Market Perspective for June 26, 2023

Last week was relatively slow, with only four trading days thanks to the Juneteenth holiday. Furthermore, there were only a couple of major news announcements after the market reopened on Tuesday. The first major news event occurred on Thursday with the reveal of unemployment claims numbers from the last seven days.

It showed that there were 264,000 claims made over the period compared to an estimated 261,000. This was the second consecutive week in which 264,000 unemployment claims were made.

On Friday, S&P Global released its Purchasing Managers Index (PMI) numbers for both the manufacturing and service sectors. The manufacturing PMI number was 46.3 percent, which was down from 48.4 percent last month and was below the 48.6 percent estimate. The services PMI was 54.1 percent compared to 54.9 percent last month and was slightly higher than the 53.9 percent expected by analysts. These numbers suggest that there is a slowdown occurring in the manufacturing sector while the service economy still has room to grow.

On Wednesday and Thursday, Federal Reserve Chairman Jerome Powell offered prepared remarks to members of the Senate. The main takeaways from his testimony were that the service sector was running too hot and was likely contributing to inflation, which is still too high for his liking.

Therefore, it is expected that there will be additional interest rate hikes in the coming months. According to Powell, there will not be a pivot toward lower interest rates soon. He also said that there was a chance that the economy would achieve a soft landing. In other words, prices could be reined in through rate hikes without triggering a recession.

Some have suggested that the Fed may be forced to consider further hikes because of actions taken by other banks around the world. The Bank of England (BOE) raised rates to 5 percent after recent CPI data in that country found that inflation had increased to 8.7 percent. The Swiss central bank also increased its interest rate to 1.75 percent last week. It’s expected that the European Union (EU) will continue to raise rates in response to recent data that inflation is still a key issue there.

The only outlier in the quest to contain inflation is Japan, which has a base rate of -.10 percent. This has caused the yen to depreciate significantly against the dollar as well as other currencies. At the end of trading on Friday, a single dollar could be traded for 144 yen. Although the Bank of Japan (BOJ) has indicated that it may intervene to stop the currency from sliding much further, it is also against raising rates. This is because it is a popular tool for those who want to engage in carry trades.

The S&P 500 was down 1.9 percent last week to finish at 4,348 on Friday afternoon. It reached its highest point of the week on Tuesday afternoon when it hit 4,397 and would slowly lose ground on Wednesday, Thursday and Friday.

Last week was also unkind to those who were invested in companies listed on the Dow 30. The index finished down 2.19 percent to finish at 33,727. As with the S&P 500, the Dow hit its high of the week on Tuesday before slowly falling on Wednesday, Thursday and Friday.

Finally, the NASDAQ would also have a losing week as it finished 2.08 percent lower. The market would hit its high of the week on Tuesday at 13,679 and end the day on Friday at 13,492.

This upcoming week sees the release of consumer confidence, GDP and consumer price figures. On Wednesday, Jerome Powell will be speaking about the state of the economy and may offer clues about his next moves. On Friday, revised consumer inflation expectation data will also be released, which could have an impact on what the Fed does during its July meeting.

Fund Spotlight: Bond Options

Ask most investors about the year 2022, and they’ll probably talk about the decline in stocks even though last year wasn’t a historically bad year. Outside technology-laden sectors, the other sectors spent little to no time around the 20 percent loss line that most use to define a bear market.

The same cannot be said for bonds. They entered a major bear market in 2020, and it accelerated in 2022. If one investment bank is correct, the 10-year U.S. Treasury bond suffered its worst performance since 1788, a year when much of the world assumed the fledgling United States could fail. Last year, the 30-year Treasury bond suffered larger losses than the Nasdaq 100 Index.

Those losses stopped in October 2022 as investors digested the turn in inflation. Monthly inflation numbers peaked in June 2022 and slumped quickly before accelerating slightly in 2023. If the recent slide in crude oil holds, monthly numbers will turn down again. Crude oil is a very reliable indicator of future inflation, and the current slump could help drag CPI numbers below 4 percent. At that point, the Federal Reserve would very likely hold interest rates steady because the current level of interest rates is a historically normal level for a CPI of between 3 and 4 percent.

