Question

Go to the following website and find information about Dimensional Fund Advisors and the process they follow: http://us.dimensional.com/


After reading all the available information carefully and doing some additional research on your own, prepare a two page (double-spaced) essay presenting the investment consulting firm and answer the following question.

“How does this firm and other make money by taking advantage of the Efficient Market Hypothesis?”

Answer 1

Dimensional investing is about investing the great ideas of investors in the market.It believes in the power of market means how the market perform.At dimensional the investment approach is based on market beliefs.The fund advisors believe in expected returns from the market rather than making forecast projection of the market which are futile.the investors will make investment decisions based on information in the market and thus set the market prices.The fund managers from the markets will identify the expected returns from the information from the market and will try to take advantage of market changes whenever possible.Thus they rely more on systematic investment approach.the dimensional fund managers work closely with the economists to understand the returns of the security in the market.The expected return from a security are supposed to be high in presence of certain characteristics which are called as dimensions.The dimensions must be realistic,constant,prevalent and of cost effective nature.

The dimensions can be company size,market,profitability and relative price are considered to be premiums of high expected returns.All the dimensions are based on the practical standpoint which can convert academic findings to actual investment strategy.The market premium is calculated by comparing the equity and bonds by determining equity premium.the company size premium helps to determine small cap premium.The profitability factor helps to determine value projections by growth models.The profitability premium helps to determine profitability of the firm.the historical data suggest that the small cap firms have out performed the large cap,equities have outperformed debt,profitability is more with more risk and value stocks have outperformed growth stocks.

The theories of investments are based on basic two criterias first includes considering risk and later assumes no risk existence and focuses more on behavioural aspects.The behavioural economists failed to propose any model for investment.

Academic models are very insightful but reality is different.The academic models focuses on taking risk.The portfolio which have higher risk are expected to give higher return also.Some investors assume that the diversification is done for time but actually it is done for risk.But in diversification also by assuming higher risk also it is not certain to earn high return because of the fact that how markets will perform cant be predicted.the The premiums increase over time .In dimensional investment the fund managers focus on the dimensions of high return and taking in to consideration of diversification,risk and cost.

The efficient market hypothesis if often used by academician to project the expected return of the portfolio.According to this theory the markets reflect all information available in the market so risk can not be constant.The theory proposes that the fundamental and technical analysis can not affect the return of a stock inside information can affect the returns.The stocks are always trading at their fair values.So arbitrage is not possible only possibility is to consider risk and make high returns.

Thus fund managers duty is keep informed the investors of particular investment strategy.Thus this increases transparency and long term investment of an investor.The dimensions of high returns are used to make investment decision by managers and to make high premium by assuming higher risk.Thus this factors can increases premium but high expected return can be earned only by assuming higher risk as per EMH. Thus markets will go up and down but fund managers role is to make investor aware of investment strategy and make it more transparent by making investor aware of risk factors and variability of returns in the market.