Unique but replaceable: Dimensional takes a team approach for successful investing

Bhanu Singh is head of Asia Pacific Portfolio Management at Dimensional Fund Advisors.

Dimensional don't have star stockpickers, rather they take a team approach to portfolio management - and it's working with their Global Value fund in the top 10 for 1 year performance.

Bhanu Singh says, as systematic investors they use their passive side to inform their active side. And with their team approach he jokes that they're all unique, but replaceable.

Bhanu explains Dimensional's investing approach to James Brandis.

Full Transcript

James Brandis: Bhanu, Dimensional is not passive, and it’s not active, so how would you describe their approach to investing and the global core equity trust?

Bhanu Singh: The way that we think of ourselves is more as systematic investors. So we use information in prices, in that way you can think of us as passive. We use that information to figure out what stocks have higher expected returns than their peers and we apply the same approach on bonds as well. So there is this fundamental foundation to our approach which is to use information and market prices, combine that with fundamentals to get an idea about which stocks we think are going to do better going forward and then build portfolios around that to deliver that higher return in a very cost efficient manner. So as much as we would like to fit into one of those categories, we tend to span both.

JB: So what sort of areas are you investing in? Are you finding a particular subset of the research and building the portfolios around that or does each portfolio have a diverse mix of those subsets?

BS: The idea here, just like everybody else in the industry is to find what we like to think of as premiums or differences in expected returns. So you start with a market portfolio in global equities, quite a big universe, and then you start looking at things that help you explain differences and why one part of the market or certain stocks in the market might do better than the other ones. We use every piece of information that is available to us, so we look at things like the price of a stock relative to its equity. That has shown over very long periods of time and lots of academic research as the area to highlight stocks that have higher expected returns going forward. Another thing to look at is the profitability of the stock. The higher the profits generated by a stock the higher the cash flow back to investors and therefore the higher the return to investors. This is going to sound a lot similar to typical valuation type manager because it is based on the same principles. At the end of the day returns on a security depend on the price that you pay for it and the cash flows that you get from it. Now if we can find systematic ways to identify stocks where we can pay less than the peers, less than other stocks in the market, and get more profits for that price, that means we are going to have a higher expected return going forward.  So we apply all of that. In the global equity portfolio for example we will be overweighting stocks that have low price to equity, or higher profitability, or are a bit smaller because a lot of the premiums that we are trying to target are larger in small cap stocks. So this portfolio combines all of our research in to one strategy.

JB: Is that a Smart Beta approach to investing? Is that how you would describe it?

BS: It seems like Smart Beta is a relatively new label and as with any of these labels I think it depends on how you define it. Smart Beta encompasses a lot of different things. I think that the way that we think about these premiums, if you are thinking about a strategy that aims to pick up these premiums in the market place in somewhat of a transparent manner then I suppose that’s Smart Beta broadly. But within that, as you can imagine, you can put anything in these strategies and call it a premium. There is a lot of work that needs to be done to ensure that the things that you are targeting are well researched, they are robust, they are reliable going forward and frankly they make sense, they are pragmatic. To do so in a way that reduces cost, because that is one of the things that we can clearly control. Research thresholds for these Smart Beta strategies tend to be a lot lower, so there is almost this tendency to say the more premiums the better, but that doesn’t always show up in better outcomes for investors. And they typically tend to be implemented like an index which we think leaves a lot of money on the table because implementing these types of strategies like an index is not very efficient. So there are differences, but if you define Smart beta the way we do things then perhaps you could call us Smart Beta but we tend to think of ourselves as quite a bit different from a typical Smart Beta strategy.

JB: You don’t have star stock pickers or portfolio managers, you work on them as a team. Is that right?

BS: Right, as much as I like to think that I contribute a lot, we joke that all of us at Dimensional are unique yet replaceable.  The strategies are based inherently on ideas that are bigger than the firm in some ways, because they are based on academic research, so we implement them in a systematic way using a team based approach. That means that if I were to get hit by a bus tomorrow, for the most part the strategies would be in good hands and it won’t affect outcomes for clients too much.

