1. The term direct indexing may be new, but the concept of replicating an index by owning the individual securities held in the index is a long-standing one. For example, Parametric’s Custom Core separately managed account (SMA) has given clients the ability to flexibly customize tax-managed index-based portfolios since 1992.
2. In addition to buying all 500 securities according to their weights, a process known as replication, a direct index manager could also use a technique known as sampling, which uses a smaller subset of securities, as a means to achieve index returns.
3. Zweig (1999) explained that before the world’s first open-end mutual fund in 1924, buying an “investment “trust” required that “you’d shell out a 10% sales charge and fork over up to 12.5% of your profits for the manager’s annual fees. And your ‘trust’ would probably refuse to tell you what stocks and bonds it held.”
4. Because of newer technological systems, direct indexing providers and software vendors can more economically monitor large quantities of tax lots and individual positions, even for accounts with low assets.
5. Liquidation in this case means selling the entire portfolio at a single terminal date at which time the gains are realized. In the interim, because the gains remain unrealized, the taxes are deferred, which allows a larger portion of the portfolio to grow and compound over time. Thus, the ability to defer capital gains and their associated taxes has been described as an interest-free loan. