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April 16, 2024

Dimensional's co-CIO on building up active ETFs — and race cars

Savina Rizova, co-CIO at Dimensional Fund Advisors in Austin, Texas, is a fan of professional race-car driving, noting there are some parallels with her specialty — systematic investing.

 

“I enjoy it because it’s science and human nature, but working to win a race," she said. "The new cars have new things, enhancements that everyone’s noticing but can’t figure out. There’s lots of technical engineering and people fight for every second and part of a second, even how fast you change gears and tires. It feels very similar to how we fight for every basis point” at Dimensional.

Barry Ross Creative

Dimensional co-CIO Savina Rizova

Rizova has worked at the firm almost continuously since 2004. She has been Dimensional’s global head of research since 2017, and became co-chief investment officer alongside Gerard O’Reilly, who is also a co-CEO, effective Feb. 1. She holds a Ph.D. in finance and an MBA from the University of Chicago Booth School of Business. As an undergraduate at Dartmouth College, she was a research assistant to famed Professor Kenneth French. 1

 

She continues to work with academics — from Eugene Fama1 and Robert Merton2 to Robert Novy-Marx3 and Marco Di Maggio — collaborating on research, co-authoring papers, and with Dimensional’s investment team to implement research in live portfolios.

The firm's currently in the lead pole position in actively managed ETFs.

 

In the arena of mutual fund conversions to ETFs, Dimensional has been one of the fastest-growing firms in terms of assets under management. Of P&I's list of the top 25 managers sponsoring exchange-traded funds/notes, Dimensional Fund Advisors ranked No. 11 on P&I's most recent list. Dimensional manages $719 billion in global, firmwide AUM, all in systematic active funds across asset classes and wrappers (mutual funds, ETFs, separate accounts); its 38 ETFs had $134 billion in AUM as of March 28.

 

 

Dimensional believes indexing “suffers from rigidity.
It’s become the easy button, but it’s not the
right button for all clients.”

 

 

“We started with mutual funds a long time ago. And in those mutual funds we applied a daily systematic investment process that targets higher returns,” Rizova said. “For a long time, the rules for ETF management were not suitable to incorporate all the value-adds we bring. But in 2019, the SEC's ETF rule allowed for daily baskets to work with APs (authorized participants) and effectively buy and sell. That meant we can now incorporate a lot more value-adds in the wrapper” such as securities lending revenue.

 

From 2020 to 2024, Dimensional grew to 38 actively managed ETFs. “We’re the largest actively managed ETF company”4 and continue to see positive inflows into all of them, she said. Also, 20 Dimensional ETFs have had more than $1 billion in net flows since inception.5

 

Why the conversions? Dimensional famously works alongside advisers who are extremely loyal to the firm and its quantitative strategies.

 

“This was in response to more and more professionals and advisers preferring the ETF vehicle over the mutual fund vehicle for taxable clients, and ease of trading through the day and for no ticket charges,” she said. That’s unlike mutual funds, which may incur ticket charges, Rizova added.

 

Dimensional also closely watches its competitors among active ETFs. Those include J.P. Morgan Asset Management, home to some of the largest active offerings; BlackRock; Avantis Investors, a division of American Century Investments; Capital Group; T. Rowe Price Group; First Trust; and a more recent entrant, Morgan Stanley Investment Management.

 

The trend globally has been unrelenting; mutual funds bled roughly $656 billion in 2023, while ETFs raked in $578 billion, Investment Company Institute data compiled by Bloomberg showed.

 

But many pension funds and other institutional investors have been slow to embrace ETFs.

 

“Some are embracing this. We have conversations about usage of some of our ETFs by large institutional clients," she said. "They realize for a certain asset class and geography it might be faster and more efficient from cost perspective, or to change asset allocations, especially in emerging markets. If you have a direct separate account that requires subaccounts, that takes time and lot of filings and cost. Instead, you can go directly into an ETF for a similar allocation."

 

Dimensional hosts an annual institutional symposium for clients and prospects, and on ETFs, “there’s a lot of interest in how they operate, especially from institutional clients because they oversee larger asset pools.”

 

Dimensional also works with pension funds’ securities lending agents to “ensure we maximize their (lending) rates. Are they competitive and up to date? We’ve also been pioneers in providing emerging market lending,” Rizova said. Their fees are “usually very attractive, or favorable relative to the competition.”6

 

In emerging markets small-cap equities, “our mutual fund there has had over 30 basis points in securities lending revenue.7 That’s how talented the portfolio management team is at getting the most revenue.”


Indexing is rigid

The pursuit of lower costs, and focus on expense ratios “has driven institutional clients to indexing. That obsession with explicit cost led them to choose the lowest cost out there. But at Dimensional, we believe low costs are important in indexing. However, indexing does leave money on the table — both through design, by non-daily management, including how you approach securities lending.”