Higher interest rates are good news for savers and investors looking to buy bonds. After years of offering zero percent returns, many short-term bond and money market funds offer yields of 4 percent or more. For the bond sleeve of a portfolio, there are a great many potential investments after the rise in rates, with even short- and intermediate-term government bonds offering decent income.

One corner of the bond market that remains volatile is long-term government bonds. These bonds have the longest duration in the market, meaning they have the greatest amount of interest rate risk. The 30-year, zero-coupon bonds are the highest risk. They’ve tumbled more than 50 percent since peaking during the pandemic. At that time, those bonds were “return-free risk,” as some banks are learning these days. It made no sense to have these bonds even as a trade because the upside was highly limited and the downside was not. Pimco 25+ Year Zero Coupon U.S. Treasury (ZROZ) and Vanguard Extended Duration (EDV) have these types of bonds in their portfolios, while iShares 20+ Year Treasury (TLT) has interest-bearing bonds that have somewhat lower duration.

These bonds remain highly aggressive for an investor’s bond sleeve because of their volatility. However, given the decline in the bonds and the relative valuation of equities, there is a case for holding them in place of some growth stock exposure.

There are four ways two assets can behave in relation to each other. Both increase; both decrease; one rises, and the other falls; one falls, and the other rises. In 2022, Invesco QQQ (QQQ) and the three aforementioned long-term bond funds — TLT, EDV and ZROZ — all lost more than 30 percent. Due to inflation and rising rate concerns last year, both bonds and stocks traded similarly.

One possibility is that these bond funds and QQQ will continue sliding together. They stayed largely correlated until the bank failures in March. If they remain correlated moving forward, then we expect the risk for stocks will exceed that of bonds. As the interest rate rises, bonds lose money in a fairly linear manner. However, as we saw with banks in March, at certain levels of interest rates, companies can start going bankrupt. If inflation and interest rates are headed for new highs, bonds will do poorly, but stocks probably will fare worse.

If this scenario plays out, cash or short-term bonds would be a better alternative to either stocks or long-term bonds.

The next possibility is that both stocks and long-term government bonds rally. Both tumbled in 2022, and both have done well in 2023. The Nasdaq pulled ahead as of March 16, with a 15.22 percent return in 2023, while TLT had a gain of 6.27 percent, the lowest of the three bond funds. Investors may not have as much upside with bonds as stocks, but stocks cannot rally much if bonds sell off again.

The next possibility is that bonds fall and stocks rise. We see this as highly unlikely right now. A significant move lower in bonds will pull stocks lower as well though. Investors have already started increasing bond and cash allocations because they offer good income.

The final possibility is that bonds rise and stocks fall. A recession and/or a bear market in stocks could be one way this happens. We have seen this scenario play out multiple times during previous corrections and bear markets. If a recession lowers inflation, it will likely play out again because the Federal Reserve will have some room to cut rates.

In theory, anything is possible, but inflation has peaked for now. The oil price drop in March will help put a lid on inflation in the near term. The past 50 years of economic history show rapid increases in inflation and interest rates, along with a deeply inverted yield curve as we have now, have almost always been followed by a recession within about two years at the latest. However, the last time similar conditions existed was in the early 1980s, and at that time, a recession was almost immediate once the yield curve started steepening. The banking troubles hint at the stress in the financial system. Finally, the Federal Reserve hasn’t thrown in the towel yet. While they did start a bailout for some banks, they aren’t bailing out the whole financial system. That day may come, but it will take greater losses in the financial markets, losses that will likely trigger a rally in government bonds.


Duration is a measure of interest rate risk. Measured in years, it gives a rough estimate of how much a bond fund or an individual bond will move for a 1 percent move in interest rates. A bond with a duration of 10 would be expected to rise or fall 10 percent for a 1 percent drop or rise in the relevant interest rate.

TLT has a duration of 17.64, EDV 24.23 and ZROZ 26.18.


TLT has a standard deviation of 14.82, EDV 19.32 and ZROZ 20.75. TLT has a beta of 2.04 versus the average bond fund, EDV 2.61 and ZROZ 2.73.

ZROZ is riskier than EDV, and both are riskier than TLT.


Over the past year, TLT declined 16.64 percent, EDV 21.97 percent and ZROZ 23.84 percent. QQQ fell 10.84 percent.

