Animal Spirits Podcast - Talk Your Book: Factor Investing with Dimensional Fund Advisors

Episode Date: October 21, 2024

On today's show, we are joined by Rob Harvey, Co-Head of Product Specialists at Dimensional Fund Advisors to discuss how DFA separates itself as an asset manager, details around converting a mutual fund to an ETF, how DFA handled the meme stock craze, value vs growth, and much more! Find complete show notes on our blogs... Ben Carlson’s A Wealth of Common Sense Michael Batnick’s The Irrelevant Investor Feel free to shoot us an email at [e-mail] with any feedback, questions, recommendations, or ideas for future topics of conversation.   Check out the latest in financial blogger fashion at The Compound shop: https://www.idontshop.com Past performance is not indicative of future results. The material discussed has been provided for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Information obtained from third-party sources is believed to be reliable though its accuracy is not guaranteed.   Investing involves the risk of loss. This podcast is for informational purposes only and should not be or regarded as personalized investment advice or relied upon for investment decisions. Michael Batnick and Ben Carlson are employees of Ritholtz Wealth Management and may maintain positions in the securities discussed in this video. All opinions expressed by them are solely their own opinion and do not reflect the opinion of Ritholtz Wealth Management. The Compound Media, Incorporated, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. For additional advertisement disclaimers see here https://ritholtzwealth.com/advertising-disclaimers. Investments in securities involve the risk of loss. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. The information provided on this website (including any information that may be accessed through this website) is not directed at any investor or category of investors and is provided solely as general information. Obviously nothing on this channel should be considered as personalized financial advice or a solicitation to buy or sell any securities. See our disclosures here: https://ritholtzwealth.com/podcast-youtube-disclosures/ Learn more about your ad choices. Visit megaphone.fm/adchoices

Today's Animal Spirits Talk Your Book is brought to you by Dimensional Fund Advisors. Go to Dimensional.com to learn more about DFA's, ETFs, mutual funds, advisor services, and more. That's Dimensional.com to learn more. Welcome to Animal Spirits, a show about markets, life, and investing. Join Michael Batnik and Ben Carlson as they talk about what they're reading, writing, and watching. All opinions expressed by Michael and Ben are solely their own opinion and do not reflect the opinion of Redhol's wealth management. This podcast is for informational purposes only and should not be relied upon for any investment decisions. Clients of Ridholt's wealth management may maintain positions in the securities discussed in this podcast.

Welcome to Animal Spurts with Michael and Ben on today's show. We're joined by Rob Harvey. Rob is the co-head of product specialists at the Metro Fund Advisors. I think DFA is probably best known in the industry anyway for small cap value. We'd say that's fair? Yes, and that's probably how they got their story. Sure. Actually, no, it's microcap. Okay. But yeah, small caps and microcaps were they got started in like the early 1980s with funds.

Yeah. Which is way ahead of the game. So it's been a rough decade for really anything outside mega cap growth, right? Certainly for small cap value, it's been a rough decade compared to the indexes. But actually, I just surprised people. Did you know, Ben, over the last five years, up until only very recently, small cap value, value had actually kept pace with the S&P? Right.

It's not, the underperformance is not as great as some people would have you believe. Well, if you zoom out, it's pretty bad. Right. But no, actually, okay, so this is, we're recording this on Monday, October 14th. Over the past five years, the S&P is up 112% and DFA small cap value is up 99%. So it's not an enormous level of, it's more like the 10 year numbers. Oh, yeah, I would say, oh, yeah, as I say on Twitter, now show 10 years. Yeah, so the 10 years were the bigger gap.

exists where it's it's like over 100% difference in total return. So we spoke about this on the show with Rob, and I want to step on too much of it. But is value investing dead? Is small cap value dead? Of course, I think when you ask those questions, the answer is things in investing don't die. It's cyclical.

