The WSJ has done an interesting advisor profile on Dale Yahnke, who uses index funds from Dimensional Advisors and Vanguard to arrange his clients’ portfolios. The problem is that Yahnke says he favors passive investing when Dimensional Funds don’t actually provide completely passive investing.
The professors at the University of Chicago, who first developed the efficient markets hypothesis or EMH (and whose students went on to found Dimensional Advisors), stumbled upon some interesting evidence at a certain point. They realized that value stocks and small-cap stocks did better than cap-weighted market indexes over time. To reconcile this evidence with EMH, they argued (questionably in my opinion) that small-cap and value stocks are riskier. They defined risk as volatility.
Consequently, Dimensional Funds use multiple factors including a cap weighted indexing, but also additional exposure to smaller stocks and stocks with value characteristics along with stocks that are less liquid, because the profs found inefficiencies or higher returns there too.
Did the profs just stubmle upon evidence that Benjamin Graham wrote about in the earliest edition of Security Analysis in 1934? Small-cap, low price/book, low price/earnings, underfollowed, illiquid stocks are likely to do better — Graham basically laid that argument out a long time ago.
The profile also mentions that Yahnke eschews hedge-fund-like mutual funds, “because many don’t have long records, plus they carry high fees and can be inefficient taxwise.”
Below we submit Steve Romick’s record at FPA Crescent from 1998 through June 2012 to the WSJ and Mr. Yahnke as evidence of a hedge-fund-like mutual fund that has done rather well. Romick had a two-year period of lagging indexes at the start of this data chart. That, of course, is when valuations on large-cap stocks reached stratospheric levels, and his temporary underperformance, due to holding cash and smaller cap stocks, set him up for longer term outperformance.
Can it be that advisors want to track the index because it makes managing clients and retaining assets easier? Indeed FPA Crescent lost 90% of its clients in the late 1990s when nobody wanted to hear that the S&P 500 Index reached record valuations, and Romick held cash and a decidedly smaller-cap oriented portfolio of stocks than he does now. Those few who understood Romick’s valuation based approach and stuck with him reaped extraordinary benefits over the longer haul.
