1. Why does DFA have so many products focused on small stocks and on value stocks? Watch the interview below with Gene Fama to help inform your answer.
While small stocks are intuitively perceived to be risky because they are less capitalized and more vulnerable to financial shocks, there is a popular misconception that value stocks are less risky because they offer a relatively high margin of safety. To the contrary, Fama points out that value stocks are in most cases characterized by financial difficulties and as such their fundamentals look good relative to their market value but they look awful relative to book values. Growth Stocks are on the other hand characterized by reasonable growth rates and are highly profitable so they are definitely less risky compared to value stocks. High capitalization stocks are equally less risky because they have an adequate asset base to withstand financial shocks.
Nonetheless, the fact that small stocks and value stocks are riskier than large capitalization stocks and growth stocks respectively implies that they not only have a higher cost of capital but they are also characterized by higher returns. It can therefore be concluded that most of the company’s products are focused on small stocks and value stocks because such products are mainly targeted toward risk taking and risk neutral investors who are more sensitive to the returns associated with the products as opposed to the risk inherent in them.
2. Characterize the performance of DFA’s small stock fund relative to small stock funds from other money managers.
3. How does DFA decide which stocks to include in their small stock fund? What implications does this process have for their view of market efficiency?
4. How does DFA manage trading costs in this fund?
5. In particular, why has DFA’s small stock fund performed so well relative to other small stock funds? Do they do anything unique that appears to drive this performance?
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