Whether or not it's going to outperform in the future as it did in the past, of course, that's an open question. But I think it's really simple. Mega cap growth stocks are outperformed because the businesses have had just a tremendous run and continue to defy even lofty expectations. If you look at like what earnings per share were embedded in share prices, go back every year for the last 10 years, they kept beating them. Yeah, yeah. And the funny thing is, it's not like small cap value has just been god awful. So I'm looking at the DFA one right now on Whitechart's website. So over the past 10 years,

it's up 10% per year. Over the past 15 years, it's up more than 11% per year. It's just that the S&P did like 13% per year over the last 10 in 14 or 15 over the last 15 years. Yeah. So on an absolute basis, you know, still, investors did pretty damn well, but compared to the S&P. It's just, yeah, it's under-relivate. And I think the one thing DFA, we, on the show, you mentioned drinking the Kool-Aid. And some people say that to, you know, be part of DFA, you had to drink the Kool-Aid, right? And a lot of people would say that over the years. But I think that the smartest thing they ever did was they partnered with advisors very

early on, especially RAs. We were a relatively laycomer to the, to the dimensional scene. Like Ben said, they got started in 1981. They've been working with advisors for forever. And we started working with them as clients in 2014. And I understand why from the outside looking in from some of the, some of the sour grapes of people that were having a hard time getting in front of advisors, it felt like it was a cold.

And listen, are there some advisors that take you to an extreme, perhaps? I never felt that way working with them. That it was, they never said how much of your portfolio do you have in dimensional funds. We only work with people that have 80% of their portfolio. Like, that was never a thing, at least for us. Right. So we've used them for a while.

And I think the other thing they do is they provide. really great research. They have great charts. I've used their historical data forever. They have this historical returns 2.0 thing that gives historical to return data going back to the 1920s on like value and small caps and stocks and bonds. And I've been using that monthly return data forever. They just give it to advisors who work with them, which is wonderful for someone like us. So, all right, with no further ado, here's our conversation with Rob Harvey from dimensional funds. Rob, all the financial advisors that are listening very much know who Dimensional Funded

advisors are. But for the general audience who is not in the industry, can you give an introduction maybe? Well, for advisors who don't know much about Dimensional, and there's more and more advisors that we work with all the time, Dimensional goes back decades in time. We had our founding in 1981. And really, the essence of dimensional was thinking about a better. way to invest in markets and achieve better outcomes without having to try and out-guess markets. So while we are an active manager, we're the single largest active ETF issuer in the market,

we don't try to go out and guess, oh, you know, is Bank of America going to do better than Citigroup, for example? We're factor-based investing. In fact, we're the original factor-based investors. And so by utilizing academic research that's out there from Eugene Fama, Ken French, right, Nobel winning academics, we can embed that in our portfolios consistently over time to achieve better results. And we have a track record to back that up as well. Michael and I talk to a lot of different companies in the wealth management space, and it's funny how many come to us and say, hey, I want you to explain to me how the financial advisor or RAA market works. And they want to get into that channel because they see how much opportunity

is there. Dimensional was there early. So when was it that the change was made from just being factor investing to also partnering and working with advisors and being on that same wavelength as them. Well, you're so right. I mean, that's a massive advantage for both dimensional and the advisors that we partner with because our go-to-market strategy is largely informed based off of feedback we get from advisors about which product do they need to fit an asset allocation, right? And what do they think that we can do best? How can we serve them best? But it's also true that that just doesn't happen overnight. You need to have a lot of trust built up with the advisors that you partner with, we've done that because we've been there

with the advisors for decades now. And one of the things I think that really sets Dimensional apart is our strong advocacy for the power of financial advice in a way that we're not financial advisors ourselves. Dimension doesn't have any dimensional sponsored financial advisors. So it's just the fact that we believe that for investors to achieve their long-term goals, a great way to do that is by partnering with a financial advisor. And so we have a lot of tools available for financial advisors to help investors stay the course. It's something that they appreciate about us and sort of that intellectual honesty that stems from our academic roots. Those things combined, I think, really makes us a fantastic partner for financial advisors.

