Usually it is the fund wholesaler who finds himself politely escorted out of an investment advisers' office with nothing but a sales pitch to show for his time. But Dimensional Fund Advisors, with approximately $31 billion in assets under management, has managed to turn that situation around.
Excluding market timers, most fund complexes are not too choosy about who pushes their funds, but not Santa Monica, Calif.-based Dimensional. The asset management firm is not only picky about who represents its products, but insists that the advisers who sell them abide by some hard and fast rules.
Dimensional distributes its products through institutional clients, including charities, endowments, pension plans and local governments. It started distributing its products to the retail market through fee-only advisers in the late '90s, said Weston Wellington, VP of the firm's research group. The firm's products are available via Schwab and Fidelity supermarkets on a transaction-fee basis, he said.
But not just any fee-only adviser can call up and begin selling Dimensional's funds. Advisers must undergo a rigorous screening process in which their business and clientele are evaluated to ensure that there is a "good fit" between the two companies, Wellington said. More often than not, it is the fee-only adviser that finds himself in the odd situation of being told, "Don't call us, we'll call you."
Dimensional works with approximately 300 fee-only advisers, which represents about $13.6 billion of mostly high-net-worth assets, Wellington said. Those chosen 300 have undergone Dimensional's screening process, which includes an initial visit to the adviser's office and a short interview. If it appears there may be a fit, Dimensional extends the adviser an invitation to a three-day seminar that they attend at their own expense, Wellington said. The seminar covers the intricacies of Dimensional's investment strategy.
Whether or not there is a "fit" is based on the advisers' willingness to adopt Dimensional's investment and business philosophy. "We look for people that are in philosophical agreement with our approach so they will use passive vehicles across their portfolio," he said. "We're looking for people that have made the belief system switch."
The "belief system switch" advisers are required to make must embrace the principals upon which Dimensional was founded. In 1981, David Booth and Rex Sinquefield established the firm on the Bogel-esque philosophy that investment returns are determined principally by asset allocation, not market timing or stock picking. But unlike John Bogel's Vanguard, or other index fund providers, Dimensional creates structured portfolios designed to capture the return behavior of an entire asset class, not an entire index.
Whereas most index funds invest a certain percentage of assets weighted equally across an index of securities, Dimensional's funds use a structured investment approach. By doing so, the funds invest in a fixed sector or group of securities which are not weighted relative to a particular index. That allows the manager to purchase securities when they are available at an attractive price rather than whenever the fund needs to be rebalanced relative to its index.
Dimensional builds, manages and markets more than 50 portfolios, using a cadre of academics who provide research and design support for the products. The "brain trust" that Dimensional has established to support and market its products include the likes of Eugene Fama, the firm's director of research, as well as Nobel Prize winning economists Merton Miller and Myron Scholes. The firm's ties to the academic world are part of its cachet with advisers, Wellington said.
But that cachet comes with a price. Dimensional adheres to the belief that passive investing will always outperform active management and insists that the advisers who sell its products think the same. In fact, Dimensional wants its advisers to gradually transfer all of their assets over to a passive investment style, preferably in Dimensional's products, Wellington said. Advisers who cannot place their entire faith in the passive management system are "discouraged from working with us," he said.
Given the recent market environment, the ranks of new converts to passive management are growing, Wellington said. Sooner or later, he says, every adviser engaged in picking actively managed funds get burned by the markets. That point represents an epiphany for some advisers who begin to see passive investing as the only reasonable way to invest, Wellington said. "They are ready to hear the story," Wellington said. "They've had what we call The Experience' where they realize that the portfolio manager isn't bulletproof."
Scott Dauenhauer, president of Meridian Wealth Management of Aliso Viejo, Calif., is one of Dimensional's converts. Dauenhauer likes Dimensional's pure 100% no-load funds with low expense ratios that range from 18 to 105 basis points. "It's kind of [unusual]," he said. "Most people they don't accept. You have to go to their headquarters and learn how they manage money. And they only want advisers to sell their funds [as] they see fit."
Plus, the academic research the firm provides is a feature that most advisers cannot get elsewhere, he said. "They are constantly doing things to make sure that you get the most for your money," Dauenhauer said.
The philosophy and passive management mantra Dimensional uses to market its products to advisers is backed up by some pretty solid numbers. In a year in which most fund shops' are reporting net outflows, Dimensional has managed to remain on the positive side, according to Financial Research Corp. Through September, Dimensional's net flows totaled $1.1 billion, compared to $914 million for the same period the prior year. Moreover, Dimensional is outpacing the rest of the industry in 12-month asset growth rate by 21%, said Whitney Dow, an analyst with FRC.
More amazing still is that the firm has been able to attract new assets in a year in which most of its funds have poor one-year performance. With the exception of its fixed-income products, year-to-date performance for most of Dimensional's funds is negative, according to Morningstar.
Dimensional's products are popular with the registered investment adviser channel because they offer advisers a process and philosophy which they can market to their clients, Dow said. "These people that [Dimensional] handpicks buy into this philosophy and it would be a pretty easy sell I would think, given the brainpower behind the product," Dow said.