2-Fund-advisor

DoNotCopy9-203-026REV:JANUARY28,2003________________________________________________________________________________________________________________ProfessorRandolphB.Cohenpreparedthiscase.HBScasesaredevelopedsolelyasthebasisforclassdiscussion.Casesarenotintendedtoserveasendorsements,sourcesofprimarydata,orillustrationsofeffectiveorineffectivemanagement.ProfessorJayLightprepared“DimensionalFundAdvisors:1993,”HBSCaseNo.294-025.Copyright©2002PresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchool.RANDOLPHB.COHENDimensionalFundAdvisors,2002InJuneof2002,DavidBoothfacedadilemma.Hisfirm,DimensionalFundAdvisors(DFA),hadinrecenttimesshownstellarperformanceaftergoingthroughsomerelativelyroughpatchesinthelate1990s.Growthwassteadyandprofitsstrong.Yet,PensionsandInvestmentsrankedDFAamere96thinsizeamonginvestmentcompanies(seeExhibit1).WhileDFAhadneverviewedmaximizingassetsundermanagementasagoal,therankingdidsuggestthatitmightbepossibleforDFAtoachievemoreasafirmthanitcurrentlywas.ShouldBoothandDFAcontinueonthepaththathadbroughtthemthisfar?OrwasthisthetimeforamajorinitiativethatcouldcatapultDFAtoastatusamongthelargestfirmsinthebusiness?TheCompanyanditsClientsDFAwasaninvestmentfirmbasedinSantaMonica,California.Foundedin1981byBoothandRexSinquefield,twoformerstudentsattheUniversityofChicagoGraduateSchoolofBusiness,DFAwasdedicatedtotheprinciplethatthestockmarketwas“efficient”—thatis,whileoveranygivenperiodsomeinvestorsbyluckwouldoutperformthemarketandotherswouldunderperform,noonehadtheabilitytoconsistentlypickstocksthatwouldbeatthemarket.Suchbeliefswereassociatedwithproponentsofindexfunds,and,indeed,SinquefieldhadrunoneoftheveryfirstS&P500indexfundswhileatanotherfirm.ButDFAwasnotsimplyanindexfundmanager.Inadditiontoefficientmarkets,DFA’sfoundersbelievedpassionatelyintwootherprinciples:thevalueofsoundacademicresearch,andtheabilityofskilledtraderstocontributetoafund’sprofitsevenwhentheinvestmentwasinherentlypassive.Atitsfounding,DFAsurmisedthatactingonthesecorebeliefswouldmakeituniqueamonginvestmentcompanies.By2002,DFAhad130employees,over100ofwhomworkedinthemainofficebytheseainCalifornia.MostoftherestworkedinaChicagoofficeandtwoothertradingoffices,inLondonandSydney.Inaddition,thefirmhadcloseworkingrelationshipswithanumberofprominentacademics,especiallyEugeneFamaandKennethFrench,whohadbeeninvolvedwiththefirmfromitsearlydays,whentheybothtaughtfinanceattheUniversityofChicago.DFAencouragedacademicstoworkonsubjectsofinteresttothefirmbygivinganyprofessorashareofprofitsfrominvestmentstrategiesderivedfromhisorherideas.DoNotCopy203-026DimensionalFundAdvisors,20022DFAhadstartedwithasingleinvestmentfundthatheldsmallstocks,butitnowofferedafairlybroadproductline(seeExhibits8and9forinformationonDFA’sequityproducts;DFAalsohadabout$2billionoffixed-incomeinvestments).Still,smallstockscontinuedtobeDFA’sprimarybusiness.DFA’sfeestendedtobelowerthanthoseofmostactivelymanagedfundsbuthigherthanthoseofpureindexfunds(seeExhibit5).ThiswasfittinggivenDFA’spositioninthemarketasapassivefundthatstillclaimedtoaddvalue.DFAbeganbymanagingmoneyformajorinstitutions,andtheseoriginalclientscontinuedtomakeupthemajorityofitsbusiness.ThetotalamountinvestedinDFAbyinstitutionswasabout$25billion.Suchclientsnumberedover125andincludedcorporate,government,andunionpensionfunds,collegeendowments,andcharities.NearlyallofDFA’sinstitutionalclientsweretaxexempt,eitherbecauseoftheirnot-for-profitstatusorbecauseofthetaxexemptionsgrantedtoretirementplans.In1989,DFAdecidedtopursuehigh-net-worthindividuals,inadditiontoinstitutions,asclients.BecauseoftheilliquidnatureofmanyDFAholdings,itdecidedthatdirectaccountswithindividualinvestorswouldlikelyleadtointolerablyhighcosts.Instead,DFAofferedinvestmentservicestoindividualsthroughalimitednumberofinvestmentandaccountingfirmsthatactedasintermediariesknownasregisteredinvestmentadvisors(RIAs).TheRIAschosensharedDFA’scorebeliefs,especiallytheimportanceofdiversification,lowturnover,andlowtransactioncosts.TheadvisorsreceivednopaymentdirectlyfromDFA,butDFA’slowfeesenabledthemtochargeamoderateadvisingfeetotheclientwhilestillkeepingtotalchargesreasonable.ThesearrangementsbenefitedbothDFAandtheadvisors.DFAprovidedtheRIAswithalow-feeproductthattheclientswouldnotbeabletoobtainontheirown.Inaddition,DFAeducateditsRIAsbyprovidingthemwithaccesstotopresearcherswhoweredevelopinginnovativetheoriesandempiricalanalyses.TheRIAsthenusedwhattheyhadlearnedtoadvisetheirclients.Inmanycases,thisadvicegeneratedquestionsthatDFAdeliveredbacktotheacademicsforcontinuedresearch.Fortheirpart,theRIAsbroughtDFAapoolofwealthyclientswhoseoverallinvestmentsinDFAwerequitesubstantial.SinceDFAdidnotadvertise,theRIAswereacrucialcond