So you worked with dimensional fund advisors, worked with financial advisors to distribute their products. It wasn't this type of thing where if you had a brokerage account at Schwab, you could go on and hit the mutual fund and hit by. And you were, early on, you were all pretty selective about who you worked with because we're going to get into the strategies themselves and how they're traded and what makes them a little bit different from index funds traditionally. But you wanted long-term permanent capital that wasn't going to bail or mess up your flows or cause any undue burden on your trading team. So talk to us about the process. And of course, looks different today, and we'll get into that. But talk to us about the process of working with

advisors, like minded advisors, of course, that really, I'm looking for a phrase other than frankly cool, but believed in the long-term provision of what you all were selling. Yeah, you're absolutely right. So especially before we had ETFs, the way to access working with Dimensional was with an aligned financial advisor. And that didn't just mean that you, you know, sort of filled out a form on the web page and you were good to go. We really wanted to make sure that advisors had all of the tools and sort of the education, the background about why we were doing what we were doing. Because one thing that's important to us historically and is still true today is, you know, those costs of fast money coming into and out of mutual funds, who is paying the bill

for that? Ultimately, it's existing investors in the mutual funds. We wanted to make sure that the investors in our funds had a long-term approach and that they were aligned with us philosophically. And, you know, that onboarding process for advisors, a lot of it was, why are we doing what we're doing? And what can you expect over a year, 10 years, 20 years, you know, whatever your investment horizon may be. And so that still continues today that, you know, a heavy emphasis we place on making sure that the community is educated about what's going on out there in markets through the lens of this academic research. and the academic research itself develops over time. But obviously now with ETFs, anyone can kind of go out there and buy a dimensional fund. We haven't backed down off of our support for advisors or the educational aspect.

It just looks a little bit different now. I want to say DFA made the push into ETFs in 2019, 2020. Is that about right? That's right. Better late than never. Yeah. And yeah, the push came a little later. Maybe some people would have expected.

But then once it came, it came in a tidal wave. And you said you're the biggest active ETF issuers, but it's not only flows that are happening. It's also you're doing these mutual fund to ETF conversions. And maybe this is a little bit wonky, but how does that even work? What are the rules behind that? And you're just taking existing investors in mutual funds, transitioning it into an ETF, which I assume is just more liquid, lower costs. Like, how does that whole concept of work?

There's a lot of messy details behind the scenes about the mutual fund to ETF conversions. All of the conversions that we've done were former tax. managed mutual funds. So investors in those funds were already naturally aligned with what the goals of an ETF are in the sense of, you know, not wanting to take distributions or minimizing them to the extent that they can. But it's a one-time thing where you get to move from the mutual fund to the ETF without having this taxable event. And we did that for many mutual funds. There were several. And then we've also launched a lot of new ETFs on top of the that. So it's been sort of a two-pronged approach. Then the conversions are sort of something that's

been done historically. We haven't done one of those in a while. And I don't see us doing one of those in the near future again either because we've converted all of the tax managed mutual funds that we had into ETFs already. But certainly there's been a lot of growth in the new ETFs that we're launching. So dimensional at its roots is you call yourself active. I would say I would describe you as Index Plus, all of the benefits of systematic, not market timing, not trying to pick the winners, but taking the best of what the index fund has to offer and making it a little bit better. And that doesn't matter if the index is large cap or small cap value.

