Introducing the new Endowus 100% Dimensional-only portfolios
- The new Endowus Dimensional Portfolios are built by curating a portfolio of 2-4 dimensional funds to maximise exposure to Dimensional’s Nobel prize winning and scientific research-backed, factor-based investing strategies.
- These funds are chosen as some of the best ways to gain globally diversified broad market exposure. The geographical allocation of the portfolio is broadly consistent with market capitalisation, while being overweight on three proven factors of outperformance, namely value, size and profitability.
- This portfolio can be invested using Cash and SRS monies and created on the Endowus Fund Smart platform on a risk scale that is suitable for you across equities and fixed income.
Passive or Active investing is not the only choice in town
Most investors focus on the distinction between passive index investing (just achieving passive beta market returns) and active investing that tries to beat benchmark indexes and generate alpha (above market and benchmark returns). However, those are not the only choices investors have. We already know that active investing in equities is a difficult game to play with more than 75% of active investors typically underachieving passive market returns.
However, even for passive, it’s not that simple as we think. We first need to define what passive actually means. Let’s take the US equities market as an example. It has several famous and commonly used indexes such as the S&P 500, the Dow Jones Index and the Russell 3000. However, the S&P 500 is an index of the 500 largest companies in the US, the Dow Jones is in fact a smaller index of just 30 stocks and the Russell 3000 Index is obviously a broader index of 3,000 stocks.
But is that the total US equities market? Nope. The total number of stocks listed in the US stock exchanges is over 4,000 stocks in just the two major exchanges - NYSE and Nasdaq. If you include the other smaller exchanges and other calculation methods that take into account OTC and grey markets, it takes that total to closer to 10,000 stocks. As you can see even what we perceive to be passive is not really as passive as we think.
Also, passive is different from indexing. Indexes can be passive but it's something somebody created to follow a certain subset of the total market. It could be the S&P 500 but it can also be the Tech sector index or the E-commerce or Robotics index which does not give you any broad market exposure but it’s still indexed and can be called a benchmark for some investors but it’s often an active index. The only way to be passive is if we own every listed stock in the exchanges and that will be the broadest measure of ownership. The fund with the broadest exposure in the US would be the famous Vanguard Total Market Index Fund holding a grand total of 3,597 stocks.
It’s important to note that Dimensional always starts with this concept of broad passive exposure to the overall markets in its funds. For example the Dimensional World Equity fund, which is the broadest measure of global equity markets has over 11,608 stocks compared to the commonly used MSCI All-Country World Index (ACWI) which has 2,995 stocks and the broader IMI index has 8,748 stocks. (all numbers are as of October 2020)
What is Factor investing and why use Dimensional?
Once Dimensional builds a truly diversified passive portfolio giving exposure to the true “Market Beta”, they also look at the other proven factors of returns and tilt the portfolios to give you broad exposures to the proven factors that are evidence-based and can be harvested through a systematic way to invest in securities with these certain characteristics (“factors”) that have generated superior performance over the long term. In order to differentiate it from pure market returns, they use words like Smart Beta or Passive Plus (Beta plus).
Research by Nobel prize winning professor Eugene Fama and his colleague Kenneth French has shown that over the long term, cheaper companies outperform more expensive ones, smaller companies outperform larger ones, and more profitable companies outperform less profitable ones. These three return premiums, coined as “Value”, “Size” and “Profitability” premium, are the most robust and popular equity factors. But others like quality, investment make up the five factor model that Fama & French have researched.
Below is a long term performance chart for each factor risk premia mentioned above, along with the market return since 1964. Each factor risk premia is constructed to be independent of the market by going long the stocks with more favorable characteristics and going short those with less favorable characteristics, and we can see that 1) they exhibit significant positive performance over time and 2) they go through different periods of volatility to the market and hence are very good diversifiers. Obviously market risk - beta - is the most important factor in generating returns and why it is important to remain invested in the market over the long term and take passive market risk.
Historical performance of factor risk premia, US market
To be qualified as a legitimate return factor, the factor needs to be persistent across time, prevalent across regions, has strong economic intuition, and can be implemented systematically at a low cost. For example, the Value factor works in both developed markets and emerging markets, and there is over 100 years of data that support Value risk premia. The discovery of factors is not the result of some sort of data mining, but is based on robust research methodology and has backings of economic theory.
