Like many investment managers who look to diversify clients’ stock holdings, Glassman Wealth Services has an allocation to Emerging Market stocks. Dimensional Fund Advisors (DFA) is one of the larger mutual fund players in the category, and to us, their Emerging Markets Core Equity Portfolio (Symbol: DFCEX) seemed like a nice blend of active and passive management for clients looking to invest there. But now DFA is increasing their allocation to China stocks, leading us to reexamine this investment’s role in client portfolios.
When our clients first invested in the fund years ago, we liked the fact that it wasn’t a true index that would blindly follow the herd of market cap (size) weighted indexes, and it would have relatively low cost, low turnover and therefore lower taxable distributions, all while still offering exposure to a promising asset class.
The other thing we appreciated was they limited their maximum country initial purchase exposure to 17.5% to prevent over-concentration. This limit really affected only China, who as of today, makes up a little over 30% of the Emerging Markets index. As China is the world’s second largest economy and no longer growing at double digits, should it really make up a full third of an “emerging markets” portfolio?
It left me curious to know how this China allocation stacked up against other leaders in the Emerging Markets space, in both actively-managed and passive index funds. After all, if a management team can choose their exposure – and not follow market cap (size) weights, would they choose to allocate close to a third of the fund to China?
The results were mixed. While the Vanguard index has an sizable 35% in China, the other large players chose to allocate less. Here’s the breakdown:
As DFA implements this change, it is going to become more like an index versus its actively-managed peers – at least among the largest funds.
The question we are asking ourselves is this: Is DFA’s factor-based allocation to stocks worth the extra 0.38% when compared to an index fund?
Investors are left with a few choices:
1. Stick with DFA’s new closer-to-the-index allocation; believe that their factor-based stock weightings could result in outperformance and are worth the extra cost.
2. Deal with tracking error (or difference in performance compared to the index return) and switch to a more actively-managed fund. This could outperform the index in some years but could also fall short in other years.
3. Save the cost; forget trying to outperform, and just invest in an index fund.
It’s no easy decision, but it’s one investors should evaluate carefully from the perspective of cost, taxes, performance, and personal investing goals.