I think actually that's not true. In certain indexes, the rules and the things that you have in place matter more than others. Talk to us about how you think about or how dimensional thinks about the active nature of their strategies to the extent that it is active. Yeah, you're right too. I mean, I mentioned before that we're active. And I think even at dimensional, the debate has raged over the years about are we really active or are we really passive? And, you know, for a lot of investors and particularly because of, you know, the consulting world, you kind of have two boxes in front of you. You have to check one, are you active or you passive? And so we don't really sit in either. I mean, to your

point, you can kind of think about us as doing indexing a better way in the sense that you want to have broadly diversified, low-cost portfolios. You know, that feels a lot like indexing. Now, what we do is different from indexing. We can talk about that a little bit too. And then, you know, from the active side, that those highly concentrated portfolios of stocks that are very high feet. That's not at all what we do. But just from alignment of what are our goals as an asset manager, we want to outperform the market. That is our objective. Fundamentally, that is very different from indexing. When you choose to invest in an index fund, you are saying, I'm comfortable never outperforming the benchmark because you never will. That's not the goal of an

index fund. We want to do better than that. And when you want to do better than that, that puts you in the active camp. So we kind of what we term what we're doing is systematic active, which is you're not stock picking. You're making well-informed bets, largely from the academic research that I mentioned earlier, again and again and again over time to tilt the odds of success in your favor. And as I said, it's worked out really well. All right. So how do you do that? How do you, how do you outperform? Maybe we'll start general that we could drill down into some specific strategies. Yeah, there's a couple different categories that I would place the sources of outperformance in. And depending on which dimensional strategy you're looking at, they have a

different emphasis on where those sources of outperformance come from. So traditionally, you think about dimensional as being factor-based. So for us, on the equity side, at least, small caps tend to do better than large caps, for example. So you would want to have more small caps in your portfolio than large caps. That has driven a lot of the outperformance that you've seen on a since inception basis across our product suite. So that is a long-term bet that you have. And you can kind of dial up or dial down how much small-cap exposure you want.

We have different products in the product suite to fit investors' preferences there. But then there's this other camp, too, which is implementation. And that, I think, really also helps us stand out about indexing, which is you don't have to have a massive overweight towards value or small cap or profitability to outperform, you can outperform investing in a broad market portfolio with little or maybe even no tilts towards the premium as long as you're thinking about implementing a better way. And what do I mean by implementation? I'm talking about the way that you trade.

What does your investment universe look like? How do you manage the style drift inside of your portfolio? Those are all really important aspects that can add quite a few basis points to the investor experience and don't require a massive overweight, if any, to the premiums that I talked about before. DFA is one of the few fun shops I've heard that really talks about that operational efficiency as opposed to other places. And it's funny, the quant stuff, Michael and I know a lot of people in the quant world, and they get very nitpicky about this stuff, saying, oh, we have a better mouse trap here than DFA. We take value that they did, but we add this rule and that rule.

So I'm curious how much you think about, like, I think it's true that you can add. add benefits around the edges, but also like the 80-20 rule of, you know, 80% of your games probably come from 20% of the rules that you, so how much do you get bogged down in the details of quants who say, you know, if we just change value to look like this, we change quality to look like this, momentum, all these different factors, and they say we can take the original concepts, but we can tweak them because we think that we have a better way of looking at this. How much do you think people get bogged down too much in the details in these factor strategies? We get confronted with this all the time, because obviously

as other asset managers are coming to advisors and investors with these ideas, eventually they bring them to us, right, because of that partnership that we have with them. What you see that Dimensional does is what succeeded. So what passed our test? You know, you think about small cap investing or value investing. We have ways that we define what is value, for example, and it's been challenged a lot, especially during periods of time where some of those premiums underperform. So value has gotten a lot of scrutiny over the last, really, really, decade in the US and people say, oh, value's broken. Well, what if you measure it that way? What if you think about this? You know, what about if you, you know, treat intangibles differently? And the truth is that

we think about these things very seriously and we evaluate new ideas coming in from academics and the community at large all the time. If there's a different way to do things that's better, then we'll do it. And our process has evolved over time. For example, you know, the investment factor that we see in small caps is relatively new. That's only been a couple of years that it's been around. It's something that we felt like could enhance the process. So we're not stubborn and stuck in our ways. And if there is new research out there, we do want to vet it with our team of PhDs and

researchers who look at this very carefully. But if it's not value add, then we're not going to change what we do. And by the way, this is one of the big benefits that we have of working so closely with the academic community is when you have someone come in from the, outside world and say, hey, I've got a better way to do value. What, right? What if you don't use price to book? What if you just use price to earnings? Who better than, you know, your Ken French's or your Eugene Fama's to help you look at that data and reevaluate it, right? And that partnership that we have with the academic community allows us to do exactly that.