Year to date, TLT, EDV and ZROZ have increased 8.22 percent, 10.84 percent and 11.49 percent. QQQ gained 14.89 percent.

From their peak in 2020, TLT lost more than 40 percent, while EDV and ZROZ slid 55 percent.


TLT has a 30-day SEC yield of 3.79 percent and pays monthly dividends.

EDV has a 30-day SEC yield of 3.82 percent and pays quarterly.

ZROZ has a 30-day SEC yield of 3.30 percent and pays quarterly.


The Federal Reserve launched a depositor bailout program in March. Traders immediately bid up Nasdaq stocks, cryptocurrency and some of the riskiest stocks in the market on the expectation of further stimulus. They also pushed the 30-year Treasury bond back near its 2023 high, along with many short-term bonds.

Aggressive investors might be tempted to buy growth stocks or ETFs  such as Invesco QQQ (QQQ) for exposure. Long-dated government bonds offer solid upside though, while also offering some opportunity if a recession or financial crisis develops. For this reason, investors who want added equity exposure in areas such as growth and technology may be better served by allocating part of that equity slice to longer-term government bonds.

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Fund Spotlight: Vanguard Extended Duration (EDV)

In 2022, long-term U.S. Treasury bonds suffered their worst performance since the early days of the American republic. Rising inflation, along with Federal Reserve rate increases, sent bond prices tumbling. This wasn’t the start of the move though. Bonds peaked during the March 2020 lockdowns and had been falling steadily since then. It’s likely that last year’s low will hold for some time. As long as inflation is brought under control, interest rates on corporate bonds already compensate investors well for inflation risk. If inflation falls further, government bonds are also compelling options for fixed income investors.

The most volatile part of the government bond market is long-term Treasury bonds. In the U.S., that is the 30-year bond. These bonds fluctuate greatly when interest rates make large moves up or down because they are valued on 30 years’ worth of cash flows along with the return of principal. The most volatile security is the zero-coupon bond because all the cash flow comes 30 years from now. Any change in the interest rate is compounded for 30 years.

EDV is a zero-coupon bond fund that owns Treasury STRIPS with maturities of 20 to 30 years. This gives it one of the longest durations in the market at 24.23 years.

Duration is a measure of interest rate risk. Most investors are familiar with the concept of a bond’s maturity. That’s how many years it has until it matures and the principal is repaid. Bonds with high coupons, such as high-yield bonds, have durations lower than their maturity. In the case of zero-coupon bonds, they have durations that match their maturity.

A rule of thumb says that a bond or bond fund’s price will move about 1 percent multiplied by the duration, for a 1 percent move in the interest rate. Last year, both the 20-year and 30-year Treasury bond climbed about 2 percentage points. This would make for a possible 48 percent move in the price of EDV. In fact, the fund fell 39.16 percent, a bit better than expected.

Since the end of 2022, the 30-year Treasury yield has fallen about 0.3 percentage points. Multiply change in yield by EDV’s duration of 24.23 years and we get a number close to the 8.50 percent gain in EDV in 2023.

Reward-Free Risk

During periods of quantitative easing, the Federal Reserve cut interest rates to zero and held them there. At that time, some financial analysts and commentators referred to long-term Treasury bonds as “return-free risk,” a play on the term “risk-free rate” which refers to the 3-month Treasury bill rate. They called long-term bonds “return-free risk” because at the depth of the 2020 panic, 30-year Treasury bonds yielded less than 1 percent. Assuming interest rates would not go negative, there was almost zero upside in owning 30-year bonds even before considering future inflation. Their warning was prescient because between EDV’s all-time high in March 2020 and the low in October 2022, it would lose 55 percent of its value.

Today, the picture has changed. The Federal Reserve is still raising interest rates, but we’ve started seeing strain in the financial system. The failure of SVB Financial destroyed tens and perhaps hundreds of billions in capital, along with the tens of billions in stock market capitalization. This is deflationary and will help depress the rate of inflation moving forward. If more banks come under stress, the Federal Reserve will not continue its rate hiking policies. In short, we’re very close to the peak interest rate for this cycle.

