Dimensional investment philosophy has gained widespread recognition in recent years for its unique approach to evidence-based investing. By systematically capturing market premiums like value, size and profitability, Dimensional aims to maximize returns for a given level of risk. In this article, we will review the core tenets of Dimensional philosophy, examine the research evidence behind it, and highlight practical implications for investors. Multiple in-depth analyses of Dimensional strategies will provide crucial insights into this investment paradigm centered around harnessing the power of market dimensions.
Origins and key principles of Dimensional philosophy
Dimensional Fund Advisors was founded in 1981 by David Booth and Rex Sinquefield, drawing upon financial research by luminaries like Eugene Fama and Kenneth French. The key insight underpinning Dimensional philosophy is that equity returns are largely explained by systematic exposures to factors like market, size, value and profitability. Dimensional strategies aim to deliver superior long-term results by structuring portfolios around these pervasive drivers of returns. This contrasts with traditional active management focused on mispricings for individual stocks. By targeting broad dimensions of expected returns, Dimensional philosophy offers a rules-based, low-cost approach for capturing equity premiums.
Robust empirical evidence for Dimensional factors
Decades of research provide strong justification for the premiums Dimensional targets. Small cap and value stocks have outperformed over extended periods due to higher risk and behavioral biases. Profitability and momentum premiums are also well-documented in finance literature. By structuring portfolios around securities with high exposure to these return drivers, Dimensional strategies have historically delivered excellent results. Investors benefit from Dimensional’s ongoing involvement in financial research to incorporate new dimensions like profitability and momentum into portfolio design.
Benefits of Dimensional approach for asset allocation
In addition to equity strategies, Dimensional approach offers insights for fixed income allocation and portfolio design. Bond returns have exposures to core risk factors like term and credit. Dimensional fixed income strategies target term and credit premiums for consistent returns. For overall portfolio construction, Dimensional advocates broad diversification across equity factors, asset classes, and geographies based on market dimensions. This evidence-based process increases expected returns for a given level of portfolio risk compared to market cap weighted indices.
Implementation challenges for Dimensional strategies
While philosophically sound, Dimensional approach poses implementation challenges. Strategies targeting small cap and value stocks may underperform the market for extended periods. This requires discipline to stay the course during periods of short-term underperformance. Portfolio turnover and trading costs are also higher for certain Dimensional strategies. However, Dimensional’s expertise in efficiently executing complex strategies helps mitigate implementation hurdles. Overall, Dimensional continues to deliver for investors seeking rules-based, structured exposure to sources of higher expected returns.
Dimensional investment philosophy offers a research-driven approach for capturing equity and fixed income premiums based on portfolio dimensions like size, value and profitability. Decades of empirical evidence support the existence of these premiums. While requiring discipline through periods of short-term underperformance, Dimensional strategies have generated excellent long-term results by systematically targeting multiple dimensions of higher expected returns.