This publication has spoken to US-based investment house Dimensional, a business operating for more than four decades, present in countries including the UK, about its particular approach to unlocking sources of return.

A fund manager taking a systematic approach to active fund management argues that it can unlock superior sources of return, making its case at a time when financial markets continue to be difficult for investors.

Dimensional Fund Advisors argues that what it calls “core equity portfolios” – low-cost, broadly diversified equity portfolios with a moderate emphasis on the size, value, and profitability premiums – can bring higher expected returns while controlling the risk of lagging a market.

Its approach isn’t the same as just trying to find sources of return, such as momentum and yield, and then tracking them via a “passive” tool such as an exchange-traded fund. This isn’t “smart Beta” – it is far more “hands-on” because the adjustments made in a portfolio can be daily, Mathieu Pellerin, senior researcher, and vice president at Dimensional, said in an interview.

“This approach is applicable at scale in a whole range of applications,” Pellerin said. The “core” equity approach also enables investors to hedge against inflation or hedge it – obviously an important consideration.

This publication spoke to Dimensional, a US-based firm that was founded in 1981 by David Booth, who is now chairman. Starting from an apartment in Brooklyn, Booth built the business to a global firm with more than 1,500 employees and $634 billion in assets under management. The business prides itself not just on trying to forecast markets but drawing data about expected returns from the market itself. As the firm says on its website: “Research has shown that securities offering higher expected returns share certain characteristics, which we call dimensions.” Hence the business’s name.

The firm told this publication that at certain times investment performance is below a market benchmark. This is because the premiums are not always positive and there are sometimes long periods when they are negative. Growth has outperformed value in recent years – looking at overlapping 10-year periods from 1926 to 2022 in the US, growth has outperformed value 21 per cent of the time. But that means value has beaten growth 79 per cent of the time.

That’s the key point for Dimensional and Pellerin‘s research is focused on that long-term value outperformance. 

Pellerin, a PhD, authored a paper, published in May, called How Targeting Size, Value, and Profitability Can Improve Retirement Outcomes. He argued that targeting the factors that drive returns can boost a portfolio by as much as 20 per cent above just holding a plain market portfolio if a person takes the core approach from the age of 25 to 65. It can also sustain retirement spending and increase bequests.

For example, Dimensional gives the case of two investors who contributed to a retirement account from age 25 to 65. They followed a conventional target date glide path in which assets were heavily invested in equities at younger ages and converged to a 50/50 mix of stocks and bonds by age 65. The equity portion is invested either in a core portfolio or the broad market without any emphasis on the premiums. As a result, an investor in the core portfolio will typically reach 65 with 15 per cent to 20 per cent more assets than an investor in the plain market portfolio.

Pellerin said this approach applies to organisations such as pension funds, endowments, family offices and other entities which take a long-term approach to managing money. In fact, he’s keen on family offices learning from the experiences of pension funds and endowments. 

He told WealthBriefing that he had attended a pensions conference in the US where it was claimed that the inclusion of private market investments in a portfolio could help a portfolio sustain retirement spending. Pellerin questioned, however, as to why an investor should allocate to less liquid and potentially riskier private equity when a conventional, diversified, low-cost small-cap public equity strategy can offer the same risk/return characteristics.

Since the early 1980s, Dimensional has been capturing premiums from this systematic approach, Pellerin said. 

The Dimensional philosophy is not contingent on what goes on in the broad business cycle, Pellerin said. 

The “core equity” approach is meant to sit inside a client’s overall portfolio, Pellerin added.