Bonds Versus Stocks

During the era of quantitative easing, many bonds offered little in the way of income. Since the return on bonds was depressed, investors switched into high-yield debt for income or stocks in pursuit of capital gains. For much of this period, stocks were “cheap” relative to bonds because the latter offered so little in the way of return. In 2022, that started changing. In 2023, the yield on investment grade corporate bonds exceeded that of the S&P 500’s earnings yield (the inverse of the price-to-earnings ratio).

Comparing the S&P 500 earnings yield with investment grade corporate bond yield is a simple way to determine if stocks are over- or undervalued versus bonds. At current rates and stock valuations, investment grade corporate bonds are cheaper. However, this ignores that stocks are riskier on the whole. Stocks should trade at a discount to bonds because stock prices fluctuate more than bond prices. An investor who buys a bond and holds it to maturity is guaranteed the nominal return.

When investment grade corporate bonds offer a better yield than that of the S&P 500 Index, stocks are quite overvalued according to this measure. To wit, the last time corporate bonds had a higher yield than the S&P 500 earnings yield was in the late 1990s and 2007, both periods of stock overvaluation. However, in both cases this result was caused by extreme overvaluation of stocks and, naturally, bear markets ensued.

Given what we’ve seen in financial markets over the past month with increasing stress in the banking sector, it appears that long-term interest rates have peaked for this cycle. If long-term interest rates have peaked, long-term government bonds offer a compelling opportunity.

The likelihood of large losses in bonds is lower than it was at any time in the prior three years. In some scenarios where bonds lose big, stocks could lose more, meaning investors with growth and tech exposure are already taking on this risk. There are also scenarios where bonds win and stocks lose. All in all, there is a compelling argument for holding a fund such as EDV in place of some equity exposure, particularly in place of aggressive growth or technology stocks.

Vanguard Extended Duration

EDV tracks the Bloomberg U.S. Treasury STRIPS 20-30 Year Equal Par Bond Index. It currently holds 80 bonds. The average duration is 24.2 years, and the average maturity is 24.7 years. The expense ratio is 0.06 percent. The 30-day SEC yield is 3.99 percent.

EDV has 1-, 3-, 5-, 10- and 15-year annualized returns of negative 29.36 percent, negative 18.74 percent, negative 1.46 percent, positive 1.55 percent and positive 4.58 percent, respectively.

EDV has a standard deviation of 19.32. For comparison, the S&P 500 Index has a standard deviation of 20.74, making EDV almost as volatile as the stock market.


Bonds are finally offering investors a compelling value proposition following last year’s sell-off. For the first time in years, investors can take on less credit risk and obtain meaningful income from investment grade corporate bonds and U.S. Treasuries. Longer-duration funds such as EDV also offer a better risk-reward proposition compared with growth stocks such as the Nasdaq or technology indexes.

This is even more pertinent if investors worry about recession risk and further downside in stocks, or if they believe long-term interest rates have peaked. A fund such as EDV can replace some of the tech or growth exposure in a portfolio, offering investors potential upside in scenarios where interest rates tumble in response to a recession or bear market in stocks.

EDV is not as compelling a holding within a portfolio’s bond sleeve because it is highly volatile and does have downside volatility risk. The income from EDV is not worth the risk when there are far less risky bond funds offering similar and, in many cases, higher yields. Investors would increase their overall portfolio volatility and risk if they swapped lower-risk, shorter-term bonds for a fund such as EDV. Compared with a fund such as Vanguard Information Technology (VGT) however, EDV doesn’t add that much risk and offers a different matrix of performance outcomes than do stocks.

In conclusion, for investors worried about recession and falling equity prices, and who believe long-term interest rates may have peaked, long-term bonds offer diversification. Long-term government bonds can rally if inflation falls, and they can rally if there is a bear market or recession that depresses interest rates. They might lag stocks in some of the “Goldilocks” scenarios, but when considering both the potential upside and downside of the technology and growth sectors of the market, a small allocation to EDV within a portfolio’s equity allocation can provide a measure of diversification without the kind of downside risk that such a position would have had for much of the previous decade.

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Fund Spotlight: Bond Strategies for 2023

For years, bond and fixed-income investing were simplified by the Federal Reserve’s zero interest rate policy. Many bonds offered zero or near zero interest. Bank CDs weren’t much better. After a brutal 2022, many parts of the bond market reset the table. Bonds became a great way to achieve income investing goals again, with yields climbing past 4 percent on short- and long-term government bonds.

