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Putting Research to Work
Nationwide U.S. Small Cap Value Fund
Interview with: Jed Fogdall

Author: Ticker Magazine
Last Update: Apr 20, 12:01 AM ET
What qualifies as cheap in the stock market will always depend on an investor’s yardstick. Even though the stock price is a combination of all possible factors, it still remains a volatile indicator, prompting investors to use a relatively stable metric when comparing thousands of companies. Jed Fogdall, portfolio manager of the Nationwide U.S. Small Cap Value Fund, relies on the dimensions of expected returns in building a portfolio of stocks with the potential of exceeding market expectations.


“The fundamental belief is that markets do the best job of incorporating everybody’s information into the price. And that price combined with other metrics for firms give you indications of the differences in expected returns.”
Q: Would you give us an overview of the history and the core mission of the fund?

A: Dimensional Fund Advisors LP has been managing the Nationwide U.S. Small Cap Value Fund (the fund) since late 2007. This particular strategy is a variation on something we have been doing since 1993, which is providing investors a portfolio that delivers the value premium in stocks that are complementary to their large cap holdings.

While the core philosophy and objective of the fund have remained consistent, there have been a few changes over time. For example, following the financial crisis, when certain industries became more concentrated in value portfolios, we put some industry constraints in place to maintain diversification across sectors.

Also, at the end of 2014, we added a profitability dimension, which was the product of a significant amount of work in the academic community as well as Dimensional’s investment team. The fund remains focused on similar size and value characteristics, but the portfolio construction now uses additional information.

In terms of our peers, we tend to be more highly diversified. We have about 1,200 holdings; some of our peers are at 100-400. This has benefits in terms of risk control as well as implementation.

Q: What is your investible market cap range in the small-cap universe?

A: The fund can buy stocks that are smaller than the 500th largest US company, which is currently around $7 billion in market cap. The lower end of the range is around $10 million in market cap. Since this is a small cap fund, the fund also has some guidelines in terms of overall market cap characteristics.

Q: What are the core principles you always gravitate to as part of your philosophy?

A: One of the things that sets us apart is our philosophy. It is influenced by the research of academics like Eugene Fama and Ken French, and others who work on related topics.

Our fundamental belief is that markets do the best job of incorporating everybody’s information into the price, and that price combined with other metrics for firms give you indications of differences in expected returns. That information can be used to build portfolios that aim to achieve higher expected returns given a certain client’s needs.

This approach permeates everything we do in fixed income and equities, from the design of the fund to trading.

Q: How do you use financial metrics in selecting stocks?

A: Using a stock’s price combined with other firm characteristics to build portfolios implies that financial metrics play an important role in our process. We have a dedicated data team responsible for continuously tracking multiple data elements which go into calculations of metrics like price to book and profitability. Maintenance of our security database is important in maintaining the desired positioning of the whole fund.

That data is used to classify stocks based on expected return relative to one another. In other words, the data is used to identify groups of stocks with higher expected returns rather than make a forecast about where the price of those stocks might be at some point in the future.

As market prices change, expected returns change, so we need to update the data to keep the fund focused on the stocks with highest expected returns.

Q: Who sets those price bands, how do you determine that relative price range, and how often do you change those bands?

A: Our Investment Committee approves portfolio parameters, including eligibility as defined by market cap, relative price, and profitability. We update these parameters at least monthly but it can be more frequent depending on market movements.

Q: How does your investment process help you to deal with thousands of companies?

A: We use computers and other tools to help us do our jobs, but the important point is that stocks with similar characteristics have similar expected returns. We design the boundaries of where we want to buy and sell based on some of the parameters we already spoke about. Once we have those boundaries, anything within those boundaries is eligible.

Q: What will finally determine what names go into the fund?

A: Once a stock falls into those boundaries, we’d generally like to own it. One of the benefits of Dimensional’s process is that we give our portfolio managers and traders fairly broad discretion on timing. I mentioned the ability to substitute similar stocks based on their characteristics. Additionally, portfolio turnover typically ranges in the 20% to 30% range annually which alleviates a lot of the time pressure. The portfolio manager in effect is saying, “here is a list to choose from, and I am indifferent to any combination of trades. As long as you meet my cash needs, go find the best prices you can.” Traders can use this flexibility to take advantage of natural liquidity in the market.

We also can talk about principles like momentum. Momentum interacts with the value premium in an interesting way so we use it in our buy and sell decisions rather than portfolio construction. A highly diversified fund has a low opportunity cost of avoiding down momentum stocks, and you get the benefit of avoiding the expected negative momentum premium.

Q: How useful do you find price-to-book value?

A: Price-to-book works well from a practical point of view, but the important thing to take away is that we are scaling price to enable comparison across companies. Other metrics can also be used, but they may have other drawbacks that make them less effective in portfolios. For example, using dividend yield in a value portfolio can reduce diversification if some companies don’t pay dividends.

Book value provides broad coverage of the entire universe. It also tends to be more stable. When you consider turnover costs, you want the action to happen because of price volatility and not because of the volatility of your scaling metrics.

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