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BAM Intelligence

Comparing DFA Small Value to Vanguard Small Value

Over the past few months, the difference in historical performance between DFA Small Value (ticker: DFSVX) and Vanguard Small Value (VISVX) has narrowed. For example, for the 10-year period ending December 2014, the compound annual return of DFSVX was 7.9 percent while VISVX earned 8.3 percent. Comparatively, for the 10-year period ending December 2012, compound annual returns were 11.3 percent for DFSVX and 9.6 percent for VISVX. What explains this reversal?

Examining the Early Period

From January 2003 through December 2012, a factor analysis shows the two funds had roughly comparable exposure to value, but DFSVX had markedly higher exposure to market risk (i.e., beta risk) and owned much smaller companies. Since both the equity market and small-cap stocks did exceedingly well during this period, with an average annual equity premium of 8.0 percent and a size premium of 4.3 percent, it’s not surprising to see that DFA Small Value had substantially higher performance than Vanguard Small Value.

Examining the Later Period

From January 2005 through December 2014, a factor analysis shows essentially exactly what we found in the earlier period: DFSVX had markedly higher exposure to market risk and small-cap risk than VISVX. Both the market premium and size premium were positive over this period, albeit the average annual size premium was just 1.0 percent. So, what explains the slightly lower returns of DFSVX compared with VISVX?

First, it’s worth noting that the average annual returns of DFSVX were slightly higher than VISVX, but the compound returns were lower due to the higher volatility of DFSVX (24.2 percent volatility) compared with VISVX (20.5 percent volatility). The primary explanation for the performance differential was that the higher volatility of DFSVX compared with VISVX more than offset the incremental return benefit of having more exposure to market risk and small-cap risk. In periods such as 2003–2012 when the size premium is closer to its historical average, the additional volatility does not tend to offset the higher average annual returns.

Second, DFA Small Value excludes both REITs and highly regulated utilities while Vanguard Small Value does not. Over this later 10-year period, both REITs (using the Dow Jones U.S. Select REIT Index) and utilities (using Ken French’s utilities industry series) had higher returns than Vanguard Small Value itself, indicating that this is likely another explanatory factor. The higher returns of these two sectors, which are frequently a substantial portion of VISVX’s portfolio, likely pulled VISVX’s returns up relative to what they would have been had Vanguard followed the same sector-exclusion methodology as DFA.

This commentary originally appeared March 30 on MultifactorWorld.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

© 2015, The BAM ALLIANCE

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Jared Kizer, Chief Investment Officer

The BAM ALLIANCE

Jared Kizer is Chief Investment Officer for the BAM ALLIANCE.

In 2008, Jared co-authored the book The Only Guide to Alternative Investments You’ll Ever Need with financial author Larry Swedroe. Jared has written several articles on topics including retirement planning and investment policy. His work has been published in The Journal of Portfolio Management, Journal of Indexes and indexuniverse.com. Jared has made appearances on local and national television, including Bloomberg Television. Additionally, he writes the blog Multifactor World.

Jared holds a master’s degree in finance from Washington University in St. Louis.

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