The three-factor model offers an elegant framework for portfolio design, analysis, and investment discipline. It brings order and clarity to the investment process, isolating and explaining the forces that drive returns in a portfolio.
Dimensional started with a single micro cap portfolio that helped pioneer small cap investing. Since then, the fund family has grown to include a broad range of portfolios worldwide. This would seem to be a perplexing number of choices were it not for the consulting technology and investment philosophy that evolved alongside the strategy line. Dimensional's funds are coordinated by elegant models of risk and return, trial-tested in academic labs and time-tested in actual portfolios.
Dimensional's research has shown that the three-factor model on average explains about 96% of the variation of equity returns among fully diversified professional investment plans. Investing therefore largely consists of deciding the extent to which your portfolio will participate in each of the equity market dimensions: small/large and value/growth. The greater the risk exposure, the greater the expected return. Because the model is so robust and explains so much of average performance, it serves multiple functions:
The Dimensions of Risk and Return
Strategy Design
The model suggests that portfolios should be sorted along size and price dimensions to control risk and best capture expected return. The model helps set the criteria for weighting stocks based on the purity of their factors.
Asset Allocation
The model precisely defines risk exposures and serves as a framework to help investors structure portfolios that accurately capture the expected returns of each underlying asset class.
Analysis
The model is indispensable for measuring portfolio "style" and past performance. It also produces expected return calculations that, though not predictive, help us manage assets with scientific rigour.
Discipline
The model helps bring purpose and focus to an otherwise chaotic investment process. It offers a frame of reference that helps investors navigate tough market conditions, set and maintain expectations, apply logic, and maintain discipline. The multifactor model helps us separate investing from speculating.
Dimensional Fund Advisors Ltd. is authorised and regulated in the United Kingdom by the Financial Services Authority (FRN: 150100). You should obtain relevant and specific professional advice before making any investment decision. Past performance is not an indication of future performance. Please read the Important Information.
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Core Equity Strategies