JB: About the global equity trust, how are you positioned recently for events like Brexit and Trump and for future events like European elections or anything that involves China. Do you set yourself up to weather these events or does your research provide you with that guidance so that you don’t need to take a position,

BS: That is a good question because there are 2 different aspects of it. One is that there are always these kinds of events happening and they impact different stocks in different ways. So if you hold a well-diversified portfolio, you tend to be able to weather the storm better than if you are holding a very concentrated position that might be adversely affected by a particular event. And second, how you manage that portfolio day to day makes a big difference. So the Global Core Equity Trust is a market wide portfolio, 5000 stocks and it is trying to pick up that higher expected return associated with stocks that are smaller, that have lower price to equity and have more profitability. Now that diversification gives us a good buffer against any kind of market events. The second part is that we think that because we use information in current prices and we think markets do a pretty good job of incorporating whatever information that is out there in to those prices. We are picking up all the analysis that is out there about what is going to happen with the European election or what is going to happen with Brexit - all of that, in our opinion, is already in prices. That doesn’t mean that the markets know what hasn’t happened yet, but based on what we already know we think that market prices are the best estimator of what sort of returns we can expect from going into certain securities. So we use that information, we rebalance our portfolios pretty much daily on a continuous basis to take advantage of the new information that is coming into prices. So that is helping us weather these kind of events pretty well. And the last part is that we build in flexibility in to our investment approach. So Brexit is an excellent example, because on the day of Brexit, a few of the indices in the US, it happened to be their rebalance date, that day. Even though the markets were quite volatile and volume was moving around quite a bit, these index managers had to go and rebalance their portfolios that day. And they paid pretty dearly in trading costs that day. We as a firm decided that unless there was some sort of immediate cash flow need that had to be met, we could step away from the markets that day and let all the volatility die down a little bit and then go back in to the markets and trade. So we were able to avoid any adverse impacts that day, sort of like liquidity type impacts because of the flexibility in our process.

JB: 5000 stocks sounds enormous. I can imagine that you would be moving them around quite quickly and I normally ask people to tell us about a couple of stocks in their fund, but I can’t imagine that you could even pick out a favourite, could you?

BS: The point is not to have favourites, the point is to use a systematic approach to harness these premiums that are available and to stay disciplined with that. Because if you start picking favourites you start to get emotionally attached to those kind of things and run in to issues. So our approach is to use the information in market prices and say 'what does that tell you?'. I can briefly describe what the portfolio looks like. So within that 5000 stocks you are going to get roughly the same weights as the market portfolio at a country level, so starting with a market portfolio in developed markets ex-Australia, the country weights would be similar. We are going to lean away from large expensive stocks that have high relative prices, think of large growth names, such as Apple and Alphabet, and some of those names, we are going to underweight. Then we are going to overweight some of the smaller and cheaper names that are too numerous to mention. So the goal here is to systematically shift the weight away from stocks that we think have lower expected returns towards stocks that we think have higher expected returns. And do so in a very cost efficient systematic manner.

JB: You have many other funds, and one of the others which sounds interesting is for pensioners to supply them with a reliable income. Can you tell us about that fund?

BS: That is a set of strategies that we currently run out of the US for US investors and we are looking to bring those solutions to the Australian market as well. At the end of the day, as you mentioned, the goal in retirement is income, or I rather call it consumption. You want to be able to afford a certain level of consumption in retirement. So let’s say, let’s make up a number and say that that number is $50,000 a year, adjusted for inflation. So if inflation goes up, you want your portfolio to pay you a bit more to hedge you against prices going up too quickly. Second, you want that steady over the course of your 25 years of post-retirement living, let’s say. In order to do so, you actually need to hedge the right risks. What do people end up doing? As they approach retirement they tend to shift assets away from equities in to things like term deposits or short term fixed interest deposit type assets which are fine for preserving the balance but interest rates change as you have seen in the last 5 years. Before 5 years ago, given the cash rate where it was, you could easily afford a retirement on a certain amount of capital. Let’s say you retired and superannuation gave you a big balance, and based on that given the interest rates you could afford retirement fairly easily using term deposits. But as you have seen in the last few years, interest rates have moved and that means that you can’t really live off the yield from a term deposit. And that is a risk that people have in retirement every single day. It is a 25 year period and interest rates can do all kinds of things. So the 2 clear risks to providing consumption in retirement are interest rates moving around and inflation. You would notice that most strategies that are catering to that retirement income or retirement consumption need actually don’t hedge those 2 risks. So the strategies that we run use inflation protected securities and the good old back-in-the-day defined benefit plan type of liability matching to ensure that you have a high degree of comfort around the level of income that you are going to get in retirement. Because it is hedging away the inflation risk and hedging away the interest rate risk. So as you get older and closer to retirement the system is giving you some numbers around what you can expect based on what you hold in your portfolio and there is a high degree of reliability there. As opposed to holding equities or short term fixed income where yes, your capital balance might be preserved, but how much you can get from that for your retirement consumption is highly volatile. So it is hedging the right risks, that is the broader view of those strategies.

JB: And then is it paying monthly, or is it still quarterly or how does that work?