Most bonds pay fixed coupons, the same amount and usually twice a year. When interest rates rise, the price of an existing bond will fall because investors can buy new bonds with higher yields. When interest rates fall, the bonds go up in price because new bonds offer less income. Investors holding bonds to maturity don’t worry as much about changes in interest rates, but those investing in bond funds will see the fund value rise and fall in the opposite direction of interest rates.

There are two main risks with bonds: interest rate risk and credit risk. U.S. Treasurys have no risk of default because the government can print money to pay principal and interest. The price of Treasury bonds moves entirely based on the interest rates. If the market pushes rates up, Treasurys sell off. If the market pushes rates down, Treasurys rally. Corporate bonds also move based on interest rates, but their price change isn’t solely determined by changes in interest rates.

Investors can quickly access the interest rate risk of a bond by looking at the duration, a statistic found on nearly all financial websites. The rule of thumb is that for every 1 percent change in the relevant interest rate, the price of the bond or fund will move by the duration. If a fund has a duration of 5 and interest rates rise/fall one percentage point, the fund will decrease/increase about 5 percent.

Credit risk also factors into bonds of companies and countries that don’t issue debt in their own currency. The higher the credit risk, the more the price of the bond will be driven by credit risk rather than interest rate risk. In the past decade, the only way to obtain significant income from a bond portfolio was through higher-yielding bonds. For the first time since before the 2008 financial crisis, these bonds finally have some competition.

Conservative Short-Term Bonds

It has been more than a decade since investors could expect a nice return in a money market fund, but those times are back. Fidelity Government Money Market (SPAXX) has a 7-day SEC yield of 3.96 percent. Since the Federal Reserve isn’t done hiking, it’s almost guaranteed to rise to around 4.25 percent in the next month and then possibly toward 5 percent or more later this year if the Fed keeps hiking. This income is “risk free” since it comes from U.S. government securities.

Investors can achieve slightly higher yields with short-term bond funds such as Fidelity Short-Term Treasury Bond Index (FUMBX), which yields 4.10 percent.

The risk with these funds isn’t loss of principal; instead, it is the potential loss of income if bond yields fall. Investors will not receive much “compensation” via capital gains as yields fall.

These funds are best suited for two environments. First, when interest rates are stable, they can produce reliable income over long periods of time. Second, when interest rates are rising, they mitigate losses. In 2022, SPAXX gained 1.31 percent. Even though it has a low duration, the rapid rise in rates sank FUMBX by nearly 7 percent.

Investors who do not expect any rate cuts and want to capture rising rates with no risk can stick with a money market fund such as SPAXX. Investors who think rates might peak later this year and who might hold the position into 2024 when the possibility of rate cuts will increase, have more potential upside from FUMBX while collecting a similar level of income today.

Diversified Bond Funds

As long as interest rates are in a normal range, investors can profit from bond diversification. Exposure to Treasurys, corporate and high-yield bonds of varying maturities can produce good income and solid long-term returns. Diversified bond funds such as Fidelity Total Bond (FBND, FTBFX) currently yield 3.13 percent.

Total bond funds were down about 17 percent at their lows last year. Adjusted for dividends, these funds lost all their gains going back to 2015. It’s worth noting the bulk of the gains came in between 2019 and 2022 when the Federal Reserve was slashing interest rates to zero. If we remove dividends, the losses on the bond portfolios exceeded those of 2008. Stripped of dividends, the low for FTBFX in 2022 came within a few percentage points of the 2008 low.

One of the axioms of investing is “buy low, sell high.” While the process of making a low can be complex and take time, the price of commodities such as crude oil, wheat and natural gas all point to falling inflation later this year. The capital losses experienced by bonds in 2022 won’t be repeated this year or next. If the Federal Reserve stops raising rates later this year, the risk of capital losses will decline and be replaced by potential gains from falling rates.

Investors who want a little more income with less credit risk can opt for the far more narrowly invested Fidelity Intermediate Treasury Bond Index (FUAMX). It has a 30-day SEC yield of 3.57 percent and a duration of 6 years. The fund gained about 3 percent from October to February when the 10-year yield fell about one percentage point. This gives investors similar income without any of the credit risk contained in FTBFX.