Finally, while factor investing started in equities, it has long been extended to other asset classes such as fixed income. The two fixed income premiums are: term premium - steeper yield curve implies that longer term bonds will outperform shorter term bonds more than when the yield curve is flatter; and credit premium - larger credit spread implies that lower quality bond securities will outperform higher quality bond securities.
This is good news for investors: there are more evidence-based passive returns, on top of the traditional market returns, to be harvested.
Evidence-based return sources for investors to harvest
There is just one thing left - investors need a trusted and experienced investment manager that can execute the strategy at low cost to help them reap the market and factor returns efficiently. Managing $527bn of assets as of September 2020, it’s size and scale allows a cost-efficient execution of its proven and robust strategies.
Dimensional Fund Advisor (“Dimensional”) is one of the pioneers in systematic factor investing it traces its origin to academia back in 1981, dedicating itself to translating academic insights on factor returns to real world investment strategy, and it has grown since then to be the leading practitioner in the factor investing world. It was founded by David Booth, (famous for putting his name on the Chicago University Booth School of Business), and advised by Eugene Fama, the father of “efficient market hypothesis” and factor-based asset pricing models, as well as Robert Merton, Bill Sharpe and Myron Scholes, all of whom are Nobel Prize laureates.
Dimensional’s investment strategies are generally extremely diversified to offer broad exposure to different markets. In equities, their strategies would overweight small cap companies, cheaper companies and more profitable companies, and in fixed income, their strategies systematically harvest term and credit premiums. They meticulously execute their strategies by balancing the tradeoffs between higher expected returns and trading costs, and employing flexible trading to minimise trading costs.
Understanding the 100% Dimensional-only model portfolios
The Dimensional-only model portfolio is a core asset allocation strategy with both equities and fixed income. They are globally diversified and broadly passive with tilts to the proven factors of return and extremely low cost products. They are exclusively available through Endowus digital platform and are offered as a clean share class which means there are no retail funds with high upfront costs or trailer fees, which Endowus needs to rebate back to the customer as is our normal policy.
Balanced Dimensional model portfolios across risk spectrums
Option 1 - Dimensional Multi-fund diversified portfolio
Option 2 - Dimensional two-fund diversified portfolio
Investors can create a Dimensional-only balanced portfolio using the Dimensional equity portfolios, and the Dimensional Global Core Fixed Income Fund.
By applying different weightings to the equity portion and fixed income portion, one can achieve different risk levels suitable for oneself. The worst 12-month return helps you to calibrate your risk tolerance - it indicates the historical worst return that has happened in a 12-month period since 2003 Jan.
How to Create Dimensional Model Portfolio now
You can immediately create the Dimensional-only portfolios shown above through the Endowus Fund Smart platform. Once you have chosen an appropriate risk level (based on the worst 12-month return) , you can go ahead and create the portfolio on the Endowus Fund Smart platform. As a first step you need to select “Add Goal” and “Fund Smart” which will take you to the Fund Smart portfolio creation page.
Here you should select “General Wealth Accumulation” and then choose from SGD Cash and SRS as your funding source. Currently, Dimensional funds are not available on CPF-OA and so the option to fund with CPF-OA is not yet available but we hope to have them on the CPF platform early in 2021 and will notify you as soon as they become available.
Then you must select the risk tolerance by sliding the arrow to the left or right. Take a step back and ask yourself what kind of portfolio loss you can take over a 12 month period, and indicate it in the loss tolerance.
Next, you can choose your own preferred mix of Endowus Dimensional Portfolio based on how you want to do the Equities:Bond Portfolio mix.
After keying in your fund choice and the portfolio allocation, you would be guided by the Endowus platform on whether your chosen portfolio is aligned to your stated risk tolerance. If the portfolio allocation you’ve selected is not aligned to your risk tolerance, you’ll be recommended to review and adjust your allocation so that the portfolio is suitable for your needs and risk tolerance. Make a deliberate choice based on our advice and adjust your portfolio to take up more/less risk accordingly.
Once you enter the initial investment amount and click on the box, the Endowus portfolio analytics system will immediately calculate the overall portfolio’s characteristics and details, providing you with all the details needed to make an informed decision to proceed with the portfolio creation or not. The portfolio’s worst/best returns, average annual returns, historical and projected return, its underlying holdings and total fees and a detailed breakdown of the total fees. The data is compiled and calculated to give you the total portfolio picture.
