The Dimensional Approach Part One
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Welcome to the jail on money show. It's saturday, november twenty third, and we are here trying to help guide you through your financial journey. And I know so many of you have investment questions.

A lot of you are wondering whether or not it's worthy to have an adviser who is picking mutual funds for you or etf for you. Will we have a great guest who is eye opening for the weekend and her name is marlin lee SHE is the global head of investment solutions at dimensional fund advisors. And without going IT to too much of her bio is so oppressive.

MOlina earned A P. H. D. And finance and in MBA from the chicago booth school of business. And instead of going into academia, SHE joined dimensional because SHE became enthrall with their system matic approach to investing.

And I too really admire the folks of dimensional because I agree with their basic crimes that passive investing works, but their twist on IT is quite interesting. So I hope you enjoy our interview today and tomorrow with marlin. Leave from dimensions.

Here we go. melina. A lot of the people who listen to us work through um and adviser, but a lot of people do not. And so I think many people do not really understand what is dimensional. They may have seen a couple of ads here and there. And I just would love IT if you could give a little bit of a background about dimension and how this group of investments funds, how what sort of came to be and what IT represents today.

Yeah, absolutely. So how much time do you have? Because this can be a long history.

hours. Let go. Okay, on the clock.

three. So yes, dimensional um we are an asset manager, so we manage money for for individuals and clients. Um and the way we do IT is, I would say, different from a lot of other managers out there.

And when you think about the different kinds of approaches to there's lots of approaches which are really based on a managers having an ability to predict the future or are Crystal ball to tell them which stocks to invest in. And we would call that traditional active management, whether trying to pick socks or time markets. So that's one bucket.

There is another bucket which folks are probably also really familiar with, which is you don't do any of that and you just hold a really broadly diversified basket like market portfolio, and that's more than index approach. Um dimensional founders. And we've we've been around for over four, forty years.

They were actually involved with some of the very first index ones. And um here there's there's a lot of advantages to having an index approach in. The many of them are very low cost.

They're very well diversified, generally low turn mover. Um and also we know that the active stuff doesn't work. So they were involved with these index funds and what they saw was that a lot of their clients um were only invested in large caps.

So they had the kind of saw business opportunity and they wanted to bring that indexing type approach into small caps so that their clients could get diversification. Um but also very early on, they realized, ed, that a very rigid index approach wouldn't work in small caps mostly because there you don't have as much liquidity, just small caps don't trade as much as large caps still. So because of that, people kind of told them, if you have this really rigid index approach, which most index funds do, right, they basically try to track and index.

And they have to trade when S. M. P. Or Russell tells them to trade. And if they tried to trade like that in small caps, that they would be killed in trading.

So very, at the very start, we had the ideas of a lot of the benefits of indexing. But that rigidity of an index leaves money on the table. So we ask .

the small caps or some other area. They first started with small caps, but then to other areas as well. And there is any thinly trade like weirdo emerging market somewhere is not going to be able you're not going to be able to really pull off indexing in a more thinly traded market. Is that the kind of the general thesis I would say.

in any segment of the market, being forced to trade and having everyone know that you are being forced to trade has cost associated with IT. Um I can give A A A quick example. We did um a study where last year, people might be familiar with the mag seven here in the U S.

Those are seven very large tech companies and that have done very well recently. So NVIDIA matter. You know, those types of socks.

And last year, um one of these big induces the not that one hundred had to do a special rebaLance because these seven names were were so big in the index that they had to trim IT. And so what happens when an index trims the way as they they basically announced, here's what's going to happen. We're going to take weight from these seven.

We're gonna scatter IT across the rest, and we're going to do so in a week time. So that's very often how an index will kind of tell everyone here's what's happening and they give them a little bit time. Um what we found is that for that case and these these are like mega caps, they're very well known, their super liquid. But if you had rebaLanced that type of portfolio when they first announced the rebaLance versus when the index actually rebaLanced, you would have had about forty basis point to point four percent higher returns, just term rebalancing a little bit early and not when every single other manager whose tracking this index would have .

needed to rebaLance. So so basically you said, like, okay, wait second, just just do IT on the announcement like you don't do IT in advance of the the announcement, right.

right? Well, you would have .

to guess right to guess you guys.

Well, we don't even bother tracking in index. So that's just an example of it's a cost that you would expect anywhere because think about what has to happen. There's lots of people who now we know what they're going to have to trade at the time of the rebaLance. And there is a whole bunch of six, seven that's going to be sold and every other name is going to be bought. So all of those assets have to do that at a single point in time.