So I'm, I refer to you as index plus, maybe an area to consider where you might be better than the index is let's let's talk about small cap stocks, for example. So during the Russell 1,000, In 2000, excuse me, there was a period of time where GameStop was one of the biggest winners. And let's say that there's a day where GameStop was up 70%. For better, for worth, the index is going to track that. Dimensional fund advisors has the ability to say, hold on, hold on, hold on. What's happening here? And maybe some of the screens now, you can talk about that.

But just in terms of like the operational trading of not tracking the index to the T can add could add incremental at performance. This is such a phenomenal example of what I was talking about before with implementation. Let's talk about GameStop for a minute here to highlight some of that implementation benefit in our process. So we all remember, you know, a few years ago when GameStop really came roaring onto the scene, right?

It was January. It had done phenomenally well. It reached $350 a share back then. And it was a constituent of the Russell 2000. It was also a constituent of the Russell 2000 value. At its height, GameStop was larger than American Airlines and Whirlpool put together. It was bigger than 40% of S&P 500 constituents. And this is a new and used video game retailer, right?

So it was a crazy time. We all remember that very well. One thing that you can take a step back and ask yourself is, okay, you're holding GameStop, which is now, again, larger than almost half of S&P 500 constituents in your small Cat Fund. What would you want your small cat manager to do with that name? And presumably the answer is sell, right? I assume most people agree with that, especially in hindsight, but even at the time, we're not making a call about whether or not GameStop is done or, you know, where we think this is the top. We're saying this does not fit the asset

class anymore. Get out of GameStop and put the proceeds back and do other Small Cat Value names. That's exactly what we did in that January, but the Russell didn't. And the, the reason that the Russell hung on to GameStop isn't because it likes it either. The Russell hung on to GameStop because the Russell only looks at its holdings one time a year. And that's on the third Friday in June, right? So it's the only time that the Russell changes its holdings. And so as a result, you rode GameStop up and then you wrote it not all the way back down, but a long way back down, right? Because if you miss the chance to sell GameStop at $350 a share, you never got that chance again. Rob, I feel like there's got to be a better way.

There should be, right? And one of the things I think you can ask yourself as an investor is, how often do I want my portfolio manager looking at their portfolio? Is it once a year? Is it four times a year? No, you're paying them to look at your portfolio every single day. That's what we're doing here at Dimensional. And just that from a couple names alone, like you said before, with GameStop's a great example, that pays. And by the way, GameStop, of course, post the, you know, Roaring Kitty tweets, kind of had a little bit of a comeback there for a while.

So it went back into the small cap space. We bought it again when it was a small cap. Then, you know, the Roaring Kitty tweets came out, did phenomenally well for just a couple days or a day or two, right? It didn't last for long. It wasn't weeks we were talking about. And again, we sold it out of our small cap portfolio, right? At a massive gain, it was a fantastic trade for us.

And it's not making calls. It's just, is this a small cap? Does it fit the story? If not, then, you know, take it out and get something else that does. So a lot of people don't look at it this way, but beta itself is a fact. And if you just look back in the last 15 years or so, market beta has been kind of the factor. I guess you could say momentum and growth. And so a lot of people look back to say like since the bottom in 2009, large cap growth sucks so the only game in town.

That's not necessarily true. If you look back at the results, it's really the last five or six years that if you compared it to like small cap value, for instance. It's really since 2019 or so that the bulk of that outperformance has happened. They were neck and neck through most of that period, which a lot of people forget. It wasn't, the 2010s wasn't nearly as divergent as this decade. So I'm just curious, I'm guessing most advisors have the core and explore kind of portfolio where they have the baseline is the index funds, and then they have factor funds around the edges, right, or the core and satellite, however you want to say it.

