Pooled market-cap index funds have become very popular as a way for small investors to easily gain exposure to a large number of stocks and bonds. While these funds can be suitable for most small investors, affluent investors are often left wanting more control, transparency, tax-efficiency, gifting ability, and cost control. With these shortfalls in mind, we set out to build a more efficient institutional earnings-focused index for affluent investors. In our years of research, the team at Linden Thomas & Co. found that market- cap index funds fell short of excellence in 9 ways:
- Market-Cap Requirements – often stocks are held in the fund based on their size, not their quality
- Pooled Ownership – investors don’t own the holdings directly
- Hidden Costs – the expense ratio is not the only cost
- Pass-Through Taxes – the sale of legacy holdings impacts investor taxes, even in down years
- No Control – no ability to do any kind of tax-loss harvesting or gifting of appreciated holdings
- No Transparency – investors often can’t see the individual holdings or cost-basis information
- No Ownership Privileges – fund shareholders have no ability to vote important proxies
- High Advisor Costs – advisors often sell model index portfolios at high annual cost
- Small Investor Herding Impacts – affluent investors are subject to the impacts of small investors moving into and out of the fund. These small investors force the fund companies to sell holdings and meet redemptions, even if the market is down
For these reasons we broke tradition to build a more efficient index for affluent investors.
Earnings Focused Institutional Indexing
- Earnings-Quality Requirements – Moving away from how traditional index funds choose equities solely based on market-cap requirements, we chose to use an earnings screen approach. This allows us to identify companies that meet high earnings standards and avoid those that don’t meet the criteria. This gives the investor a diversified portfolio while maintaining a focus on quality.
- Direct Ownership – Direct ownership of holdings gives investors total control and transparency over their holdings. This also empowers the investor to do tax-loss harvesting or gifting of shares to better manage taxes.
- Transparent Cost – Just a management fee, giving the investor clarity into what their costs are.
- Ownership Privileges – The owners of the holdings can take back voting rights on matters that are meaningful, instead of letting big Wall Street firms do it for them.
- No High Advisor Fees – No high investment advisor fees on top of other hidden costs.
- No Small-Investor Herding Impacts – Affluent investors avoid being subject to the impacts and pass-through taxes of small investors selling during down markets.
Outcome? Efficiency is Directly Correlated to Results
The outcome of this journey is that our clients/investors end up with a diversified portfolio tailored to their needs while maintaining a focus on quality, direct ownership, transparency, and control. While pooled market-cap indexes may fail to deliver the optimal investment option for affluent investors, the Linden Thomas & Co. earnings-focused institutional indexes have excelled. Below illustrates how efficiency is directly correlated with results:
Past performance is not indicative of future results. The above information is shown as supplemental information only and complements the fully compliant presentations. Periods greater than one year are annualized.
Pooled funds provide instant diversification and simplicity, making them suitable for small investors. On the other hand, institutional direct indexing offers customization, potential tax advantages, and the ability to align investments with personal values. It is more suitable for investors with larger portfolios who seek greater control. Ultimately, the choice between these two approaches depends on an individual investor’s goals, preferences, and circumstances. However, overall institutional direct is built for the individual, while retail indexing is built for the institution.