The rebaLance here and the market needs to prepare itself, right? So there is going to be a bunch of, let's to say, hedge funds or other types of managers who who are going to a look forward and say, hey, all these names are gonna need to be bought in five days so let's buy IT today and then we'll sell IT to these people, these index fund tracking ers in five days. They're happy to do that.

It's a service to provide liquidity so that as its can track and dies. But people who are doing this, they expect to get paid. And here's the here's the chAllenge of seeing this for a lot of investors is the return comes right out of the index return.

So it's not like an expense ratio or you can buy a in index fine for single digit basis points in terms of the expense ratio, right? But the cost that we're talking about here, trading costs, you never see IT IT doesn't it's not captured in the expense ratio. IT comes straight out of the index return.

That's interesting. I didn't realize that, of course, that makes so much sense because they don't want .

to have a separate line item. Well, yeah, it's not really a line item that that IT takes. A lot of did and research worked to identify how much these costs can be.

But basically, what happens is flutists think about something that added to a very well widely track index. What happens is as people know it's going to be added, people start to buy IT. It's Price often starts to go up before IT gets added to the index.

And then once IT added, sometimes there's a bit of a Price reversal as well and that means that the index had to buy IT at the highest Price, which is not where you want to buy things, right? It's called the reconstitution effect and IT is something that um you know dimensional tries to and it's it's very much in our DNA of were not index tracking ers. And well, we have a lot of the benefits of we d like very broad diversification. Um we try to be very competitive on cost, but we also try to um add flexibility into the process so that we're not being forced to trade at Prices that we think with disadvantage our .

investors. okay. So I wanted buy a dimensional large cap fund and i'm going to buy something that kind makes I all IT that it's gonna place or be a part of my large capos tions gonna. Maybe look like a broad market index, the S M P five hundred, right? Generally speaking, you have a large cap index.

How much does this differ from the index against that, that I might be replacing IT for? Like if I say hate my broker, my broker boy, my old if I said to my adviser, hey um I wanted buy dimensional funds. You don't have this level blend with legers pretend and but I have very I have this S M P five hundred fund.

I've only to forever. I've got low cost basis. But you know what? I'm going to take IT. I'm going to take the hit and i'm going to now move into the dimensional large cap und.

How similar is are the is the perform? Has the performance been or different? Has the performance been of those two types of assets?

yes. So we do well. We do have funds that look very similar to like an asp five hundred. I would say we we also have lots of other types of funds. So IT really depends on how much people are willing to look different from an index where we have some that look very, very different um and why they look different is first because we're not trying to mimic the the index for the vast majority of our strategies.

But even if we just take that away from large caps um because I would say if anyone's thinking about, like what is the fund at dimensional， I would say it's actually our core portfolios. Um so those are market wide, meaning they hold all of those marriage caps, but then they also hold mid caps, small caps microcap um and think they are much more broad market. And um we're talking about, for example, in the us, thousands of names like almost three thousand.

And how that would look different is that will focus on socks with higher expected returns. And this is not bashed on you know our our portfolio managers got on which ones are going out perform in the future. Nothing at dimensional is um is first person specific.

It's all based on academic research that um has really stood the test of time. So this is research that's been done on you decades and decades of data that we see patterns and returns all over the world and we use that to basically to help the portfolio. Small caps to value stocks and stocks with .

higher profitability. Now when I look at small cap value, high profitability, basically your core portfolios, um I get I think that like one of the things that jumps out is well, how they done in the last you know, five years. Small cap value, high profitability is seems like the small cap in the value would make me feel like, oh no, I wish I on the S M.

P, five hundred high profitability, I guess, would make me sort of line up this. So how does this thing move on a generalized basis? You're trying to find the best names, but what's the time horizon that i've to hold this for your research to be proven right?

Yeah that such a great point where pretty much in the last fifteen years or so, everything is on form. That S M P five, right. So global diversification hasn't worked or IT has not global diversification has not helped anyone who otherwise would have just held the S M P five hundred.

Um so a big chunk of that has to do with those mag seven that we talked about earlier. They've just done really well in the last fifteen years. Um if you go just the ten years before, sometimes we call that period the lost decade where you saw the exact flit scenario we are actually the S M P five hundred under performed pretty much every single other segment of global markets.

So the time period, the way I like to think of let just start with, with the equity return. So what's the return that you should get from stocks over a safe asset like treasury bells? And for that, we know that there's there's lots of volatility in this return, right? It's very volatile.

It's very noisy. But I would argue every single day, investor should expect stock returns to outperform tables, so should always expect a positive bi premium. why? It's because who on earth would invest in stocks if they weren't being compensated for taking on that extra volatility.

