April 25, 2013

Your Move, Bogleheads: Advisor Finds DFA’s Returns Trump Vanguard’s

But Vanguard slugs back to defend its low-cost strategy

Vanguard founder John Bogle. (Photo: Bloomberg) Vanguard founder John Bogle. (Photo: Bloomberg)

Admittedly, few investment companies inspire more passionate feelings than Vanguard and Dimensional Fund Advisors (DFA). So many investors are invested in the idea that either one of those companies is the best that there are numerous analyses devoted to comparing them.

A Google search on “DFA vs. Vanguard” yields 114,000 results. A page on the Bogleheads website—named for Vanguard founder John Bogle—has 168 posts; Morningstar has a similarly named thread in its discussion forum. Indeed, the New York Times recently waded into the dispute with an article last month.

Now comes advisor Jeff Troutner, writing “DFA and Vanguard,” the subject of his firm Equius Partners’ April newsletter.

While there are legions of Vanguard fanatics out there, the good folks at Equius are confirmed DFAheads, as many advisors are.

Troutner argues that media coverage of investments tend to be biased toward Vanguard because of a simpleminded focus on costs, thereby missing out on the research DFA employs to engineer funds he claims delivers higher net returns over time. “You really do get what you pay for,” Troutner writes.

Troutner, the chief investment officer for Equius, a Northern California-based advisory firm, says a broader look at the numbers is less favorable to Vanguard than unsuspecting advisors might think.

That is because Vanguard has different share classes which, in effect, cost small investors more than lower-fee classes often used in fund comparison calculations. Troutner says a small Vanguard investor can end up paying as much as four times what an institutional Vanguard investor will pay.

He says that while DFA’s funds cost 25 basis points more, on average, than Vanguard funds, “the smallest investors at Vanguard will pay 70% more for a basic market fund than they would for a comparable DFA fund.”

Beyond costs, Troutner says that the real issue is performance, and he disputes a Morningstar calculation cited in last month’s New York Times report that favored Vanguard fund investors' 10-year returns over DFA investors to the tune of 6.614% over 5.05%.

Writes Troutner: “There is nothing ‘actual’ about the returns the Times published. They don’t represent actual mutual fund returns and they don’t represent returns investors actually realized.”

To generate what he says are actual returns, Troutner made 10-year calculations that included returns from “all fund share classes,” not just Vanguard’s lowest-cost share classes. Equal-weighting the assets favored DFA, 12.8% to 10% (the time period differed from the Morningstar calculation because it included the most recent quarter). But asset-weighting the returns favored DFA more significantly (14.5% to 10.1%) since most DFA investors are heavily weighted to the small-cap and value funds on which DFA’s reputation is based.

Beyond actual return, Troutner, like many DFAheads who stress the value of an advisor, says that “realized” returns are what investors should keep their eye on.

“The returns shown on the previous page cannot be realized by investors unless they are willing to buy and hold—with periodic rebalancing to their target allocation—through thick and thin,” he writes.

To cost-conscious investors who value cheap index funds, in which Vanguard excels, Troutner cautions that “indexing doesn’t come with a behavior modification pill, and firms such as Vanguard do not prevent investors from jumping in and out of their funds any more than active fund companies do.”

Troutner notes that DFA’s favored small-cap and value stocks have higher expected returns but tend to decline more in tough markets as seen in 2008-09, thus illustrating the advantages an advisory relationship has in maintaining investor discipline.

In a response requested by AdvisorOne, Vanguard spokesman John Woerth took issue with Troutner’s argument:

“We have considerable respect for DFA and their investment professionals and have no interest in denigrating a competitor. That said, we stand firmly behind our low-cost, diversified investing approach (whether passive or active).”

Troutner’s “analysis is based on 10 years ended March 31, 2013, a period which greatly favored the small-value approach. Basically, at any point since 2000, the trailing 10-year performance of small value would have looked really good relative to the broad market… The peak was the 10 years ended 4/30/2010 where small value outperformed the market by 900 basis points annually. Of course, this was the reverse of the previous period. For the 10 years ended 3/31/2013, small value outperformed the broad market by 214 basis points annually.”

Woerth added that Troutner’s chart comparing asset classes “showed DFA outperforming in three categories, Vanguard outperforming in two categories, and a tie in one…hardly compelling evidence that favors one firm over the other.”

Woerth continues, quoting four Troutner assertions he disputes as misrepresenations:

1. Vanguard is all about fund expenses.

Woerth: False. Vanguard is all about value and giving investors that best chance of investment success.

2. Vanguard cares more about the small, less affluent investor.

Woerth: Huh? Vanguard serves investors of a wide range of means, serving individual and institutional investors directly, in partnership with financial advisors, and through company 401(k) plans.

3. An investment in any number of Vanguard index funds will cost the small investor four times what it costs the larger investor.

Woerth: Besides contradicting the previous claim about catering to the small investor, all clients have access to Vanguard index funds through our ETF Shares, which feature expense ratios as low as 5 basis points. We do offer Investor Shares ($3,000 minimum) and Admiral Shares ($10,000 minimum), as well as various Institutional Shares, on most of our index funds.  The difference in expenses ratios of Investor Shares and Admiral Shares for Vanguard Total Stock Market Index Fund is 12 basis points—0.17% vs. 0.05%.

4. Vanguard downplays the importance of discipline.

Woerth: To the contrary, discipline is a core principle in our investing philosophy.

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