Investments can be complex. There are countless types of holdings out there and seemingly countless ways to buy, sell, and hold these investments in different strategies. Beyond that, there is also the investment structure. You can have open-end funds, closed-end funds, exchange-traded funds, exchange-traded notes, derivatives, private holdings, individual holdings, swap contracts, options, and the list goes on.
Currently, a couple of the holdings we have from Dimensional Funds are going through a conversion of structure. They are moving from an open-end mutual fund to an ETF. This is happening for some U.S. holdings on June 11th (namely DFA Tax-Managed Targeted Value, a small-cap value U.S. mutual fund, ticker DTMVX) and internationally on September 10th. Why is this happening, and why do we think this is a good thing?
Mutual Fund vs. ETF
Let’s first start with the purpose of mutual funds vs. ETFs. The purpose of both of these vehicles is nearly identical. Both provide a spot where you can buy a fund which in turn allocates to tens, hundreds, or thousands of other holdings within the fund on your behalf. The idea is to buy a fund, get access to the market you are trying to access, and do that in an efficient way, according to a philosophy you believe in. How a fund (ETF or mutual fund) allocates to the underlying holdings is a matter of how that fund is set up and who is managing the fund, not the structure itself.
When picking investments, we strongly believe evaluating any investment should be based upon the merits of the investment philosophy. How and why is capital being allocated within the fund, and does this align with the desire and need of the allocation we are making. Certainly, there are always other considerations like taxes and cost, yet if the investment part isn’t in line, you aren’t setting yourself up for overall success. Instead, as the saying goes, the tail is wagging the dog.
Small Cap Value
We hold the Dimensional funds that are converting because we believe strongly in the way they are implementing an investment strategy for the holding in your portfolio. In the case of the funds converting, the intent of the small value holding is to get great exposure to smaller cap value companies in the U.S. so that when these types of companies perform well, this fund has great exposure there. This has been happening in spades with the last year or so of small-cap value resurgence. Just look at the last year of performance below vs. the bigger, more common S&P 500 ETF.
This is also true within the international space where we are using a holding there to capture large-cap non-U.S. companies. Over the last year, the tax-managed version of the Dimensional fund is doing quite well vs. an ETF that invests in the large value space internationally:
All along the way, we have had the ability to continue to hold these funds from Dimensional or use a different company and have an ETF. However, because of how we wanted these investment dollars allocated, the investment philosophy won over structure as we believe it should.
However, now with the conversion coming, there are a couple of added benefits that happen:
- Investment philosophy remains where we want it.
- No tax to change – if we were to have sold out of these holdings before to go to an ETF, we would have taken capital gains for you to do that. This would not make sense in our minds since we like the investment itself. However, with the structure of a conversion here, it becomes a tax-free exchange for the dollars that move from the mutual fund to the ETF automatically.
- Tax efficiency going forward is enhanced – inherently, by the way ETFs are structured (through creation and redemptions), they can typically defer taxes longer than mutual funds. Over time, if you are selling investments to live off of or rebalance, the trade-off is not significant, but an ETF structure often allows for the delay of tax recognition and more control over the timing of that recognition. While mutual funds quite typically do have year-end capital gain distributions, that is extremely uncommon for ETFs. So, by nature of this conversion, the already efficient tax-managed mutual fund structurally becomes even more efficient.
- Cost savings – the way Dimensional is doing this also allows for the opportunity to revisit the underlying costs of the fund. While already lower than most, we will see the DTMVX holding move from 0.40% to 0.30% and the DTMIX holding move from 0.45% to 0.30%.
We believe this conversion to simply be an enhancement to an investment strategy we already thought made sense. The benefits of lower cost and lower tax are icing on the cake.
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The S&P 500 Index includes a representative sample of the largest 500 companies in the U.S.
The MSCI EAFE (Europe, Australia, Far East) Value Index captures large- and mid-cap securities exhibiting overall value style characteristics across Developed Markets countries around the world, excluding the U.S. and Canada.
Chad spends his day helping BDF deliver on it's promise of helping you enjoy a full life. In addition, Chad leads BDF's Investment Committee which oversees both the strategic and tactical decisions for the firm’s entire client portfolio base. Chad is a frequent speaker and often quoted in publications such as The Wall Street Journal, Forbes, Investment News, Smart Money, ETF Perspectives, and Dow Jones Newswires.