I'm just curious how much grumbling you've heard from advisors that, you know, why don't we just have more of our money in just the simple index fund or all of it in the U.S.? Because obviously advisors hear that stuff from clients too, right? clients say, why would I ever own international stocks? Why would I ever own value stocks? Look at the S&P 500 or the NASDAQ 100 is the only game in town. Why would I ever invest in anything else? I'm just curious how those conversations have gone for you. Well, first of all, I have those conversations pretty much every day. And then have for years. So, I mean, this is a very popular topic with investors. And I can understand why. You look at the performance of the S&P 500

over the last year. And like you said, even over the last couple of years, it's been phenomenal. So you get lots of questions about is value dead, is small cap investing dead, right? And I think it's important, first of all, to compartmentalize the argument a little bit here. When we say that the factors aren't working, we are talking about specifically in the U.S. In the vast majority of other markets outside the U.S., they've been doing really well. You look at our emerging market funds, you look at our international funds. The factors have been working great, right? We're doing very well versus our prospectus benchmarks.

We're just talking about in the U.S. And even in the U.S., there's been periods of time where those premiums work really well. July of this year, for example, we had our microcap strategy put up double-digit returns in a month where U.S. large caps did less than two. And that wasn't enough to reverse what we saw in the year. But man, you get one more month like that, and it turns around quick, right? And that's sort of the point of small-cap investing, which is we don't know when the premiums will material. But when they do, they can be powerful and it can be sudden.

One of the thing I'll point out about the premium investing in general is, and I think this is uncomfortable for investors and rightfully so, investors look at sort of the long-term average and they see something like, you know, oh, a small cap allocation in your portfolio would have led to 50 basis points outperformance versus a one that didn't over, you know, 50 years or something. And so they expect to have that 50 basis points show up every single year. It's not going to, though. Because in fact, it's very rare that you do see exactly that 50 basis points of outperformance.

If small caps always outperform large caps, if value stocks always outperform growth stocks, why would anyone invest in large cap growth stocks, right? This is part of the journey. We've seen this before. We will absolutely see this again. It's painful to go through. But this is part of the experience of factor investing, is that not every day is going to be smiles and sunshine and value land.

And by the way, we've seen this story unfold not even that long ago, right? We all remember the dot-com boom where if you had a website, that was just a great sign for you and the stock was going up and up and up. And the valuations that you see in the large-cap growth space now are very similar to what we had in the dot-com boom. And so that is also something for investors to think about. We're not saying whether that's the top or this is the right time to rotate in the small-caps. All we're saying is before you buy more large cap value, you have to be comfortable with the fact

that Nvidia is trading at over 60 times earnings. Will it trade over 70? Maybe if somebody decides to buy it there, but that's where you're getting in right now. So that may be uncomfortable for some investors. Rob, I heard a take the other day, I forget who I'm stealing this from. Man, I don't remember. But it was compelling. And I want to get your read on it.

So somebody said that, like, they weren't mentioning you specifically, I will. say that maybe is dimensional a victim of its own success in the sense that you all pioneered or helped to pioneer quantitative investing for the masses, right? I'm not talking about like the hedge fund quantitative stuff, but quantitative investing for the masses and that a lot of the premium that existed for owning value stocks was like an embarrassment premium that used to exist because these active stock pickers, nobody wanted to show investors that they owned this piece of garbage. And so there was like an embarrassment premium, for lack of a better word. And with the rise of quantitative investing, you're just buying the cheapest stocks, whether it's price to book, price to sales,

even EBITDA, whatever it is, you're buying the bottom third or whatever your metrics are, and nobody's embarrassed anymore because factor investing is in vogue and is defensible. I think there's some truth there. I think the better explanation is like Apple and Microsoft and Google just having lofty expectations and then doing even better than them. But I don't want to discount fully that sentiment that quantitative investing, its rise, you would think should lead to smaller excess returns on a go forward basis than before it even existed. I think that's a reasonable statement. Well, you know, we're not the only ones to have been asked this question because Fama and French who pioneered this research were asked the very

same question time and time again over the last couple of years in particular. And they actually came out with a paper in 2022, I believe. And a title of the paper was, stop asking us this. For market participants, if you think we get asked a lot, the academic community is vicious. So I am sure they were asked quite a few times. And, you know, they went back and looked. And basically, what they had done was look pre-92-93 when the research came out at the premiums and then look at it afterwards.

