23 Jun Evidence based investing: You’re never too smart to learn
“Unless you try to do something beyond what you have already mastered, you will never grow.”
Ralph Waldo Emerson
We are NOT passive investors
People often assume that our investment philosophy is a ‘passive’ one investing solely in index funds as we don’t employ actively managed funds within our client portfolios, or attempt to time the markets.
Index funds have – quite deservedly in our opinion – experienced a huge surge in popularity in the last few years and whilst there are a few of them which we do use within our portfolios, there are some issues with investing solely in pure index-tracking funds. Our investment philosophy is therefore based on a more academic and evidence-based approach.
We have been investing our clients’ money in Dimensional Fund Advisors’ (DFA’s) pure asset class funds ever since they became available in the UK in March 2004. These funds are only available to firms offering a comprehensive financial planning service alongside their investment management proposition, and there is a very clear and important distinction between their approach and that of pure index tracking.
It’s passive investing, Jim, but not as we know it
DFA’s aim since it was founded in 1981 has been one of applying academic research to practical investing. The bedrock of their investment philosophy is the 3-factor model created by Eugene Fama and Ken French (and subsequently expanded to four, and now five factors). Eugene Fama was awarded the Nobel Prize for Economics in 2013 for his contribution to modern portfolio theory and developing the efficient markets hypothesis and he has been a board member of DFA since its inception.
With that kind of heavyweight academic research behind it, DFA could perhaps be forgiven for simply managing the c. $500 billion of client money that it currently looks after using those original principles. However, this is where DFA differs from so many other fund managers.
Never stop learning, because life never stops teaching
DFA was founded on academic principles and employs many academics amongst its ranks. As such, it is a unique blend of individuals working to combine high-level science-based research with highly skilled ‘technicians’ who implement the strategy determined by the research. This means that those people are never going to be content to sit on their laurels but instead will continue to research how markets work and to try and identify persistent differences in the expected returns of those markets which they can then exploit within their funds.
When you have academics of this calibre within your ranks – one of whom is a former rocket scientist for example – the research they carry out is going to involve complex calculations, and if – like me – you regularly attend their conferences, you know at some point you are going to be presented with something like this:
Using the Valuation Equation
Data source: Dimensional R = Discount Rate
(In this instance the function of the equation is to provide guidance on how to identify differences in expected returns based on stock valuations).
Focus on the best outcomes for the client
The important message here is that, in the 35 years DFA have been in business it has continued to translate highly complex financial research into real world investment solutions to help investors to pursue and achieve their financial goals. Their approach to investing is very different from the standard ‘buy and track the index’ approach followed by the mainstream passive investing market, yet also a million miles away from that of active managers.
We believe that this evidence-based and academic approach to investing, coupled with the context provided by a robust financial plan, offers our clients the best chance of delivering successful financial outcomes. If you would like to learn more about this approach to managing family wealth, please download our Guide to Investing, or get in touch with us.
“Research is creating new knowledge.”