One Vanguard, Many DFAs (Part 2)

The mutual fund industry’s two indexing leaders have left different legacies.

John Rekenthaler 26 May, 2016 | 11:00
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In part 1 of this article, we looked at the “broad” and “narrow” approach that Vanguard and DFA took. In part 2 of this article, we will explore the business logic of these two indexing leaders.

DFA did not--and has not--used the language of strategic beta to describe its approach, but that is what it does. In DFA's words, academic research has identified “dimensions of higher expected returns in the global capital markets. Portfolios can be structured around those dimensions, which are sensible, backed by data, and cost-effective to capture.” Whether these additional returns from exposure to these factors (or betas) are fully paid by the price of additional risk is unclear. The main point is that DFA--as with fund companies that talk about the intelligence of their betas--promises that, by neglecting portions of the marketplace, its funds will outperform the naive, broad indexing strategy.

For Vanguard, this notion sounds suspiciously like those espoused by active managers. Strategic-beta investors think they can identify a pool of higher-returning stocks. So do active managers. Strategic-beta investors also believe that, no matter how cheaply a broad-index fund is priced, they can outgain that fund by applying insight. So, too, do active managers.

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John Rekenthaler  is vice president of research for Morningstar.

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