And that aligns very well with our. live fund data as well, because obviously we're, you know, sort of informed by their research. And what they found is that the premiums work across all sectors and all markets with the exception of value in the U.S. That was the one question mark that they had, particularly in the post-92-93 period. But they didn't also show that value, statistically speaking, was significant enough to underperform growth, that you would have been better off in growth. Because as Ben said, before, a lot of this is being driven off of the last couple of years. So even when you go back to 92, 93, there are lots of great years in there for value. So their takeaway was premiums

are still working. Value is the question in the U.S., but because of the fact that it's not statistically significant underperforming or outperforming, why would you discard all the decades prior that we do have research on that shows that value is positive? So stick with your prior, value investing still works. Was there a conclusion? A counterpoint to what I just said is that, well, if the popularity of these factors cause them to underperform, how do you explain them continuing to underperform in a time where who the heck is clamoring for small cap value stocks, right? In fact, they are out of fashion, so maybe therefore they should be outperforming and they're

not. So listen, these things are, they're fun to debate. It's really hard to come up with a definitive conclusion as to why they're not working right now. I think probably the easiest explanation is the simplest one. It's that there's investor preference for large cap growth, which are performing phenomenally well because the businesses are performing phenomenally well. I don't think there's like, we have to really overthink it. I would agree with that sentiment. And by the way, I mean, when you think about this last year, you know, a lot of people that I talked to say, I wish I held nothing about

Nvidia. I wish I held more Nvidia, right? That's the darling of the year to date period. When you look of the top performing stocks in the Russell 3000, Nvidia is not even in the top 40. There are a whole lot of securities that did much better than Nvidia did. And they're in the small cap and microcap space. And I'm not saying that lifts, you know, that high tide lifts all boats for small caps and that somehow magically makes small caps better, but it helps. And there are still phenomenal opportunities out there in the small cap space. To your point, Michael, I mean, you know, investor sentiment, if they want to continue to own these, you know, Mag 7 or, you know, fan mag or whatever we're calling them at these valuations, there's nothing to say that they can't

keep going up as long as people are still willing to pay more. It's just from our perspective, it might be a good idea to take a step back and evaluate whether or not that's where you want to jump in. Rob, my whole view and thesis behind investing in factors is not so much looking for the outperformance as much as the diversification benefits. So I like, I think even if these factors give you the same exact return as the S&P do over your 40-year investment time horizon, wherever it is, if it helps you sit through a lost decade of the S&P because these factors do better, that's where I think the benefit comes from. In recent years, a lot of people have been saying that the small cap factor,

like maybe that shouldn't work as well today because companies are staying private longer and you're getting fewer IPOs, there's more VC money, and you have these bigger corporations who are seemingly unchecked from as like monopoly status, they can just buy out all their competitors. Do you find any evidence that this stuff actually matters in small cap, or do you think the universe is still fine? And the fact that, you know, you don't have Amazon coming public at $400 million market cap anymore. These companies are coming at, you know, hundreds of billions of dollars in market cap, as opposed to when they're much younger in their life cycle. Well, first of all, your comment about, you know, sort of that lost decade in diversification,

music to my ears, I bang that drum all the time with investors because we tend to forget the fact that it wasn't that long ago from, you know, 99 to 2009 where you would have been better off sticking cash under your mattress than to invest in the U.S. equity market. People forget about that. So just that offsetting factor of, yeah, look, it's, you know, whatever is doing great today may not be great tomorrow. And so thinking about investing in other areas of the market is just a good idea in general, regardless of what that performance has looked like.