Within the bond universe, broadly diversified funds will always deliver a return somewhere in the middle of the bond market. These funds are best for investors with very long holding periods who want to minimize the number of funds in their portfolio.

Long-Term Government Bonds Are an Aggressive Option

In prior years, investors referred to long-term government bonds as “return free risk.” Income was a pittance and did not compensate for the risk because bond yields couldn’t get much lower with the Federal Reserve at zero percent. Getting the lower bond yields seen in Japan and Europe would require the Federal Reserve to cut going into negative territory with interest rates. The risk in long-term bonds manifested itself in 2022. Long-term Treasury bond funds tracked the Nasdaq, with both asset classes losing more than 30 percent of their value.

With bond yields rising since then, long-term government bonds offer potential capital gains in the event of a recession and interest rate cuts. From the October low to the December high, the Fidelity Long-Term Treasury Bond Index (FNBGX) gained 16 percent. In February though, the fund gave back close to half those gains. This level of volatility is unsuitable for most investors. Additionally, the 3.75 percent yield offers no income advantage on money market and short-term bond funds but still contains substantial downside risk if inflation and interest rates do not peak this year or eventually go much higher.

That said, unlike in 2021 and 2022, long-term government bonds can potentially hedge a portfolio against recession and bear market risk if yields drop. If and when signs of recession appear, aggressive active investors may consider using long-term government bond funds as a hedge against that risk.

High-Yield Bonds Remain Attractive

High-yield bond funds are least attractive in a recession and most attractive in growing economies when credit risk is low. Talk of recession has picked up because the yield curve is inverted and inversions of this size have been followed by recessions in the past, but the timing of such a recession is unknown. At the moment, the Atlanta Federal Reserve’s GDPNow model has been hiking its growth forecast for the first quarter, hitting 2.8 percent as of February 27. The market has been reducing its assessment of credit risk since July. Spreads between higher-yield bonds and similar Treasurys have been falling since then.

Fidelity Floating Rate High Income (FFRHX) has a duration that approaches zero because the bonds in its portfolio reset as interest rates rise. FFRHX has a positive return since the end of 2021 because most of the bond market risk last year was centered on interest rate risk, not credit risk. It has an 8.55 percent 30-day yield, and that can go higher with Federal Reserve rate hikes.

Credit risk is the main worry for investors in this fund. The low in FFRHX came in July 2022 (the fund was down about 5 percent from its high at that point) because that is when credit risk peaked.

Floating-rate funds such as FFRHX only suffer if interest rates start falling, in which case the yield on these bonds will also.

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Fund Spotlight: Dimensional U.S. Small Cap Value (DFSV)

Small-cap value stocks outperform in the long run. They are riskier, turning off some investors. They are too small for many large institutional investors. The entire U.S. stock market is valued at around $44 trillion, and the value of all the companies in DFSV’s portfolio come to less than $4 trillion. Not only is it hard to invest but it is even harder to get out. Therefore, this space is avoided by most institutions and large investors or only gets a proportionate value of their assets, less than 10 percent of an equity allocation.

In addition to being passed over by large investors, small-cap value stocks are also avoided by financial analysts since there isn’t a great deal of interest. This means investors have to do their own research, which the vast majority do not. These stocks are also more volatile, which turns off conservative investors. Paradoxically, all these negatives probably explain small-cap value’s outperformance. Most of the time, this asset class is trading at a discount.

Dimensional Fund Advisors is a fund provider based on the academic research of Eugene Fama and Kenneth French. Many of the funds using factor-based methods base their models directly on the work of Fama and French or derived models that use their research as a starting point. Dimensional goes straight to the source — Fama sits on Dimensional’s board of directors.

In a nutshell, they created a new asset pricing model after finding that small-cap stocks with low price-to-book ratios outperformed the market. This shouldn’t be the case if variations in stock returns were mostly random, something that earlier academic research showed. This was sometimes described as the “random walk” theory. Investors who believe in this theory would do best buying a passive fund covering the entire market, such as the S&P 500 Index. In contrast, Fama and French’s work suggested asset allocation among market segments, such as market capitalization and traditional growth and value, or international and so on, had an impact on returns. Later, they discovered that other factors such as momentum could explain returns and thus be used as the basis for investment selection.

