DFA reconstitutes its portfolios on a daily basis, but the Fama-French factors don’t move meaningfully day to day. As a result, mindful of trading costs, we rebalanced monthly. The differences between DFA Small Value and our artificial blend are de minimus, implying that investors can use a combination of ETFs from a variety of providers—within a relatively broad range of asset mixes—to mimic the exposure of the DFA fund. The clone isn’t all that sensitive to the percentages. Any ratio of VBR and IWC between 85 percent and 15 percent and 75 percent and 25 percent works pretty well and is certain to save on fees (Figure 12).
Lagging DFA by a squeak is no cause for concern. The inequality in SmB and HmL betas is the source of our remaining mismatch in returns. Our clone still has lower SmB and HmL loadings than DFA. If we reduce the shortfalls, we’ll reduce the bandwidth around the clone. Coefficients equal to DFA will lead to equal returns; if investors want to “win” and have their clone outperform, then they can make sure their clone factor coefficients are greater than their DFA target. We used Vanguard and iShares funds because they had long histories but were an imperfect fit; today there are more offerings with even higher “small-cap” and “value” factor loads, so we could make an even better clone.
Benchmarking Benchmarks: The Investment Landscape Viewed Through A Factor Lens
To obtain the desired target values of SmB and HmL, etc., we’re building portfolios of index funds, which is simple enough, but how do investors know what building blocks to use? There is a wide range of SmB and HmL loadings within the small-cap value space that allows investors to accurately target the dimensions of higher expected returns (Figure 13). Any low-cost fund is a suitable building block. Vanguard isn’t on no-transaction fee platforms, other than its own, because it won’t pay distribution fees; but that’s not a problem. Mutual funds—and ETFs, by extension—are generally priced as if they are highly differentiated products, when in reality it is very much a commodity business.