Monday, June 29, 2015

Investing Patience is a Virtue in More Ways than One

Each year at the end of June the Russell indexes rebalance, making sure that the mix of stocks each index owns continues to represent the slice of the market it was designed to represent.  While the list of companies being added and subtracted was announced earlier this month, on Friday the additions and subtractions to the Russell indexes took place.

This delay between the announcement of the changes and the actual changes themselves can be a bit of a problem for index funds, since they need to sell the stocks that leave their index and buy the ones that come in on the same day.  Meanwhile, traders know that there are going to be huge sales of some stocks and huge buys of others, and they know exactly which stocks will go through those trades and on exactly what day, so they can load up on the ones that will be in demand and go short on the ones that will be losers on rebalancing day.

It hasn't been a huge problem, but one that can add up over a lifetime of investing.  Now large brokerage firms are putting more pressure in traditional index funds as well.  According to a Reuter's article from Thursday, many have cut discounts that they make available to index funds because too many other institutional and retail investors are front-running the index rebalancing.

Unfortunately, the Reuter's article incorrectly lumps Dimensional Funds Advisors in with the major index fund companies as being affected by this.  In fact, one of the reasons we like using DFA funds is that they DO NOT strictly follow any one index, and weren't forced to buy or sell any stocks on Friday.  This flexible approach has added real value to portfolios, but it can be hard to explain how value can be added without any market predictions or stock forecasts.  As a friend of mine said:

"Telling the Dimensional story can be difficult because they don’t fit the traditional active management model since they don’t rely on forecasting to attempt delivering market beating returns. And they aren't like an index fund because they do not outsource their investment decisions to a benchmark that delivers its stated objective on the day of reconstitution only to immediately drift from its target because prices change daily."

We've posted a short video to our website explaining some of the differences between traditional index fund trading and DFA's flexible approach to investing - it's worth the three-minutes to watch it.

1 comment:

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