Dimensional's co-CEO tells clients at Monterey event that DFA is changing its Classic-Coke intellectual fund recipe

DFA is a remarkably successful marketing firm and one of the first to utilize evidence-based, scientific and academic studies. The immense contribution by Booth to U of Chicago, my alma mater, is a small indicator of the profitability of their approach.

It is, however, very hard to judge any investment approach based on evidence using current academic and commercial approaches. Economics and finance as bodies of knowledge seem far too new to even start to address this challenges. Back-testing has well known weaknesses. Another factor is implementation. Say effective algorithms are created through experimentation, other than just back testing, then the actual implementation of products would need to be assessed, etc.

Certainly, DFA has the money to support deep and rich, non-proprietary research. For economics and the industry to move beyond back-testing and into true double-blind, control group experimentation and testing will likely take some generational shifts.

Finally, there is always the proverbial wise client’s, very tough question of the industry and investment approaches: If they were so good and productive, no company would need any client money to invest.

As a support organization for Advisors and RIA firms investing with DFA, even though we appreciate and like the 3 dimensions (3 factors), it is a pleasure to see the 4 dimension added. It will be a pleasure training our every increasing Advisor base about the 4 dimensions.
From Dynamic Wealth Advisors to Dimensional Fund Advisors, CONGRATUALATION.

Is there academic support fot he 4th dimension?

Interestingly we just came across a couple of articles relevant to this topic.

For the first time in history, individuals are responsible for investing their life savings and to do so for decades during and after their work lives. We have to admit honestly that the state of knowledge about how to invest is very rudimentary.

A couple of recent articles about how the “best and brightest” Noble prize winners invest their own money is sobering if not concerning. They have direct access to the best thinking and knowledge on investing and they are as confused as everyone else.

For example:
“Readers might take comfort in learning that even some of the world’s great mathematical minds have admitted to wrestling with the same issues they do: How do I invest my 401(k)? Should I take some risk? How about international stocks?”

“If the creme de la creme of the economics profession and American academia can’t get these sorts of things right, why should we expect everyone else to?”

“Retirement is not like buying a cup of coffee,” said Joseph E. Stiglitz, a 2001 Nobel Prize winner, former Clinton administration economist and Columbia professor. “It’s not something you get to do over and over again and learn from your mistakes.”

Recent research suggests that people, by nature, often make poor economic decisions.

Analysts examining the actual behavior of individuals — as opposed to what most economists’ theories predict — find that it rarely conforms to standard notions of what’s rational. Instead, it often involves systematic mistakes that end up producing the very opposite of what people say they intend.”

We are digesting two articles on this study for our blog and will post a link.

Now, maybe DFA and other firms have a “secret sauce” that is not known or studied in the academic sciences of finance and investing but if there is any evidence-based approach that can work – now is the time to make it public to firms, individuals, institutional investors and even governments.

Developing experimentally proven, fact-based investment strategies is an urgent global need.

re: Academic sources for additional factors

See Professor Robert Novy-Marx’s recent works:

1. The Quality Dimension of Value Investing, December 2012

2. The Other Side of Value: The Gross Profitability Premium, June 2012

Both are available at his site at the University of Rochester:

http://rnm.simon.rochester.edu/

More popular/accesible recap of Professor Novy-Marx’s work may be found here:

Swedroe: Look At Value, Quality And Momentum
By Larry Swedroe | June 04, 2013
Looking beyond the three-factor Fama-French may be just what your portfolio needs.

http://www.indexuniverse.com/sections/guest-blogs/18884-swedroe-look-at-value-quality-and-momentum.html

Thanks for citation. Ah, so this is not an academic work but just another promotional article by a money manager based, supposedly – since we have no access to the data cited, on back testing.

So if this was presented to a client or advisor, what kind of evidence and proof would this be called? If it hasn’t been independently validated is it anything more than opinion?

What kind of proof and evidence should clients and advisors require before implementing any professional service?

See earlier post [below], with reference to Professor Robert Novy-Marx, or google his name. Easy to find.

Ira Artman added: (Tuesday 6.11.13 7:13a.m. PST)
re: Academic sources for additional factors… etc.

We will study the quality dimension paper. The only method is back testing, we assume. Have critiques been issued. All good ideas need to be disprovable and falsifiable. How would these be and have that been undertaken?

OK, so let’s unpack the claims.

The Proposition: “Novy-Marx (2013) finds that a simpler quality measure, gross profitability (revenues minus cost of goods sold, scaled by assets), has as much power predicting stock returns as traditional value metrics.”

So this a clear empirical question, it is factually correct in the future or not.

- This approach is not new -“BlackRock, the earliest adopter (when still BGI) of Sloan’s (1996) accruals-based measure of earnings quality”. So we have then data to test this approach since ’96. – May not work with all asset class: “Quality driven performance improvements are more elusive, however, in the large cap universe.” “Elusive” is an interesting choice of words. Does that mean it doesn’t work?
More – “This suggests that large cap investors trading on value and profitability have little to gain by incorporating other measures of quality.” This is sounding like less of a “breakthrough” after all. – To get the real promised returns however, it requires trading strategies – “Investors trading on value and profitability can, however, realize significant improvements by also incorporating momentum signals into their trading strategy. This is really confusing. So we have a 2 major independent variable – trading strategy. How is this operationalized, tested, defined? Are the contributions of the quality approach lost if some kind of, pretty much ad hoc trading behavior is included. BTW, there are “strategies” (what is said should be done) and actual trading behavior (what is actually programmed and executed).

There is more but let’s stop here, for now.

Bottom line – where are funds using this strategy, as defined in this paper where we can see the audited results? How will different funds apply the same ideas? Is there anyway to know that the calculations used in this paper will be applied uniformly or accurately? How is one to assess trading strategies.

As a marketer, I appreciate the public claims and promises of all this being special. But also as a marketer in a highly regulated industry it seems basic truth in advertising is at play here as well.

Looking forward to an energetic exchange on this.