The market segment that showed the best performance was small-cap value, as shown in the earlier work of Fama and French. In 2022, Dimensional Advisors launched an ETF based on their work: Dimensional U.S. Small Cap Value (DFSV). Since the launch of DFSV in February, it has consistently outperformed iShares Russell 2000 (IWM) as well as small-cap value competitors such as Vanguard Small-Cap Value (VBR) and SPDR S&P Small-Cap Value (SLYV).

Investment Strategy

DFSV starts its universe with the cheapest 10 percent of the U.S. stock market as measured by market capitalization. It then narrows this universe by hunting for stocks with lower price-to-book ratios, cutting off at the bottom third. It looks for companies with higher profitability that haven’t been aggressively expanding. Short-term signals such as price momentum can also be a criterion for investment. Liquidity screens and the need to keep turnover low also impact which stocks make it into the portfolio. Holdings are weighted by market capitalization as a way of keeping turnover down.

Costs are kept low, but at 0.31 percent, it’s relatively pricey compared with passive alternatives such as VBR and its 0.07 percent cost.

DFSV has already earned a Morningstar Silver rating.


DFSV currently holds 957 stocks. The weighted average market capitalization is $3.4 billion. The portfolio of stocks has an aggregate price-to-book ratio of 1.27, which compares with 1.99 for the Russell 2000 Index and 1.33 for the Russell 2000 Value Index.

Financials dominate the portfolio with a 27 percent allocation, but this isn’t far above the benchmark’s 24 percent. Industrials are also slightly overweight at 20 percent of assets. Consumer cyclicals are in line with the benchmark at 14 percent of assets. Energy at 9 percent is overweight by three percentage points. Technology rounds out the top five at 8 percent of assets, underweight by 1 percent. Utilities, healthcare and real estate are the sectors with the largest underweighting.

The top 10 holdings have a small percentage of assets, as expected in a diversified fund with nearly 1,000 holdings. Allocations in the top holdings range from 0.76 percent of assets down to 0.54 percent. At the top is Transocean (RIG), followed by Commercial Metals (CMC), TechnipFMC (FTI), IPG Photonics (IPGP), Bank OZL (OZK), Foot Locker (FL), New York Community Bank (NYCB), FNB Corp. (FNB), Jackson Financial (JXN) and Genworth Financial (GNW).

DFSV doesn’t have enough history for beta and standard deviation, but a sister mutual fund trades under the symbol DSFVX. It has a beta of 1.18 and a standard deviation of 29.26, making it more volatile than the Small-Cap Value category on both scores, albeit only slightly.


DFSV has gained 12.80 percent in 2023, beating both the category and the benchmark index. It has similarly beaten both since its inception a little less than one year ago.

Its sister fund DFSVX has a long history of performance. Over the past 20 years, it has gained 800 percent, well ahead of iShares Russell 2000 Value’s (IWN) 547 percent. Over the past 15 years, it gained 278 percent to IWN’s 209 percent. DFSVX ranks in at least the top 27 percent of small-cap value funds over the past 5-, 10- and 15-year periods.

Notably, DFSVX performed much better in the past year. It gained 6.50 percent, while the category and index rose less than 2 percent. This landed it in the top 13 percent of funds. Both DFSVX and DFSV made new all-time highs in February of this year. This shows the fund can also outperform in down markets.

Caution is warranted though. In 2008, DFSVX lost 67 percent from high to low. While there are some signs the current market resembles the early 2000s (DFSV’s performance this past year reinforces this comparison) and DFSVX did end up gaining over the entirety of that bear market, it would be unwise for investors to assume a repeat should markets turn lower.


DFSV is one of the top options for investors seeking small-cap value exposure. Although DFSV is a little more expensive than the competition, if it can do as well as its mutual fund counterpart DFSVX, it can more than make up for the higher expense ratio. For example, DFSV is outperforming VBR by several percentage points in 2023, with about six weeks of trading done. That dwarfs the difference in their expense ratios.

DFSV can serve as a core holding for younger and more aggressive investors with longer time horizons. More conservative investors should stick to smaller satellite positions, although investors can be more aggressive in bear markets and major corrections when adding the fund offers a much stronger risk/reward proposition.

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