An Overview of Dimensional Fund Advisors' Strategy

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This case discusses the strategy of Dimensional Fund Advisors (DFA) whose investment philosophy particularly focused on research by Fama and French and Banz. They researched how small cap companies tend to outperform large cap companies over time. FDA also created an additional competitive advantage by created trading efficiencies to reduce transaction cost. a). Fama and French found that stocks with high betas did not have consistently higher returns than low-beta stocks and that a high book value to market value was the most important variable related to predicting high stock returns on small cap stocks. b) DFA's business strategy centers on the core concept that markets are "efficient" and they combined solid academic research with the abilities of skilled traders to produce superior returns. DFA's Small Cap objective is to deliver the size effect (research has indicated that small companies provide higher expected returns than larger companies in the long term) and provide the diversification benefits of investing in small companies worldwide. Dimensional defines small companies as those whose market capitalization comprises the smallest 12.5% of the total market universe. Dimensional's followed the Fama/French research in multifactor portfolios designed to capture the return premiums associated with high book-to-market (BtM) ratios. They relied on academic research versus a technical or fundamental driven strategy. They also focused on maintaining low transaction costs. Since their core strategy was focused on small cap (illiquid) issues, DFA would simply absorb the selling demand of others instead of bidding for stock in the open market. c) DFA's trading strategy tried to reduce transaction costs by establishing a protocol for buying small caps in large blocks which eliminated the seller's risk of price volatility. To reduce the adverse

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