Four Decades of Innovation at Dimensional
In 1981, Dimensional launched its first strategy, the US Micro Cap Equity Strategy, which focused on investing in small capitalisation stocks known as small caps. Since then, they have expanded their portfolio offerings to include other strategies that invest in small-cap stocks, such as single-country strategies, regionally diversified solutions, and strategies focusing on small-cap value stocks.
Dimensional’s approach to small-cap investing has been shaped by ongoing research from academics and their own research and investment teams. They have been at the forefront of understanding what drives expected returns across small stocks and how to capture these returns in a systematic and cost-efficient manner.
In the early days, they recognised the opportunity to invest in an overlooked market area – small-cap stocks. At the time, institutions primarily invested in large companies, with small caps being an underrepresented segment. Dimensional saw the potential in this space and developed a small-cap fund to capture the higher returns associated with smaller capitalisation stocks.
One of the first to launch small-cap value strategies
One key breakthrough for small-cap investing came in the early 1990s with the research on the value premium. This research showed that stocks with lower valuation ratios tend to outperform, and Dimensional was one of the first to launch small-cap value strategies based on this insight. They introduced the US Small Cap Value Equity Strategy in 1992 and the World ex-US Small Cap Value Equity Strategy in 1995.
Flexibility has always been a crucial aspect of Dimensional’s approach. They utilise a flexible daily portfolio management process to avoid buying illiquid names at unfavourable times and take advantage of market opportunities.
Academic research and adapting to changes in the market
In addition, Dimensional integrates momentum considerations into their process. Studies have shown that stocks with sizeable recent underperformance tend to continue underperforming, while stocks with significant recent outperformance tend to continue outperforming in the short term. By considering momentum, Dimensional seeks to avoid buying stocks with downward momentum and delay selling stocks with upward momentum.
Overall, Dimensional’s approach to small-cap investing has evolved, incorporating insights from academic research and adapting to changes in the market. Their focus on innovation, cost-efficiency, and capturing the drivers of expected returns has made them a leader in small-cap investing.
Profitability considerations across all strategies
Dimensional Fund Advisors acknowledges that valuation theory predicts differences in expected returns across small-cap stocks. They have learned from advancements in understanding the size premium that small-cap stocks with specific characteristics tend to underperform and fail to deliver the size premium. To improve the returns of their small-cap portfolios,
Dimensional excludes small growth low profitability firms, as these stocks historically have had lower average returns. This exclusion was initiated in 2010 and refined in 2013 by introducing profitability considerations across all strategies that purchase small caps. Apart from profitability, Dimensional also considers firm investment as a factor that informs expected returns.
Three-factor asset pricing model
According to valuation theory, firms that require heavy investment to sustain profits tend to have lower cash flows and expected returns than firms with similar profits but lower investments. In 1992, Professors Eugene Fama and Ken French published the three-factor asset pricing model, which improved upon the single-factor Capital Asset Pricing Model and saw the formal addition of both size and value as systematic drivers of differences in expected returns across equities. Based on their research, Dimensional excludes small-cap stocks with very high levels of asset growth from strategies investing in small caps.
In recent years, Dimensional has used information from the securities lending market to enhance its small-cap investing process. They found that securities lending prices contain valuable information, particularly regarding the relative borrowing costs of small-cap stocks. Expensive stocks to borrow tended to have worse performance over shorter timeframes. Dimensional utilises this information by excluding expensive-to-borrow stocks and down-momentum stocks from their purchase decisions.
New opportunities for investment innovation
Furthermore, Dimensional engages in securities lending to lend securities and return borrowing fees to investors, thereby helping to offset strategy expenses. This is one of the ways they aim to reduce costs for small-cap investors.
As a company, Dimensional is constantly searching for new research and ideas to advance its investing strategies. They recognise that change is constant and anticipate that the evolution of research and client needs will create new opportunities for investment innovation. They look forward to continuing their tradition of innovation in small caps and other investment areas.
Small-cap investing can make a significant difference
Investing in small-cap stocks can offer unique opportunities for growth and higher returns. However, it’s important to note that they also come with increased risk and volatility. That’s why having the expertise of a specialist in small-cap investing can make a significant difference.
At GSB Capital, our experts have years of experience in finding and analysing smaller companies. They have a deep understanding of what to look for in these investments. Our reputation in the small-cap investment arena often gives us direct access to company management and exposes compelling new investment opportunities.
Ready to access unique opportunities in the market?
By entrusting your small-cap investments to our team, you can benefit from their expertise, extensive research capabilities, and access to unique opportunities in the market. Contact us today to learn more about how we can help diversify and balance your portfolio with small-cap investments.
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