DeepSummary
In this episode, Benjamin Felix and Cameron Passmore interview Wei Dai, Head of Investment Research and Vice President at Dimensional Fund Advisors. Wei discusses the main risk premiums Dimensional targets in their portfolios, including size, value, and profitability premiums. She explains how these premiums vary across different regions and provides insights into Dimensional's integrated approach to pursuing multiple premiums.
Wei delves into the different weighting schemes used in portfolio construction, highlighting Dimensional's approach of tying security weights to market cap weights while considering size, value, and profitability simultaneously. She also addresses topics such as currency hedging, premium timing strategies, valuation ratios, and diversification's impact on capturing premiums.
Additionally, Wei shares her insights on evaluating systematic investment managers, the downsides of performance fees for such managers, and Dimensional's implementation of research findings like short-term reversals. The conversation covers the process of translating research into portfolio implementation at Dimensional and the value the firm adds despite publicly available research.
Key Episodes Takeaways
- Dimensional Fund Advisors targets the size, value, and profitability premiums in their equity portfolios, and their research suggests the expected magnitudes of these premiums do not reliably differ across regions.
- Dimensional favors an integrated approach to pursuing multiple premiums, simultaneously considering size, value, and profitability, rather than combining separate single-factor portfolios.
- Dimensional's weighting scheme ties security weights to market cap weights while gradually increasing or decreasing weights based on expected returns, aiming to balance expected return, risk, and costs.
- Dimensional's research finds limited evidence to support timing strategies based on valuation ratios, momentum, or mean reversion, suggesting a focus on staying consistently invested in premiums.
- Diversification can increase the reliability of capturing premiums by mitigating the impact of individual securities driving or detracting from the premiums.
- When evaluating systematic investment managers, Dimensional emphasizes rigorous research underpinning strategies, implementation expertise, and the right incentives for researchers.
- Dimensional cautions against performance fees for systematic managers, as they can incentivize increasing tracking error without necessarily improving expected returns.
- Dimensional has incorporated short-term reversals into their equity strategies, using a reversal screen to delay buying recent winners and selling recent losers, aiming to increase expected returns without additional turnover.
Top Episodes Quotes
- “So in our equity strategies, we will target the size, value and profitability premiums.“ by Wei Dai
- “In the end we cannot really reject the hypothesis that the expected premium is the same between any two regions.“ by Wei Dai
- “Ultimately, when you think about those portfolio designs, you care about expected return, risk and costs. These are really fundamental aspects to portfolio design.“ by Wei Dai
- “In short, it's time to stop timing, if that makes sense.“ by Wei Dai
- “So if you're thinking about absolute return, it's volatility, if it's excess return, it's tracking error. So then you can see there is some incentive to increase your deviation from the benchmark in order to make the payoff more valuable.“ by Wei Dai
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Episode Information
The Rational Reminder Podcast
Benjamin Felix & Cameron Passmore
5/23/24
Designing a robust portfolio requires considerable expertise, data, and experience. And while there are plenty of published articles that can guide how you build your portfolio, they are not investment solutions by themselves. Wei Dai is the Head of Investment Research and Vice President at Dimensional Fund Advisors, and she joins us today for a comprehensive and informative conversation on portfolio design for higher returns. Her background includes a Doctor of Philosophy degree in Statistics, Operations research, and Financial Engineering from Princeton. She has also earned a bachelor's degree in mathematics and applied mathematics from Zhejiang University. Her work has been published in multiple journals, including The Financial Analysts Journal. She has also collaborated on articles with esteemed figures such as Professor Robert C. Merton and Robert Novy-Marx. In our conversation with Wei, we explore the contents of these articles, key findings from research conducted by Dimensional Fund Advisors, and how they are implementing this knowledge in their portfolios. We discuss the fundamental aspects of portfolio design, like expected return, risk, and costs, with Wei providing a detailed breakdown of each subject. There’s a lot to be learned from today’s conversation, and while things get pretty technical, you are in very capable hands! Tune in for a fascinating dive into the latest research on portfolio design and much more.
