When the market changes, but the fund does not.
Many Ways to Fail
There are many sound reasons to sell a fund. Its sponsoring company might be embroiled in a scandal. Its senior management might have fled. The fund might have violated its prospectus, or made several abnormally poor investment decisions. Or, perhaps, the fund was one that should not have been bought in the first place (high expenses, indifferent track record), and its poor showing provides the excuse to correct one's initial mistake.
None of those would seem to apply to DFA International Value, however. Last week, a friend (and frequent source for this column) informed me that his son's employer recently dropped that fund from its retirement plan--an action that he regards as being a classic investment mistake. I agree; here's why.
The First Look Doesn't Flatter
There's no denying that the fund's returns have disappointed. DFA International Value has appreciated by a mere 1.03% per year over the trailing decade (through July 31). Over the past three years, it has landed slightly in the red. Investors would have been better off owning pretty much any Treasury fund.
Of course, that comparison is second-guessing. All risky investments sometimes lag Treasuries. (Aside from Bernie Madoff's funds, that is, which demonstrated that portfolio volatility is but one flavor of risk, and not the worst flavor at that.) If DFA International Value held an unlucky asset class but fought valiantly against a headwind, then the fund's performance would be vindicated.
However, that is not what happened.
When compared with its peers, other foreign large-value funds, DFA International Value shows average 10-year returns, modestly below-average three- and five-year returns, and risk above the norm. That combination makes for a Morningstar Rating of 2 stars--generated by comparing the fund's risk/return profile against other funds in its category--which places the fund in the lower third of its competitive group. The fund also trailed the wordy MSCI ACWI ex USA Index, which tracks the performance of non-U.S. equities.
The initial picture, therefore, is rather dim. The fund has competed against two rivals, its category peers and the foreign-stock benchmark, on the two fronts of return and risk. It failed in all four cases, over each of the three trailing time periods. That would seem to constitute a pattern--and be sufficient evidence for termination.
The Second Glance Does
But there's more to be said. To start, while that MSCI index is good for measuring general foreign-stock funds, it's an imperfect match for funds that follow a value strategy. The better comparison for DFA International Value comes from the MSCI ACWI ex USA Value Index, which holds only lower-cost equities. When the value index is selected, the fund's apparent underperformance disappears. Over each of the trailing three-, five-, and 10-year periods, the fund's returns and volatility almost exactly match those of the benchmark.