Dfa’s Research-Based Strategies and Potential

DFA’s Research-Based Strategies and Potential

When analyzing DFA, we must first determine DFA’s business strategy and core beliefs. DFA’s business strategy is based off its belief in efficient markets and sound academic research. Even with a passive strategy, knowledgeable traders can create profit for DFA and its clients. DFA specializes in investing in smaller stocks and managing investments for large institutions. Its strategy focuses on the “importance of diversification, low turnover, and low transaction costs” (Cohen 2). To reduce transaction cost, reduce the burden of its mostly illiquid small stocks, and to reach the market without having to advertise, DFA uses registered investment advisors (RIA). To create value with these stocks, DFA buys entire blocks of small stocks from a roster of its trusted brokerage firms at discount rate.

If DFA sticks with its current strategy, a lot of its performance will be based on macroeconomic risks. If there is another large recession, smaller businesses will be negatively affected again. DFA will not do well, if it does not have other investment options. However, its passive strategy based off academic research should create steady returns. The main issue is whether or not their safe investments will beat the benchmarks and those returns will attract new clients.

DFA does seem to truly believe in an efficient market. Several of its strategies and decisions prove this. Its semi-strong-form EMH and passive strategy go in line with an efficient market strategy. DFA does not fundamentally analyze firms it is investing in, because it believes the market is efficient and the stocks correctly reflected the firm’s relevant information. DFA does not try to aggressively beat the market, because it does not believe that is possible. Instead, DFA wants steady returns for its clients.

The Fama-French model makes sense under many circumstances that can be proven by historical evidence and studies found in the case. The model presents three stances: First, stocks with a higher beta do not consistently have higher returns than low beta stocks, secondly, stocks with a high book to market ratio consistently yield higher returns than low book to market ratio stocks, and finally, small stocks outperform large stocks. Fama and French analyzed this data multiple times and found the book to market effect to be strong each time.

Given this information we can expect the small stocks to outperform large stocks. Looking at Exhibit 8, we notice that small cap portfolio has generated higher annualized returns in short term periods compared to US large company portfolio. As the economy bounces back from a recession, small business stock should be on the rise. Logically speaking, small stocks have higher rewards when they boom and smaller losses when they fall. Larger stocks also can reach a price in which investors turn away from paying and begin