DFAI - DFAI: A Globally Diversified ETF With Strong Potential For Outperformance

2023-04-26 04:09:21 ET

Summary

• DFAI invests across the world in all major geographies excluding the United States.
• While the fund is highly diversified in practically all key ways, I think the fund has the potential to outperform U.S. markets.
• DFAI is a lower-volatility, diversified fund that also carries some apparent undervaluation within its price; on a multi-year time frame, I think DFAI's recent popularity should prove well founded.

Dimensional International Core Equity Market ETF ( DFAI ) is an exchange-traded fund that invests in large-, mid- and small-cap stocks across 22 developed markets but specifically excluding the United States. The fund had 3,579 holdings as of 24 April, 2023, with assets under management of $3.5 billion. The net expense ratio is reported as 0.18%.

DFAI is essentially a highly diversified equity fund, investing across all types of companies of all sizes in all major geographies (excluding the United States, and also emerging markets). The fund was set up in 2020, and appears to be very popular in spite of its relative youth. Net fund flows have been strong over the past year, with the fund growing by about $1.8 billion.

The fund's top 10 holdings are listed below, but you will notice that even the largest holding represented only 1.56% of the fund as of recent.

The top 10 holdings are a mixed bag in terms of sectors and even stock exchanges/primary regions. Pictured below is a table from Morningstar that provides us with a straightforward sector exposure breakdown.

There is clearly very little bias here, not even at the higher categories of Cyclical, Sensitive, and Defensive. If you were to take a tech-oriented fund, for example, you would expect higher beta. If you were to take a fund with high exposure to consumer staples, healthcare, and utilities, you would expect lower beta. The balance that DFAI offers would generally be expected to get the best of both worlds, but the high level of diversification (and the avoidance of U.S. exposure; a top equity market) means that returns would not expectedly generate relatively high returns. I view DFAI as the kind of fund one might choose in order to avoid regret; if DFAI performs poorly, most other funds probably will be (while the opposite is also likely to be true).

Still, DFAI also functions like a hedge (or diversifier) for U.S. equities and/or the U.S. dollar. As a side point, I calculate the contemporary beta (DFAI relative to the S&P 500) as being about 0.90x. This appears to be fairly stable, based on the annualized volatility of various time periods for both DFAI and the S&P 500.

To make some financial assumptions in order to build a valuation model, we can refer to DFAI's benchmark index's most recent factsheet as of March 31, 2023. DFAI's benchmark had reported trailing and forward price/earnings ratios of 15.07x and 12.78x, respectively, with a price/book ratio of 1.64x. The trailing dividend yield was 3.14%.

Morningstar, previously cited, expect DFAI's portfolio's earnings growth to hit 9.76% on average over a three- to five-year time frame. Using this as a base, and guessing that dividend distribution rates will be similarly high going forward (but stable), with no share buybacks assumed for now, I generate a model that implies an IRR of over 14% per annum over the next five years. This also assumes a constant earnings multiple, which I think is actually on the lower side, if anything.

This is actually a remarkably sound return profile, especially given the relatively subdued volatility of the fund. On a volatility-adjusted basis, DFAI looks very attractive.

So, while DFAI appears superficially to be another long-beta fund (which is true, really), the fund still seems to be undervalued with the potential to out-perform U.S. markets. Risk-free rates are low, and while DFAI's portfolio carries some degree of "country risk premium" (data sourced in my calculations from Professor Damodaran ), the IRR is simply objectively high relative to the risk involved.

Additionally, while one could argue earnings growth estimates are generous, I don't think so; the implied return on equity is still going to be in line with historical averages, and in fact it ends in my forecast slightly below my year one projection (which is based on MSCI's numbers).

Overall, I think DFAI is not only an attractive diversifier but a potential out-performer in its own right at current prices.

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