BS: The way that it currently works is that you actually sell down units to fund your consumption. So you have an idea that if you are consuming whatever the number may be based on your balance, every year, or every quarter or every month if you like, you can sell down those units to fund your retirement over time. And the portfolio continues to adjust as you get older as your liability characteristics and how much fixed income you should have vs equities change over time. So we are constantly adjusting that and typically you are just selling down to consume, which in some ways you can understand that gives you a lot more flexibility. A lot of these type of strategies have a fixed yield going out and the problem with that is there are years when you might need more or years when you might need less. And if you just have a fixed yield you don’t have a lot of flexibility around it. If you are actually selling down units to consume, then you have a lot more flexibility in retirement to tailor your consumption based on what your needs are rather than based on some fixed 3,4,5% number.

JB: Well Bhanu, I want to hear about your personal journey with Finance. Can you tell us where your career began?

BS: It actually began at a small accountancy firm in LA for about 3 months. I went to UCLA in Los Angeles for my uni and believe it or not I wanted to be an accountant for a while. Nothing against accountants, but when I started doing it I realised that wasn’t my cup of tea. And then long story short I sort of stumbled into Dimensional. They were headquartered at Santa Monica at that time, which is nearby. Through a contact I was able to get an interview there and managed to get hired on the trading desk as an analyst, which is sort of the bottom of the pole, if you will. From there I went on to trade some US equities for them and I have been here now 12 plus years I think.

JB: Were you a book learner? Was there a book that helped define your investment style?

BS: Not necessarily. I try not to read too much non fiction when I am not at work, so I try to stick more to fiction. In terms of learning I have truly been blessed in terms of the people that I started working with. So just off the top of my head, Henry Gray who is our global head of equity trading, Bob Deere, who is a very senior investment director for the firm globally, he was my first boss at Dimensional. I can’t point to you to say that they taught me certain technical things, it is more that they have such a rigour to their thinking that I was really impressed by as a young man. So I really picked that up from them. Then actually I left dimensional in 2008, right before the crisis, to go to business school at university at the University of Chicago.

JB: What a great time to go to business school.

BS: I know, everybody who was coming in there was going “just be happy that you are here and not out in the market place” but I kind of like to think that being on a trading desk at that time would have been quite an experience as well. I think I got the best of both worlds. Professors like Ken French who works closely with us at Dimensional, those guys are just on a different level when it comes to intellectual rigour and thinking, and they instil certain discipline in you. And you will see that throughout dimensional, we are quite rigorous in our approach, how we look at things and how much we trust data versus common sense. There is a lot of trade-offs to manage there and it requires a framework to navigate that and I think mentors at work plus Chicago have really helped me get better at that.

JB: You mentioned that you liked non fiction books, are you reading something good at the moment.

BS: Actually, surprisingly, I am reading a book called Excellent Sheep, it is by an author named Daniel Deresiewicz. And he is speaking about the role of elite institutions in our education system. He is himself a professor at Yale, so he has a firsthand view of not only the professors but also the students there. His overall message seems to be that we need to move towards more of a liberal arts education that teaches people how to think rather than what to think. He thinks that elite institutions are becoming more and more of a funnelling system towards certain professions rather than challenging students in their first four years at uni. It is an interesting thesis and an interesting book. I am not sure that I buy all of his arguments but it is nonetheless very interesting to read.

JB: That is a good tip. Excellent Sheep. We’ll Google that.

BS: Excellent Sheep. There is a little subtitle after that, I forget the name of it now, but I am almost finished with it and it is good. It makes you think.

JB: What does your average working day involve?

BS: It is never the same actually. Primarily, my first job is that I am responsible for a lot of the strategies and the portfolio management team, not only in Australia but in Singapore and Tokyo. Keeping an eye on all the strategies to make sure that everything is being done that needs to be done. There is a lot of working with portfolio managers in the three offices, talking to them about what are the ongoing things in the portfolios and how all that is being done. Lots of working with research to see what we are working on, what are we hearing from our clients in terms of their needs and how we can help them to build better solutions in certain areas. Analysing academic research with the research group. Those type of things. And then working with clients on solutions that they are looking for, so talking to a lot of institutional investors and a lot of our advisor clients as well. So it is a mix of those things from day to day and then in the middle of it you can throw in that I manage a team of 20 plus people so there is a lot of day to day things related to that as well.

JB: And what is your non-working time like? Do you have any passions outside of finance?

BS: I do, but right now they are being completely overtaken by my 2 year old. So I get home and at that point she is way too enthusiastic to see her dad at the end of the day, so from that point until bed time she will not leave me alone, which is nice.

JB: That sounds like a wonderful thing. And what's her name?

BS: Her name is Vedhika and she just turned two. So I spend a lot of my evenings and weekends with her.

JB: That sounds like a great reason to go home. Bhanu, Thank you for telling us about yourself and about Dimensional.

BS: Thank you.