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Fine-Tuning Portfolios Through "Dynamic Indexing"

By Crucial Clips     July 1, 2015
The following text is a transcript of a portion of a speaker's presentation made at an industry conference or during an interview. This transcript solely represents the view of the individual who spoke, and not the view of Financial Advisor IQ or any other group.
Source: FA-IQ, Jun. 12, 2015 

MURRAY COLEMAN, REPORTER, FINANCIAL ADVISOR IQ: Hi, this is Murray Coleman with Financial Advisor IQ. I’m talking today with Barry Kaplan, Chief Investment Officer at Cambridge Wealth Counsel in Atlanta.

And Barry, more than 10 years ago, you started using DFA funds with your clients. And from our past conversations, you indicated that the reason behind that was that it kind of gave you the best of both worlds: active and passive management, or more passive with a twist, correct?

BARRY KAPLAN, CHIEF INVESTMENT OFFICER, CAMBRIDGE WEALTH COUNSEL: Yes, I’d agree with the “passive with a twist.” What happened was — we started doing a lot of research and we figured out that everything we saw, the overwhelming data, is that passive beats active. And when you compare the active managers to the indexes, essentially anywhere over the entire world in equities, active trails passive over any five-year period 75% of the time.

MURRAY COLEMAN: Why DFA? Why not go with the Vanguard or another common index fund provider?

BARRY KAPLAN: What we figured out is that Vanguard — who is a wonderful company, and we really like them — their issue, as with every other index follower, is in their prospectus. It says that they have to follow the index exactly. There should be no deviation from the index, OK? The problem is that the indexes themselves were meant to take the temperature of the market. They were not designed to be investment vehicles. It just so happens that, as investment vehicles, they’re pretty good. But they have certain flaws.

MURRAY COLEMAN: How do DFA funds solve some of the flaws of index funds?

BARRY KAPLAN: What DFA will do is they’ll say, OK, we’re supposed to have a constant exposure to small cap. And they monitor their portfolio every day. And if, for example, they want an average stock size of $2 billion in a small-cap fund, average market cap. And over time, over the last couple of months, it’s drifted up because certain stocks have gotten bigger. They’ll turn around and they’ll start buying something that’s smaller than $2 billion in market cap. Or they’ll adjust to value and growth drifts.

MURRAY COLEMAN: So it’s a more dynamic indexing, is what you’re saying basically?

BARRY KAPLAN: Right. They’re reallocating every day. And if they deviate a little from what the index is, they don’t care. What they’re trying to do is go right to what the goal of the index was, which was to be indicative of small-caps. And they don’t care what the index is on that particular day. They’re true to what they should be.

MURRAY COLEMAN: Is there any circumstances where you find better alternatives than DFA funds?

BARRY KAPLAN: It depends. We always keep kicking the tires. We like some Vanguard bond funds. We like some AQR funds; but again, if you take a look at these other places where we’re going to, they all follow the same sort of lineage. They’re all passive funds. The AQR has a bit of a twist; the DFA has a bit of twist — but enough that I would still call them passive.

MURRAY COLEMAN: OK. Well, Barry, I really appreciate your time today. Thank you very much.

BARRY KAPLAN: Thank you.