Appendix 1a: Deep Dive into the Dimensional Equities Portfolios
We have provided two options for the equities portfolio. Both options provide extremely diversified exposure to global markets, and tilt towards the proven return factors: Value, Size and Profitability. The reason for providing two options is two-fold. Firstly, there is no way to perfectly replicate the total equity market and the two options focus on slightly different priorities. The single fund is a simple and clean way to express the broad market exposures with the factors embedded and Dimensional executes it under the umbrella of the single fund in an efficient manner. If you do not want to make it complicated then just go with this single fund option.
However, our analysis shows that there are some further benefits of diversification which can be achieved by using three different funds as the covariance of the portfolios is low. As a result the multi-fund portfolio has slightly less volatility and better returns and slightly lower cost.
Our intention is to transparently present the choices with the two portfolios and the flexibility to express their preferences based on their risk appetite, needs and goals.
If we go into some details and compare the two portfolios, the multi-fund portfolio is more risk optimised on a fund level because the three funds are lowly correlated with each other. As a result of the inclusion of the Pacific Basin Fund, which is a great diversifier, the multi-fund portfolio has less exposure to the United States and more exposure to Pacific Basin countries such as Japan, Australia, China and Taiwan compared to the single-fund portfolio.
Portfolio characteristics of Dimensional equity portfolios
Geographical breakdowns of the Dimensional equity portfolios
Correlation between Dimensional equity funds
The Dimensional equity portfolios have underperformed the benchmark on a 1 to 10 year basis due to the exposures to Value and Size. The Endowus 100% equities advised portfolios, which has 73% allocation to Dimensional equity funds, has exhibited similar underperformance but with its exposure to the S&P 500 US markets, have tracked the global index much better.
Periodic returns of the Dimensional equity portfolios
The main driver of this underperformance is the Value tilt in Dimensional’s portfolio. The below chart shows the historical performance of Value companies vs. Growth companies. Value companies have outperformed growth companies from 1926 - 2010 by 4.3% per year. However, starting from 2010, this reversed and Value companies started to underperform, though marginally. The situation worsened quickly in the last 3 years but there are some signs in recent months of some of this trend reversing but it is too early to tell.
Annualised returns of Value and Growth, US market
It is natural for investors to question whether the Value factor no longer holds; the most informed answer is that we do not know and it is impossible to prove that it is - periods of poor performance does not invalidate the long term efficacy of the Value risk premia. There has not been robust empirical evidence to prove that the Value premia is now obsolete, and the consensus amongst academia and practitioners is that it is caused by collective irrationality in the market.
Even with the recent gruesome Value underperformance, the Dimensional equities portfolio still outperformed the benchmark for the 17-year period from 2003; this is a great testimony that in the long term, factor premia works. Recently we did start seeing Value rebound, and from Sep 1 to Nov 30, the Dimensional World Equities has outperformed the benchmark by 2.93%. While there is no certainty whether this would sustain, it provides renewed hope that maybe the Value factor is not lost.
Recent outperformance of Dimensional World Equities Fund vs benchmark
Finally, below table presents the risk of the Dimensional 100% equities portfolios in terms of the worst historical return over the 12-month, 5-year and 15-year period, as well as the annualised volatility since 2003 Jan. The portfolios’ risk profile is in line with the market benchmark, and their 15-year worst performance becomes positive, once again emphasising the importance of time in the market.
Appendix 1b Deep Dive into the Dimensional Global Core Fixed Income Fund
The Dimensional Global Core Fixed Income invests in a large number of investment-grade corporate bonds and government treasury across developed countries.
Unlike other discretionary managers, the portfolio is rule-based and managed systematically to increase exposure to lower-quality bonds when spread widens, and to longer maturity bonds when yield curve steepens. This process effectively harvests the long term, evidence-based credit and risk premia prevalent in the fixed income market. Compared to the existing Endowus 100% Fixed Income Advised Portfolio, which includes actively managed PIMCO fixed income funds, the Dimensional Global Core Fixed Income Fund displayed safer characteristics (see below table).
It is desirable for investors to diversify the equity portfolio by tapping into the fixed income market, and to enhance returns by gaining fixed income factor risk premia. The Dimensional Global Core Fixed Income Fund thus fulfills this crucial role in a disciplined and systematic way.
Risk metrics comparison
Historical return comparison