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Identify the sources of value DFA is providing its investors DFA creates different value to its customers. For Registered Investment Advisor, the value was the educative access to top researchers who were developing innovative theories and empirical analyses. For high-net-worth individuals, it is low management fee as the services are provided through RIA. For other investors, the value is high performance of portfolio it manages. The sources of values DFA managed to create come from: – Close relationship with prominent academics, who also have stake in DFA. The academic research has played crucial role in the performance of DFA’s investment portfolio and brought substantial return to its customers over a long period of time. – Reputation of the DFA in small cap market help the firm reduce transaction cost, pick and choose the right stock to invest, contributing to positive return for its customers.
8. What are some of the trading costs associated with small, value stocks? How does DFA manage these potential trading frictions? Given the fact that small and value stocks have lower liquidity compared to large and growth stock, transaction of small and value stock is more difficult. There are some trading costs associated with them: – When investment fund wants to buy small and value stocks in open market, their price will go up very quickly. This increase in price will negatively affect the next purchase of the same stock of the investment fund. DFA instead of going to the market and bid for stock, it absorbs the selling demand from the others. By taking a large part of stock, it can even obtain a discount on the stock purchase. – Once the investment fund owns an amount of a certain stock, the future sales of stock to the market may pose some pressure on the price of stock. DFA when buying stock from seller would try to make sure that it take the whole position of the seller so that it avoids the scenario when the seller sells the other part to the market and the price of stock goes down immediately after DFA buys it. – Same applied when the fund tries to sell its stock. If investment fund sells a large block of stock, the price of stock will be pushed down.
To avoid this transaction cost DFA normally offers small amounts of stock to the market each day. It takes more time to sell out but the price of stock will be maintained. 12. Likewise, throughout the 1990s, growth stocks outperformed value stocks. Hence, should DFA reconsider its current strategy? What if growth continues to outperform value over the next five years. Would your answer change? Again, how would you explain the poor performance of the fund to your clients? Although the growth stock outperformed value stocks in 1990s thanks to the high-tech boom, DFA should not reconsider its current strategy because of the following reasons: -Looking at a long period of time (from 1926 to 2004), despite some up and down, value stock still outperform growth stock (Tim’s calculation) -DFA’s philosophy of investment has been based upon market efficient.
And according to market efficient theories, the higher return of growth stock given the lower level of risk compared to value stock will go away as people start to chase growth stock. Switching to growth stock will not help DFA to make sustainable return. Even though the growth stock continues to outperform for the next five years, our answer would not change. The growth stock cannot outperform the value stock for too long because it has lower level of risk. Value stock will soon bounce back in terms of return soon. 14. What future strategies would you recommend DFA pursue? Make a specific recommendation, and justify it. Should they abandon/modify/maintain their current size and value strategies? Should they explore other interesting anomalies and adopt similar strategies?