An Analysis of Mutual Fund Design : The Case of Investing in Small-Cap Stocks

In 1982, Dimensional Fund Advisors launched a mutual fund intended to capture the returns of small-cap stocks. The quot;9-10 Fundquot; is based on the CRSP 9-10 Index, an index of small-cap stocks comprising the 9th and 10th deciles of NYSE market capitalization. Although linked to the CRSP 9-10 Index, the design of the 9-10 Fund incorporates investment rules and a trading strategy that are aimed at minimizing the potentially excessive trade costs associated with such illiquid stocks. This design causes the Fund's security weightings to deviate from the CRSP 9-10 weightings. The resulting return deviations between the 9-10 Fund and the CRSP 9-10 Index are sometimes large. On average, the 9-10 Fund provided a 2.2% premium over the 9-10 Index over the 1982-95 period. This paper decomposes the return difference between the 9-10 Fund and the CRSP 9-10 Index. We show that both the investment rules and the trade strategy components of the Fund's design contribute significantly to the return difference, although the magnitude and significance of their relative impacts vary over the life of the Fund