So I think that's very important for, for, you know, investors to keep in mind. Rob, dimensional as of the end of last quarter. So September, 2024, had $794 billion in global, firm-wide AUM, all in systematic active solutions, not just equities, by the way. You guys have a pretty big fixed income business as well. 40 ETFs, $162 billion in AUM there. The number one active ETF issuer, number seven overall ETF issuer globally by I'm curious now, and unfortunately with ETFs, we just don't know exactly, but you have any sense

of where the flows are coming from? Like, do you think it's still predominantly, I would guess it's still predominantly advisor-driven? Yes, absolutely. And you know, you're right in the sense that it's much more difficult to track in the ETF space than with mutual funds. But since we launched our ATFs back a couple years ago, we've partnered with close to 40% more financial professionals than we did prior to ETFs. Because if you were an ETF-only advisor, you didn't have much business with Dimensional, if any. Now you do.

So we can clearly see that that interest for systematic active with advisors who really care about that ETF wrapper has just opened a lot of doors for us. So the advisor community by far has been the driving factor from that. Rob, anything else that we miss that you wanted to hit on today? No, I mean, I think from my perspective and from dimensional's perspective too, you know, you would kind of mention the core satellite approach. And, you know, people have oftentimes thought about the satellite of their portfolio being maybe where the factors would play, like you'd have a little small cap or a little value and, you know, kind of rotate through

factors if that's where you felt like the performance was coming from. The message that I think is important for investors is even in the core ports of your portfolio, like if you're in a market-wide portfolio, for example, you can do better than what's offered to you in commercial indices by thinking about that second category I mentioned earlier, that implementation, that by itself is enough to add outperformance. And, you know, Michael was asking about sort of the growth of ETFs. One of the things that we had seen recently over the last couple of years is there's been phenomenal growth in our market-wide ETFs that compete against things like the Russell 3000. And they performed very, very well. You still have diversification. You have that low cost that investors care about,

but you actually have not just the ability to outperform, but the track record of doing so as well. So for investors who like indexing, for those reasons that I listed, it's probably worth taking a look at dimensional because I think what we have is a little bit better. Sorry, it's part of the implementation there just when we have these rebalances and the index providers have to say, here, these are the 30 stocks that are coming out. These are the 30 stocks that are coming in. It's totally telegraph. So you're saying you can maybe make that process a little smoother.

Well, yeah, you guys don't have to participate in the run up because we know empirically that these stocks run up, they get front run because we know what the rules of the index are. It's not like some gigantic mystery. Whoa, what's going to get at the S&P 500? We know. And so there tends to be a drift higher and then a give back. And you guys don't have to participate in that particular game.

That's exactly right. And we get asked that question a lot from investors who maybe haven't been introduced to the reconstitution effect before. It is visibly bothering them. And oftentimes when I have that conversation with people about, But hey, just so you know, you're playing poker with your hand face up when you, you know, invest in an index fund. Everybody knows what you're going to do, and they will absolutely take advantage of that information. But the cards are pretty good.

And the defensive index funds, the cards are pretty good. For the, you know, for the last couple of years, that's definitely been true, especially one index in particular. But, you know, historically when you look at our track record versus indices that index funds are trying to replicate, it's phenomenal. So I think that's something that investors have to step back and say, you know, Am I okay with, you know, all other active managers and traders and hedge funds going out there and front running what I'm doing? Or do I think I kind of want to be able to zig when everybody all zags? And if that's the case, maybe index funds aren't right for you and Dimensional is a good place to look. Not a bad pitch.

All right. Rob, thank you very much for coming on. We appreciate the time. Thank you. Okay. Thanks again to Dimensional Funds, memberdimensional.com to learn more. Thanks to Rob. Thanks to production team, as always, Animal Spirits at the Compound.

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