Research Update - US Core Portfolios
US Core Equity 2 and US Vector Equity

Oakwood’s research has led us to select the DFA US Core Equity 2 (Core Equity 2) and the DFA US Vector Equity (Vector Equity) portfolios as part of a larger allocation to US equities. Core investments are the workhorses of your portfolio. What do we mean by core? A core holding is just what it sounds like: It’s the central part of your portfolio. The core requires an investment that will be reliable year in and year out. It is a solid foundation of your investments, and as such, should provide stability. For purposes of this discussion, we will focus on the Core US Equity portion of client portfolios.

As you can see in the Structured Global Equity Strategies section of this edition of the Oakwood Outlook, each Global Equity strategy (Conservative, Moderate, and Aggressive), consists of varying percentages of the US equity market. In constructing this portion of client portfolios, the Core Equity 2 for the Conservative Global Equity Strategy, and the Vector Equity, in differing percentages, for the Moderate and Aggressive Global Equity Strategies.

How do the Core Equity 2 and Vector Equity Portfolios differ?

The primary difference between the Core Equity 2 and the Vector Equity Portfolios is their respective exposure to value and small capitalization stocks, and the resulting differences in volatility as measured by standard deviation. A company’s size is determined by measuring its market capitalization and its placement on the value/growth spectrum is measured by using the ratio of a company’s book value to its market value (BtM). We are well grounded in the scientific evidence that relative performance among stocks is largely driven by two dimensions: small versus large, and value versus growth. Many economists believe small cap and value stocks outperform because the market rationally discounts their prices to reflect underlying risk. The lower prices give investors greater upside as compensation for bearing this risk.

Oakwood clients have the distinct advantage of having their US Core Equity portfolio invested in the Core Equity 2 or the Vector Equity portfolio, with its increased exposure to small capitalization and value companies. While both the Core Equity 2 and Vector Equity have a tilt towards value and small capitalization stocks, the Core Equity 2 has less exposure to these areas, and less volatility, than does the Vector Equity Portfolio. The weighted average market capitalization for the Core Equity 2 is $57.2 billion as compared to the Vector Equity of $29.7 billion. The weighted average BtM ratio of the Core Equity 2 is 0.50, as compared to the Vector Equity weighted average BtM ratio of 0.63. Note that the higher the ratio, the higher the value orientation. When comparing either of these measurements to the total stock market, you can see a tilt towards value and small capitalization stocks, as shown below.

How are the Core Equity 2 and the Vector Equity alike?

Both the Core Equity 2 and the Vector Equity portfolios invest in the US equity market with a tilt toward small cap stocks and value stocks. By spreading the investment gradually across all but the largest growth stocks in the market, the Core Equity 2 and the Vector Equity portfolios can hold stocks for maximum efficiency and minimize counterproductive trading costs. The result is the inclusion of the maximum number of stocks in the asset classes that have historically provided higher expected returns. To integrate the portfolio, the US market is divided into a number of book-to-market (BtM) and size categories. To achieve a value tilt relative to the market, the portfolio’s target weights are gradually increased for stocks in the value (highest BtM) category and decreased or eliminated for stocks in the growth (lowest BtM) category. The portfolio’s small cap exposure is achieved by gradually increasing the target weight of small cap stocks relative to their market weight and by decreasing large cap stocks.

The graphs below depict the integrated approach that the Core Equity 2 and Vector Equity Portfolios take in investing.

A focus on the whole rather than the parts frees us to choose portfolio components based on the right reasons—their cost, consistency, strength of design, and tax efficiency.