So even though we know that it's not going to be positive every day, that we should at least expect them to be like. And this is a concept I like to just use like this. Just use vegas as an example.

We kind of know every day or every single bet the house is expected to win. yes. But on any you know there there's a lot of variation in that. So some some bets are successful, some but are not um but over time, we expect the house to start to win. And right if you were gambling for for years or an infinite period, the house is definitely gona win.

right?

It's kind of the same way. But but where for equity returns, we expect every single day there to be a positive return. We also know that it's very variable.

So sunday might be negative, some days is might be positive. But the longer you give me, the more likely I am to have a positive experience. The investor is basically the house. In this this analogy.

I A lot of people and walk into this universe of investing, right? And they feel like, how am I gonna an advantage? Like, I don't have any advantage. Like, well, all the big guys, all the institutions, they have the advantage. But IT, essentially what you're saying is every investor, given the right time horizon, should have an advantage, right?

Yes, absolutely. As long as they are being smart about IT. So you've got to give me a career.

I got ta be smart. Are you crazy? Come on. okay.

So i'll go back to the premium stuff. But but I want na pick on this thread a little bit. Jail what we know because you you can talk about who has the advantage.

And there has been tons of research on this. But also you just see IT in different reports. We put together one, the S M P. Puts together one called speak a, where what we see is that the managers that you just mention, the institutional managers, the first professional money managers, you would expect them to have an edge, but they don't.

So for example, if we just look at all of the managers um that ran ran mutual funds or etf over the last twenty years, only seventeen percent managed to survive an outperform, a passive benchmark. So what does that tell us isn't this is where investors need to be smart of active management or traditional active management. Stock picking market timing IT doesn't work.

It's not what puts the industry you know, at the highest probability of success. I think that this is part of why so much money has flock to index funds is because by in investing in an index fd, they would have done Better than the majority of traditional active. The rub there, of course, is what we were just talking about earlier, joe, is that you can still do Better than that mostly by getting rid of some of the dumb decisions they make that leave money on the table.

They're buying at generally at the highest Price um and vice first are selling at the low. So those would be, I would say earlier, who has the advantage is definitely not a professional money manager. Institutional client investors can have the advantage if they don't play that game, and they can really have the advantages if if they also fine. An approach that's more like dimensional, where you also aren't leaving money on the table and index. I have a quick question for you.

Yeah, now that dimensional approaches to go back a little bit, that is based on the the data and systems that were built by, I don't know, David booz company, right? And that he's a fan, one of the founders and and so how is how we have those models change since in over the last forty years, like what like the thesis was a smart one, but what has shifted now from like the initial way of building the dimensional approach?

Yeah, so there's, I would say, the initial way. So way, way, way back when we are unfounded, like one thousand nine hundred eighty one, we were focused our very first fund was focused on smoke APP, as I mentioned. And back then, IT happened to coincide with some research that said small caps outperformed large caps um but that actually I wouldn't say was the main thesis.

The main thesis was you should hold the entire market and get diversification. So and and that you don't need to a Crystal ball to get there um and that you have to pay attention to cost as you trade. I would say that those are the three that were core to dimensional that we bring forward today, right? That you don't have to pick stocks, that you want diversification and you want to pay attention and costs.

Those are the three so easy when you say it's razer very hard .

to execute well. You know making sure that you're minimizing costs um everyday is is there's a lot of things that you have to pay attention to, a lot of didn't systems that you need to do IT across the thousands of socks that we do in markets all around the world. So what has changed is, is that early research in the in the small cap space has, uh, we kind of what we did some research here at to show that that's not just the U S.

phenomenon. That's actually quite robust in markets all around the world um and then we've added to IT. So over time, we followed the academic research, which has shown their additional variables that help us identify which socks have higher returns.

So yes, it's small cap that was already there, but over time, we've added value, we've added high profitability. And then there are a bunch of other things too, but I would say that those are the three main ones. Um we're also paying attention to things like momentum, things like securities lending. So there there's there's been additional research through the decades, which say here are more variables that help you to get a picture of expected or returns across the market because IT doesn't make sense for to have the same expect or return.

If you have a question about your own investing, about your own planning, about anything going on in your financial life, please get in touch with us. Good to drill on money that com, collect the contact us button and of course, check that box if you'd like to join us on the air. Don't forget, design for the free weekly newsletter comes out every friday you can, subsequent to jail on money, on the auto sa APP, or wherever you find your favorite podcast, don't forget to please leave us a rating and review wherever you listen, and of course, lift someone up, change your work, change your wealth, change your life. Thank you for listening, and we will talk you tomorrow.

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