Dimensions

Evidence from practising investors and academics alike points to an undeniable conclusion: returns are related to risk. Gain is rarely accomplished without taking a chance, but not all risk-taking is rewarded. Financial economics over the last fifty years has brought us to a powerful understanding of the risks that are generally rewarded and the risks that are not.

Three Equity Factors

Market Shares have higher expected returns than fixed interest.
Size Small company shares have higher expected returns than large company shares.
Price Lower-priced "value" shares have higher expected returns than higher-priced "growth" shares.

Everything we have learned about expected returns in the equity markets can be summarised in three dimensions. The first is that stocks are riskier than bonds and have greater expected long-term returns. Relative performance among stocks is largely driven by the two other dimensions: small/large and value/growth. Many economists believe small cap and value stocks outperform over the long term because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk.

Size and Value Matter
In British pounds. UK Value data provided by the London Business School and simulated by Dimensional from StyleResearch data. UK Small: 1956-June 1981 provided by London Business School and ABN AMRO; July 1981-present simulated by Dimensional from StyleResearch securities data. UK Market is the FTSE All-Share Index, published with the permission of FTSE. Non-UK Value is the MSCI World ex UK Index, net dividends. Non-UK Small: 50% EMEA small companies simulated by Dimensional from StyleResearch securities data (25% continental Europe, 12.5% Asia Pacific ex Japan, and 12.5% Japan) and 50% Fama/French US Small Cap Index. MSCI indices are net dividends; data copyright MSCI 2006, all rights reserved. Emerging markets index data simulated by Fama/French from countries in the IFC Investable Universe. Simulations are free-float weighted both within each country and across all countries.

Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Compound returns have an assumed rate of return, are hypothetical, and are not representative of any specific type of investment. Standard deviation is one method of measuring risk and performance and is presented as an approximation.

Two Fixed Interest Factors

Maturity Longer-term instruments are riskier than shorter-term instruments.
Default Instruments of lower credit quality are riskier than instruments of higher credit quality.

Dimensional approaches fixed interest primarily as a strategy to maximise overall portfolio benefit. Shorter-term, high-quality debt instruments tend to have less risk. Dimensional engineers lower-risk bond strategies so investors can temper their total portfolio volatility or take more risk in equities, where expected returns are greater.

Dimensional Fund Advisors Ltd. is authorised and regulated in the United Kingdom by the Financial Services Authority (FRN: 150100). For professional investors and advisers only. You should obtain relevant and specific professional advice before making any investment decision. Past performance is not an indication of future performance. Please read the Important Information.

Tour: The Importance of Diversification