Wednesday, July 9, 2014

Dimensional Fund Advisors Shows How to Bet on Emerging Markets When You're Honest And Admit You Don't Really Know What's Going to Happen

This looks very, very smart.
The approach seems to solve one of the major portfolio construction problems in Emerging/Frontier investing: if you try to control risk by buying market cap you end up owning all the banks and not much else.
From Bloomberg:
Dimensional Winning in Emerging Markets: Riskless Return 
Investing in emerging-market small-cap stocks paid off in a big way for Dimensional Fund Advisors LP this year.

Dimensional’s $4.7 billion Emerging Markets Small Cap Portfolio produced the highest risk-adjusted return of 197 similar funds in the first half, according to the BLOOMBERG RISKLESS RETURN RANKING, by spreading cash across more than 3,000 stocks of small businesses in 17 countries from India to Brazil, while skirting Russia. The fund, managed by Karen Umland and Joseph Chi, gained 1.2 percent when adjusting for price swings, double the return of the MSCI Emerging Markets Index.

Umland and Chi shun stock picking and invest based on research from Dimensional board members Kenneth French and Nobel laureate Eugene Fama, 75, whose model argues that small-cap stocks, often defined as companies with a market value of $250 million to $2 billion, beat broader markets on a regular basis. The fund, which has 11 percent of assets allocated to Indian stocks, was bolstered by the 56 percent rally in that country’s small caps leading up to Prime Minister Narendra Modi’s May electoral win.
“The past six months has been a good period for small-cap stocks in emerging markets,” Umland said by phone from Santa Monica, California. “Small caps in India, for example, have had a very strong period and we have a slight overweight in India compared to most benchmarks based on our methodology.”

Risk Control
Her fund produced a total return of 11 percent in the first six months, seventh-best in the ranking, and had the seventh-lowest volatility, at 8.8. Bloomberg’s risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. The returns aren’t annualized...MORE 
We are fans of DFA's Fama/French Forum and have featured their thinking on a couple topics close to our jaded hearts:
Fama/French: "Luck versus Skill in Mutual Fund Performance" (LMVTX)
UPDATED--The Missing The "Best Days" in the Market Fallacy
"The Equation that Will Change Finance"
Fama-French Have A Come-to-Buffett Moment
Fama/French Forum: "Q&A: Seeking the Inefficient Asset Class"