We recently took a look under the hood of three similar, but different, passively managed U.S. small value funds—Vanguard’s Small-Cap Value ETF (VBR | A-100) and two structured portfolios: one from Dimensional Fund Advisors (DFSVX) and one from Bridgeway (BOSVX). (Full disclosure: My firm, Buckingham, recommends Dimensional and Bridgeway funds in constructing client portfolios.)
In that comparison, we noted one of the differences between VBR and the two other funds is that VBR—an index fund—includes REITs in its holdings, while DFSVX and BOSVX don’t. We discussed how the inclusion, or exclusion, of REITs significantly impacted the relative performance of the three funds in 2013 (when REITS dramatically underperformed small value stocks) and in 2014 (when REITS dramatically outperformed small value stocks).
Finally, we addressed some of the reasons a fund would consider excluding REITs: they’re tax inefficient; they have lower expected returns than small value stocks; and investors may already have exposure to REITs in other holdings. What’s more, if an investor wants exposure to REITs, they can own them directly in a REIT index fund and determine the amount of exposure they want.
The REIT Effect
Today we’ll see how the inclusion or exclusion of REITs impacted longer-term results. To begin, we’ll examine the performance of VBR and the Dimensional Fund Advisors (DFA) U.S. Small Cap Value Fund, DFSVX, over the 15-year period from 2000 through 2014.
During this period, VBR returned 10.70 percent per year, while DFSVX returned 11.62 percent. Note that over this period, the annualized return of the size factor was 3.6 percent and the annualized return of the value factor was 4.9 percent. Thus, you would expect DFSVX to have outperformed, because it has higher loadings on the size and value factors.
I would further note that during the most recent 15-year period, the annualized factors delivered somewhat higher returns than their long-term record indicates. From 1927 through 2014, for example, the annualized size factor was 2.2 percent and the annualized value factor was 4.0 percent.
VBR currently has about a 10 percent allocation to REITs. To determine how DFSVX’s exclusion of REITs impacted the relative performance of the funds during this period, we’ll now analyze the results from a portfolio allocated 90 percent to DFSVX and 10 percent to DFA’s REIT fund (DFREX). For investors who wanted exposure to REITs, this would be the way to replicate the holdings in VBR. It also makes the comparison of the two funds’ performance more of an apples-to-apples one.
From 2000 through 2014, DFREX returned 12.60 percent, outperforming DFSVX by almost a full percentage point. The annually rebalanced portfolio containing the two DFA funds would have returned 11.81 percent—1.11 percentage points more than the return of VBR.