In our ongoing conversations with financial advisors, we often hear similar questions about our investment philosophy, how we build portfolios and current market conditions. This blog post is the first in a two-part series of answers to some of the most frequently asked questions.

How and why does Loring Ward build portfolios using Dimensional Fund Advisor funds?
We strongly believe in the ability of Dimensional to get us pure asset class exposures as well as to capture what Dimensional likes to call the “factor premiums” in domestic, international and emerging markets. Factor premiums refer to Dimensional’s belief (which we share) that certain characteristics of securities — such as their smaller market capitalization or their low price relative to their book value — can provide a higher return in the long run than stocks that lack such factors. Studies have shown that in the long term, there can be a positive benefit to owning such securities, but we also recognize that over shorter periods of time these factor premiums may not always be positive. However, we do believe that the potential for these premiums to be positive in the long run holds true and can be captured by patient, consistent, long-term investing. We also believe that such factors show up positively not just in U.S. markets but globally as well.

Are there advantages to bonds in a low interest rate environment where real returns after fees might be flat or negative?
Yes, there are!  But let me answer what I think the question is: Why do we continue to invest significantly in bonds when yields have been so low?

First, we view the role of bonds in portfolios primarily as being there to provide the portfolio cushion and diversification. Through its low correlation to stocks, bonds are there to bring the level of risk that is always inherent (and high) in the stock markets down to a level that is tolerable for most investors. There really is no other way to do that than to hold some proportion of bonds in your portfolio.

Secondly, I would challenge the idea that holding bonds during this most recently extended period of low bond yields has led to “real returns after fees that are flat or negative” as the question stated. Since yields hit their sustained low in early 2009, the Dow has more than tripled and the Russell has more than earned 18% per year on average. So, I disagree that using low yielding bonds has led to flat or negative portfolio real returns.

How do Loring Ward portfolios measure up against competitors’ portfolios, even actively managed portfolios, net of fees?
We run comparison sheets of our portfolios to other competitors all the time through our GAP Analysis tool and custom analysis that we do for large mandates. Here are what we believe are some of our strengths against many of our biggest competitors when we go head-to-head at the model level and at the fund level:

  • You won’t be surprised by style drift or by cash drag or by high fees or by high turnover that costs the fund because our portfolios are committed to maintaining low turnover with consistent exposure to the key size and style factors that we consider beneficial.
  • What can happen in some competitor portfolios, particularly those that employ multiple third-party investment managers, is that there can be both overlapping positions as well as investment strategies which, in our opinion, cancel each other out and in the end lead to what is effectively just an index fund that charges an unnecessarily high management fee.
  • Our portfolios, on the other hand, consistently target a small but important number of factors we believe add value in the long-run, and we also tend to focus a lot more on risk management and on liquidity, and those all should be important criteria by which you judge any manager.

Why is it important to be globally diversified?  Aren’t just a few hundred holdings enough?
In both cases, the answer is that we believe that in most cases, more diversification is better than less. At a global level, diversification can help smooth portfolio returns because things like strength and weakness happen in different countries at different times than they do here. There are also different opportunities overseas at different times that may not arise in the U.S.