In designing our client portfolios, we are free to choose from among thousands of mutual funds. We generally prefer passively managed funds with low expense ratios because we believe they offer the best value to our clients. Although there are some excellent companies to choose from - Vanguard comes to mind, for example - we rely heavily on Dimensional Fund Advisors, Inc. DFA is an institutional investment manager that serves more than 200 corporations, college endowments, government organizations, and charitable foundations. Its directors and board members include some of the world's most distinguished academic theorists, including Nobel laureates Merton Miller and Myron Scholes. The DFA family of no-load funds was previously only available to institutional investors. Individuals can now gain access to DFA through a limited number of registered investment advisors, such as Shearwater Capital.

What is it that makes DFA funds different? Although they are passively managed, they offer superior value compared to conventional index funds. Each DFA fund is designed to capture the returns of a specific asset class, whereas index funds merely replicate market indexes. DFA funds also provide increased returns through innovative trading strategies and portfolio engineering.

DFA also adds value by minimizing transaction costs. Rather than replicating an index in a mechanical fashion, DFA uses discount block trades. This results in slight variations in day-to-day market weighting that are not permitted in most index funds. The advantage is that net investment returns are enhanced by reducing trading costs. The effectiveness of this strategy is illustrated by the fact that DFA has achieved negative trading costs in illiquid market sectors such as U.S. small company stocks. This translates directly into increased returns for our clients. DFA's enhanced index funds add 1-2% to returns per year over conventional index funds.

Table 1: Adding value over simple index funds

• Portfolio engineering
  
• Innovative trading strategies
  
• 1-2% increased returns per year over conventional index funds

Model Portfolios

Recommended Reading for Investors