Key Points From This Episode:
(0:03:37) The main risk premiums that Dimensional Fund Advisors target in their portfolios.
(0:05:42) How long-term drivers of returns vary across different regions: an overview of the tests and outcomes they’ve seen at Dimensional Fund Advisors.
(0:07:15) Unpacking whether the value premium differs from the profitability premium across regions; why it makes sense to be globally diversified.
(0:08:57) Typical approaches to a multi-premium strategy in a portfolio: a rundown of the three approaches they take at Dimensional and the trade-offs between each.
(0:13:44) How they evaluate portfolios at Dimenstional: the benefits of taking a holistic, integrated approach, and instances where that doesn’t make sense.
(0:17:24) Weighting schemes: Dimensional’s approach to assigning individual security weights to achieve the desired level of exposure and how investments factor into weights.
(0:26:46) Advice on how investors should decide whether to currency hedge their foreign asset exposures, and insights on how to approach currency hedging.
(0:30:42) Premium timing: Why timing exposure to premiums is so tempting; parameters that must be defined to implement timing strategies; and which strategies worked in their research.
(0:39:21) Valuation ratios: why it theoretically makes sense that they would be related to differences in expected returns and why they aren’t useful in timing premiums.
(0:42:11) An overview of the main implications for pursuing premiums that arise from Dimensional’s research.
(0:44:10) Diversification and how to improve your odds of capturing return premiums.
(0:46:38) The tradeoff between concentration and expected returns, and defining the optimal balance.
(0:49:06) What investors should look for when choosing a systematic investment manager, why not all systematic strategies are created equal, and Dimemsional’s approach.
(0:52:52) The downsides of performance fees, specifically for systematic managers and what it was like writing a paper with Robert Merton.
(0:57:41) How short-term reversals differ from momentum, ways that reversals are related to liquidity, and how reversals vary across different stocks.
(01:03:12) The ways that Dimensional is implementing this knowledge in their portfolios; how their ideas go from research to publication to implementation.
(01:08:18) What sets Dimensional apart, and the value that they add, despite their research being available online.
Links From Today’s Episode:
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/
Rational Reminder on Instagram — https://www.instagram.com/rationalreminder/
Rational Reminder on X — https://twitter.com/RationalRemind
Rational Reminder on YouTube — https://www.youtube.com/channel/
Rational Reminder Email — info@rationalreminder.ca
Benjamin Felix — https://www.pwlcapital.com/author/benjamin-felix/
Benjamin on X — https://twitter.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/
Cameron Passmore — https://www.pwlcapital.com/profile/cameron-passmore/
Cameron on X — https://twitter.com/CameronPassmore
Cameron on LinkedIn — https://www.linkedin.com/in/cameronpassmore/
Wei Dai on Linkedin — https://www.linkedin.com/in/wei-dai-64a3071a/
Wei Dai’s Academic Papers — https://papers.ssrn.com/sol3/cf_dev/AbsByAuth.cfm?per_id=2888456
Dimensional Fund Advisors — https://www.dimensional.com/
Episode 234: Prof. Robert C. Merton — https://rationalreminder.ca/podcast/234
Papers From Today’s Episode:
Assessing the Relative Magnitude of Premiums — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3981766
Pursuing Multiple Premiums: Combination vs. Integration — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3793594
Weighting for the Right One: Weighting Scheme Design for Systematic Equity Portfolios — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4016481
To Hedge or Not to Hedge: A Framework for Currency Hedging Decisions in Global Equity & Fixed Income Portfolios — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3703333
Another Look at Timing the Equity Premiums — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4586684
Premium Timing with Valuation Ratios
How Diversification Impacts Investment Outcomes: A Case Study on Global Large Caps
How Diversification Impacts the Reliability of Outcomes — https://carlsoncap.com/wp-content/uploads/DFA_-How-Diversification-Impacts-the-Reliability-of-Outcomes.pdf
On the Valuation of Performance Fees and Their Impact on Asset Managers’ Incentives — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3686987
Reversals and the returns to liquidity provision — https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4339591