At a recent Dimensional Fund Advisors conference at the University of Chicago's Gleacher Center, advisors stood in line to get their pictures taken under lettering high on a wall that read Nobel Laureates. Except for self-serving claims of intellectual superiority and cavalier disparagement of active management, there's never been anything jazzy about the way DFA goes about selling its passively managed mutual funds. You should use DFA, advisors are usually told, because it is the only correct way to invest.
But now, for maybe the first time in its history, DFA is using another pitch to sell advisors on the DFA family of funds: higher profits. A new white paper by consulting firm CEG Worldwide LLC basically concludes that DFA advisors net higher incomes, on average, than other advisors.
It found, for example, that 56.8% of DFA-affiliated advisors earn at least $150,000 annually, compared with 15.7% for the broader community of independent financial advisors.
The paper, commissioned by DFA, cites several possible reasons for the higher rate of success. The lower overhead of passive investment management is one explanation, the paper says. But it also suggests that DFA advisors use a more focused business strategy that tends to attract more affluent clients. The diversification offered by DFA's funds, particularly the success of its international and emerging market funds, have also helped attract wealthy clients, the paper says.
Advisors relying primarily on DFA have higher minimum accounts than the average advisor and tend to be small firms. They also service a higher percentage of retirees and professionals than the average, the white paper states.
The paper found that 67.7% of surveyed DFA advisors require minimum accounts of at least $250,000. Non-DFA advisors, meanwhile, have a typical account minimum of $190,000, the paper says.
"They're focusing on the right clients," says CEG Worldwide founder and President John Bowen, who co-authored the paper with Russ Alan Prince. The paper was based on interviews in May of 229 financial advisors who use DFA funds.
Bowen, a former DFA-affiliated advisor himself, adds, "So often advisors try to be all things to everyone. DFA advisors have substantially less clients, but make a lot more money."
Among the other results of the survey:
Among high-income DFA advisors, 34.3% have account minimums of at least $1 million, compared with 9.2% of moderate-income DFA advisors.
Tax-managed mutual funds are popular with DFA advisors, with 89.4% using them to some extent
and 55.8% saying they plan to use them more.
Exchange traded funds are also used by 65.5% of advisors. Individual bonds are used by 64.4%, individual stocks by 47.8% and separately managed accounts by 31.3%.
Of DFA advisors surveyed, 48.4% have one partner and 45% employ no more than two people. One third of those surveyed serve 49 or fewer clients.
The majority of DFA advisors, 91.2%, charge clients a 1% annual fee on accounts up to $1 million, as opposed to a flat fee.
Reflecting the rising phenomenon of multiple custodians, Charles Schwab is the most popular custodian among DFA advisors, with 79% using the company. TD Waterhouse is used by 28.8%, Vanguard by 19.2% and Fidelity by 18.3%.
Those familiar with DFA note that the white paper breaks new ground for the company. A maverick in the mutual fund company community, DFA's investing philosophy is grounded squarely in research conducted by scholars at the University of Chicago Graduate School of Business.
Instead of concentrating on glitz, the company's marketing pitch has always centered on the argument that the market is efficient and that actively managed funds have no hope of beating it. DFA essentially presents its funds as building blocks for a diversified portfolio designed to capture the market, and no more.
DFA's philosophical bent, in fact, sometimes takes on the characteristics of a crusade, with DFA officials often ridiculing active management and proponents of market timing, stock analysis and market forecasting. In one infamous speech, DFA Co-Chairman Rex Sinquefield likened the market and stock forecasting in some magazines to "investment pornography."
The white paper appears to be the first time, observers say, that DFA is making the argument that DFA funds are good because, essentially, advisors can make a lot of money using them. While this new tact may bring new advisors into the fold, it apparently has rubbed some people the wrong way.
One advisor who is a longtime user of DFA funds and ardent supporter of the company's investment philosophy, expresses reservations. Speaking privately, he says he's concerned that the white paper takes the focus away from doing what's best for clients and puts it on what it takes to earn more income. "This is something you would expect from Merrill Lynch, not DFA," he says.
Although the white paper generally casts a favorable light on DFA advisors, a few results did raise some eyebrows even among DFA officials. The white paper found, for instance, that 14.9% of DFA advisors use hedge funds, and 23.1% expect to make more use of them. The results were similar when it came to advisors' use of separate accounts.
Those results are somewhat surprising, considering DFA makes an effort to ensure that advisors use DFA as the core holdings in their portfolio strategies, if not the sole holdings. Dan Wheeler, director of DFA's Financial Advisor Services, acknowledges some surprise at the percentage of DFA advisors expressing interest in hedge funds.
But he says that's natural considering all the "sizzle" associated with the hedge fund market nowadays. More importantly, he says, is the fact that DFA advisors have 60% of their assets under management in DFA funds.
The white paper also found that 60% of DFA advisors actively manage less than 20% of their stock investments. Of advisors surveyed, 32.4% say they have no actively managed investments at all.
"This was more of a confirmation that we're on the right course," says Wheeler. "It reinforced to us what we felt in our gut. We now have data to show our business model is working and our advisors are pretty much on board."
One reason DFA has been able to keep its philosophy intact is because the base of its advisor community is comprised of small firms as intent on controlling expenses as DFA is on controlling management fees. "The challenge there is we will come across, say, a large accounting firm where there is no way they are going to stand up and say we are only going to do passive," Wheeler says. "We honestly see (small firms) as the future of the business. The relations the client has with the advisor, that's really the core of the business."
As for concerns that DFA is letting profits overshadow ideals, Wheeler disputes this, saying the company hopes the white paper will only serve as a benchmark for success among its advisors. "We've always taken the position that if you do what's right for the client, the numbers will take care of themselves," he says.
Advisors who have had success using DFA funds seem to agree.
Jeffrey Troutner, president and owner of TAM Asset Management Inc. in Tiburon, Calif., says his typical client has about 80% of assets invested in DFA funds. Like many other DFA advisors, Troutner says, he reverted to DFA funds after watching his investors see their investments get killed in actively managed products.
"It's hard to answer without sounding arrogant or superior to others, but basically most of us have come from the active side," he says. "At some point, we decided it made sense to adopt a strategy that put success more in a client's favor."
The higher incomes cited in the white paper are partly due to the lower expenses associated with running a shop centered on passive investing, says Stuart Zimmerman, principal of Buckingham Asset Management in St. Louis. "You don't have to spend your time trying to find winners out there-who the great managers are," he says. "We can devote our time to clients."
Troutner agrees, saying, "We don't have research people, don't have portfolio management people ... In my practice, my biggest role-and I tell clients this-is to manage their expectations."
Despite the bear market, Buckingham, along with its subsidiary BAM Advisor Services, constitutes DFA's second largest advisor firm, with $1.7 billion under management. Zimmerman estimates the firm's typical client is about 70% to 80% invested in DFA funds.
With the turbulent performance of the market the past two years, the firm is finding that clients are more receptive to what DFA is preaching-risk management and diversification, says Mont Levy, another Buckingham principal. "The evidence we've seen in this bear market is these portfolios have seen minimal to no damage over the last two and a half years," Levy says. "Our business is actually booming during this period."