 

Dimensional believes indexing “suffers from rigidity. It’s become the easy button, but it’s not the right button for all clients.”

 

For example, “how you deploy cash? How do you incorporate short-term reversals? If you don’t have a daily process with flexibility, you don’t effectively incorporate those into a systematic approach."

 

Here's the thought process behind forming a U.S. portfolio at Dimensional: "We start with what’s out there in the U.S., say a common stock; then refine the universe, what’s liquid enough. We exclude REITs from U.S. equities. REITs throw out non-qualified dividend income. From there, we decide how much to over- and underweight parts of the market depending on highest expected return vs mega-cap growth. We identify the universe on a daily basis. For example, say a stock’s become a target of a cash merger and it’s no longer trading like a stock. It’s now trading like cash,” she explained.

 

The Magnificent Seven has led to meaningful concentration in the S&P 500 and U.S. large-cap indexes, Rizova noted.

“In our large-cap and all-cap funds, those securities have lower weights. They’re mega caps, so they typically trade at high valuations. Not all of them are highly profitable. So they’re likely to be underweighted in our portfolios. Because of that, we are going to deviate from the market, sometimes positive or negative. But we work to educate clients,” Rizova said.

 

And in the conversion race, many new ETF entrants cost less than mutual funds.

“When we launched the ETFs, we spent time making sure that would not be a driver. Dimensional mutual funds and ETFs are very similar in cost if not identical,” she said.

 

Dimensional has at least one active ETF that costs less than 0.1%, or 10 basis points. The Dimensional U.S. Equity ETF has a net expense ratio of 9 basis points, Dimensional's website showed.8

 

On the mutual fund side, “we have converted all our tax-managed mutual funds into ETFs over the past two years," Rizova said. "We currently have no other filings. On ETFs, we launched everything we filed for. If we decide to launch more, we will register.”

FOOTNOTES

1. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.

 

2. Robert Merton is a Nobel laureate and Resident Scientist at Dimensional Holdings, Inc. and provides consulting services to Dimensional Fund Advisors LP.

 

3. Robert Novy-Marx provides consulting services to Dimensional Fund Advisors LP.

 

4. Largest active ETF manager based on AUM as of March 31, 2024. Data provided by Morningstar.

 

5. Source: Dimensional. Total net flows is since launch or conversion as of December 31, 2023.

 

6. Dimensional ETFs are priced within the lowest quartile of Morningstar category peers as of March 31, 2024.

 

7. Fiscal year as of October 31 (November 1, 2022–October 31, 2023).

 

8. Fee and expense information as of the prospectus dated February 28, 2024. Total Operating Expense Ratio is also 0.09%.

 

DISCLOSURES

Consider the investment objectives, risks, and charges and expenses of the Dimensional funds carefully before investing. For this and other information about the Dimensional funds, please read the prospectus carefully before investing. Prospectuses are available by calling Dimensional Fund Advisors collect at (512) 306-7400 or at us.dimensional.com.

 

ETFs trade like stocks, fluctuate in market value and may trade either at a premium or discount to their net asset value. ETF shares trade at market price and are not individually redeemable with the issuing fund, other than in large share amounts called creation units. ETFs are subject to risk similar to those of stocks, including those regarding short-selling and margin account maintenance. Brokerage commissions and ETF expenses will reduce returns.

 

Securities lending involves risks. Revenue is not guaranteed and may fluctuate. Lending activities are conducted by the Custodians for the funds.

 

Securities lending is an over-the-counter market that involves the borrowing and lending of securities predominantly for the purpose of covering short-sale positions. Participants include pension funds, mutual funds, and foundations, which lend their security holdings, as well as option traders, hedge funds, and other asset managers, which borrow security holdings. These parties rely on their respective intermediaries (custodians for the lenders and prime brokers for the borrowers) to broker their transactions and manage counterparty risk.

 

This information is not meant to constitute investment advice, a recommendation of any securities product or investment strategy (including account type), or an offer of any services or products for sale, nor is it intended to provide a sufficient basis on which to make an investment decision. Investors should consult with a financial professional regarding their individual circumstances before making investment decisions.

 

RISKS include loss of principal and fluctuating value. Small cap securities are subject to greater volatility than those in other asset categories. Value investing is subject to risk, which may cause underperformance compared to other equity investment strategies. International investing involves special risks, such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. These risks are described in the Principal Risks section of the prospectus. Dimensional funds are distributed by DFA Securities LLC.

 

UNITED STATES Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.

 

Investment products: • Not FDIC Insured • Not Bank Guaranteed • May Lose Value Dimensional Fund Advisors does not have any bank affiliates.

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