I often write about avoiding ETFs that have been on a hot streak such as Cathie Wood's ARK funds, whose fund family quickly grew to about $35 billion in assets before losing two-thirds due to performance and fund outflows. Concentrated portfolios and high fees typically don’t work in the long run.
The Avantis story is different and is likely to produce a better outcome for investors. This new ETF family started in late 2019 and today has over $43.4 billion in assets in 28 funds with an average annual expense ratio of 0.24%. In a little over four years, Avantis has grown from scratch to be the 15th largest issuer of ETFs.
Avantis was founded by former executives of Dimensional Fund Advisors (DFA). Both DFA and Avantis follow a semi-passive strategy with low fees and low turnover. Low turnover isn’t no turnover so Avantis chose the ETF platform as its primary fund wrapper as the creation and redemption process doesn’t pass through capital gains to shareholders. DFA is still primarily a mutual fund company though, in recent years, has been issuing ETFs and converting some mutual funds to ETFs. Avantis is a unit of American Century Investments.
DFA was founded on academic research such as that by Eugene Fama and Ken French showing that small cap and value stocks have higher expected returns than the market overall. Often lost in this message is that it was compensation for taking on more risk rather than a free lunch. That risk has played out over the past decade as small cap value stocks have significantly underperformed.
Avantis's "Profitability" Factor
Avantis adds in an additional factor they call profitability. It defines profitability as ongoing cash flow from operations. So, for example, if a company had a one-time event increasing free cash flow, that would be excluded. Avantis also adjusts book value to exclude goodwill and also excludes REITs and utilities for the value funds. Research by Sunil Wahal, a consultant to Avantis and finance professor at Arizona State University, shows that companies with high profitability have outperformed similar value companies with low profitability between the years 1973 and 2023. Below is an illustration of their results.
That, of course, is back testing which typically fails going forward. How has it worked since Avantis launched? The Avantis US Small Cap Value ETF (AVUV) is the largest Avantis fund with about $10.5 billion in assets. Between 2020 and April 19, 2024, AVUV gained 73.9%. The DFA US Small Cap Value mutual fund (DFSVX) gained 60.4%, according to Morningstar. Though DFA launched the Dimensional US Small Cap Value ETF (DFSV) in 2022, I’m comparing to the mutual fund since it has a longer history. Still, a few years is not enough history to reach any statistical conclusion.
Morningstar analyst, Ryan Jackson, told me “Avantis is definitely cut from a similar cloth as Dimensional. Not only did its founder start there, but the lineup of products is quite similar—systematic, broadly diversified strategies that tend to lean toward smaller, cheaper, and higher-quality companies. Most of their funds are well constructed and managed with an eye toward reducing trading costs.”
Avantis's Repetto on Low Costs
I spoke with Eduardo Repetto, chief investment officer of Avantis. Repetto had been the co-CEO at DFA. I was curious as to why he chose American Century to launch his funds as it’s not known for having ultra-low-cost funds. He explained his funds had to have very low costs so launching a new stand-alone fund family would be too expensive for the investor. He knew the senior leadership team at American Century and they reached out to him. They needed a new brand of low-cost, academically-based funds and they already had the infrastructure in place so the incremental costs would be low, allowing for low costs to investors.
I asked Repetto whether their data showing past performance could merely be data-mining. He adamantly said no, stating he first started with a fundamental definition of a stock’s fair price and then tested that definition to see if it produced higher returns. As compelling as that argument is, every one of the hundreds of factors discovered started with a theory but the vast majority didn’t work going forward.
Repetto told me he believes in market efficiency to a degree but not in a strong-form sense. Strong-form means beating the market can only be attributed to luck. He did tell me he believes in William Sharpe’s Arithmetic of Active Investing that demonstrated some money must underperform the market if some outperforms. Avantis sent me a report claiming that, as of March 31 their funds have bested their benchmarks by an average of 1.80 percentage points annually over the past three years.
He said he expected Avantis to continue to outperform the market. I asked him point blank what he thought the probability is over the next decade of his small value fund outperforming DFA’s. Repetto responded that he “felt confident his fund would outperform the majority of small cap value funds that exist today.”
Wrapping it Up
Since 2020, Morningstar shows DFA has had $85.4 billion of outflows in their mutual funds and $72.4 billion inflows to their ETFs. DFA, founded 42 years ago, still has well over ten times the assets of Avantis. And while Avantis has gained $35.6 billion in new assets over the same time, American Century lost about $17 billion.
I think Avantis and DFA are great fund families and worthy of the three 2024 ETF.com awards they received. In my mind, it has never been about index vs. active and I do view any fund other than a total stock index fund as active. It’s about low cost diversified vs. high cost concentrated investing.
Will Avantis best DFA in performance? Will either best a plain old cap weighted total stock index fund? I know that I don’t know. But I do know that being consistent is important – don’t keep switching based on recent performance.
I also know that ETFs have far more tax efficiency than mutual fund wrappers. I applaud both Avantis and DFA for introducing their funds in ETF wrappers.
