When we founded Acropolis as an independent firm nine years ago, there was one thing that we weren’t going to invest in: open-ended mutual funds.

We firmly believed that mutual funds were not in the best interest of our clients because the management fees were too high, they had too much turnover that led to high costs and taxes, and they were stylistically impure (when a Large Cap fund invests in Mid Cap or a Developed International fund invests in Emerging Markets).  At the same time, exchange-traded funds (ETFs) were a burgeoning field and we could increasingly get inexpensive, tax-efficient and diversified exposure to almost any asset class that we wanted with ETFs.

Over time, we came to believe that index mutual funds like those from Vanguard were also great choices for 401k plans and we use them extensively for our 401k practice because they are low cost and allow for small and regular contributions.  For private clients, we still preferred ETFs because they are usually cheaper, more tax-efficient and have liquidity throughout the trading day.

So it was a surprise to some folks within the firm when we started talking to the mutual fund company Dimensional Fund Advisors (DFA) early this year.  Why would we start using mutual funds, especially as the industry is moving away from mutual funds toward ETFs?  How would we use them?  What about the costs, turnover and loss of intraday liquidity?

The answer is simple: we are always looking for the best way to access a particular market or asset class and will use the best structure (mutual fund, ETF or a set of individual securities) to accomplish our goal.  In the past, there were very few instances where we thought that a mutual fund made more sense than an ETF or our own selection of individual securities.  But DFA funds provide the same low costs, tax efficiency and pure asset class exposure we desire.

After a lengthy process, we were approved to be among the relatively few qualified advisors able to offer DFA funds.  DFA enforces strict limitations on who they will allow to use their funds because a number of their funds seek exposure to very small, niche markets where having ‘hot money’ flow in and out of the fund will hurt long-term shareholders.

Since Acropolis approaches investing with a long-term viewpoint and intends to hold securities over a very long time other than periodic rebalancing and tax loss harvesting, DFA agreed that we were a good fit for their funds.

While DFA funds aren’t active in the sense that there is a person selecting stocks, they aren’t exactly passive since they don’t track indexes; they are somewhere in the middle of the spectrum: using the principles that index funds use in a low cost, tax efficient way, but improving on the indexes through research and trading.

For example, the first fund that we bought was the DFA Micro Cap fund to replace the iShares Russell Micro Cap ETF in our portfolios.  Because the underlying holdings in a Micro Cap fund are relatively illiquid, the iShares ETF is forced to buy and sell securities at less favorable prices in order to closely track their index and provide intraday liquidity.  DFA, on the other hand, has more flexibility regarding buy and sell decisions.

DFA is able  to buy or sell a stock when market conditions are best, which is usually a function of liquidity or the stock’s momentum that are generally determined using quantitative analytics that measure characteristics established by the managers.

The result has been better performance on a pre and post-tax basis.  Over the past five years ending September 30, the DFA Micro Cap Fund outperformed the iShares ETF by nearly 3.5 percent per year on a pre-tax basis.  Even after-tax, DFA outperformed by almost 2.75 per year.  Both funds have similar asset class exposure, but DFA’s flexibility regarding buy and sell decisions as well as their use of cutting edge research has added substantial value over time.

Some of the DFA funds are fairly obvious replacements for the ETFs that we use today and we have already implemented a number of the funds.  Still, this is a process and we take our due diligence very seriously.  DFA doesn’t have a ‘magic bullet’ and there are some funds that we have already ruled out because they aren’t an improvement over what we do today.

As we consider all of the available options, you will continue to see individual stocks and bonds, exchange traded funds, and now, a few select mutual funds, all in pursuit of a better investor experience.  And, as always, you can rest assured that we are leading the charge with our own money and buying the very same securities in our own accounts that we buy for you.