We’ll now look at the funds’ performance over the last 10 calendar years, 2005 through 2014. During this time frame, the annualized return of the size factor was just 1.1 percent and the annualized return of the value factor was just 0.3 percent.
VBR returned 8.50 percent, DFSVX returned 7.93 percent and DFREX returned 8.14 percent. The DFA portfolio allocated 90 percent to small value and 10 percent to REITs, and rebalanced annually, would have returned 8.05 percent.
VBR outperformed the DFA portfolio by 0.45 percentage points, virtually matching the difference between the current expense ratios of the two portfolios (0.41 percent). The current expense ratios are: VBR, 0.09 percent; DFSVX, 0.52 percent; DFREX, 0.18 percent; and the 90/10 DFA portfolio, 0.49 percent. Also during this period, the size and value premiums were much smaller than their long-term averages.
Our final look will be at the most recent five calendar years: 2010 through 2014. In this period, the annualized size factor return was 1.2 percent and the annualized value factor return was -1.1 percent. During this period, VBR returned 16.57 percent, DFSVX returned 16.77 percent and DFREX returned 16.97 percent. The DFA portfolio allocated 90 percent to small value and 10 percent to REITs, and rebalanced annually, returned 16.99 percent.
In this case, the returns of the Vanguard fund, the DFA funds and the DFA 90/10 portfolio were very similar. This is about what we would expect, because the size and value premiums canceled each other out, and the return on REITs was only slightly higher than the return on small value stocks.
What conclusions can we draw? The first is that asset pricing models, while not perfect replications of the way the world works, do a very good job of explaining returns.
Second, if you expect that, over the long term, the size and value premiums will be about their historical averages and REITs will underperform small value stocks (from 1978 through 2014 the Dow Jones Select REIT Index returned 12.7 percent versus the 15.2 percent return for the Fama-French U.S. Small Value [ex-utilities] Index), then you should also expect that DFSVX will outperform VBR, due to its higher loadings on these factors.
On the other hand, we should also expect that there will be periods, possibly even very long ones, when the small and value factors will provide negative returns and REITs will outperform. During such periods, you would expect DFSVX to underperform. What you want to avoid is the mistake of chasing performance. Investment decisions should be based on long-term evidence, not recent performance.
The bottom line is that to avoid making mistakes in analyzing the performance of similar funds, even two passively managed funds in the same asset class, it’s important to ensure you’ve looked under the hood and understand each fund’s sources of returns.
Larry Swedroe is the director of research for the BAM Alliance, a community of more than 150 independent registered investment advisors throughout the country.