadians don’t have access to l0w-fee DFA advisors with sites similar to assetbuilder.com in US. The cheapest DFA advisor I’ve found in Canada charges 0.6%, and thats for assets over 500k…
What would be a reasonable cost to have access to a DFA balanced fund? If the total MER, including the advisor fee, was around 1-1.1% , I believe this fund would be a serious competitor to the active balanced funds like Mawer’s and PH&N.
I would prefer to pay a a very low management fee to the advisor and then pay a hourly rate for consultations and meetings…
Hi Dan
I started reading Moneysense a few years ago, and questioning our CFP about all our mutual funds and their fees after reading about your indexing strategy. Conveniently, we moved and she retired, so we found a CA,CFP who also believes in indexing and is a DFA advisor. We are in the process of breaking down all our mutual funds (trailer fees) and transferring them into mostly the DFA Global Fund. The MER we are being charged is 1.5% for the DFA fund, a far cry from the 2.5% of the mutual funds.
As I have started to take baby steps, opened up an account through RBC Direct and have a few thousand in the Basic Couch Potato, using TD e-series funds. I am now wondering whether I should start to manage our annual RRSP contributions, and keep the DFA fund with the advisor or to eventual manage it all on my own. We have about $200,000 with the advisor, so wonder if we could ask for more discounted MERs.
I have read lots of good things about DFA funds, so wonder if the fee is worth it.
@OK: Thanks for the comment. I doubt you will be able to negotiate a lower advisory free at $200K. The real question is whether you feel the advisor is adding value for you in terms of planning and other services, not just investment management. The DFA fund is excellent, but it’s not worth hiring an advisor just to get access to it.
One quibble: you mention you are using the TD e-Series funds through RBC Direct, but this is not possible. The e-Series funds are available only through TD, so if you use RBC Direct you must have the I-Series funds, which are quite a bit more expensive. May want to check that out.
https://canadiancouchpotato.com/recommended-index-funds/
Hi Dan
After looking up our accounts, you are very correct in that the funds we have are the TD Index-I-series. I have only started to do some initial investing to see how it would work. I am working up my confidence to pull the plug on the advisor and do it myself.
I honestly feel that we the public have been “sold down the river” by the whole financial industry, who have a huge conflict of interest in commissions, in the transparency with their fees and how it erodes your portfolio over time. We thought we were doing everything right, maxing out RRSP and starting up an RESP, but it wasn’t until I started reading your articles in Moneysense that I questioned the fees. Guess it is better to come late to the party than not at all.
After reading this piece and doing research I just went with DFA through an advisor. My fees are about 1.3%. I like the DFA approach, my access is now through TD Waterhouse and I have confidence in my advisor so I am happy. I will give it a year and if will move into the TD e-series funds as directed through this site.
Thanks for all the articles and good advice.
Just re-read this old thread. Wondering if Dan could do a current analysis of a dfa portfolio vs DIY. Also does anyone know how to get cheaper access to dfa funds ie advisor fee below 1% ?
Thanks
I concur with Edgegoat. I was with DFA for a year but moved to TD Waterhouse’s Strategic Managed Portfolio in November 2013. The TD program is similar to DFA in that you pay a .6% MER and a .9% advisor fee. The advisor fee brings nothing to me so I am considering going to ETF’s either through PWL Capital’s DIY Investor Service or through Purpose Investments. I would like to reduce my costs-especially when I am paying fees for suspect or useless advice.
@Marko and Edgegoat: I don’t think anyone would argue that it’s worth paying an advisor for “suspect or useless advice,” no matter what the fee. If the only thing you value is investment products, I don’t think it makes much sense to work with a DFA advisor instead of doing it yourself with ETFs. The only reason to work with an advisor (DFA or otherwise) is because you feel you’re getting useful advice. On accounts over $1 million it’s possible to get this for less than 1%. Below that account size, I doubt it.
For the record, PWL Capital’s managed account service uses a combination of DFA funds and ETFs:
https://www.pwlcapital.com/pwl/media/pwl-media/PDF-files/Toronto%20-%20Model%20Portfolios/2013-12-31-PWL-Model-Portfolios.pdf
Thanks Dan. That gives me a good baseline to compare to. In the pwl portfolios there seems to be a 2/3 weighting towards the dfa vector equity funds and 1/3 total market. Are those value/small cap funds and is this also the reason there is a focus on short term bonds in the fixed become portion ( ie go more aggressive on equities and go short on bonds to reduce volatility) ?
Mario – thanks for your reply. For the .9% fee you are better off with a dfa advisor like pwl folks. At least they will do a good financial plan for you and take care of rebalancing
Thanks Dan. I had a conversation with Justin at PWL prior to moving to TD Waterhouse. I liked him and his approach so I think I will call him next week. My problem is that the TDW rep here locally over-promises and under-delivers. I have made $39K since moving to TDW in Nov 2013 so I now have $735K with them. That puts me in the .9% fee bracket with of TD’s Strategic Managed Portfolio.
Thanks to Edgegoat as well.
@Edgecoat: Yes, the DFA funds are in there for the small/value tilt and the ETFs are there to reduce the overall cost of the portfolio (compared with using all DFA funds). And, yes, the short-term bonds are there to keep fixed-income volatility to a minimum. They are not a tactical play because “interest rates have nowhere to go but up.”
@Marko: How’s your experience with TD Waterhouse’s Strategic Managed Portfolio as my advisor advising me to invest on that portfolio?
@Marko: What kind of TD Waterhouse’s Strategic Managed Portfolio you invested? Balanced Income, Balanced-Retirement, Conversative Income, etc?
I know I’m digging up an old post here, but I’m curious what the rules are around DFA funds if one leaves their financial advisor. Must they be sold immediately? Or can they be held or sold in an account without an advisor?
@Bryan: I am not aware of any online brokerages that allow do-it-yourself investors to hold DFA funds.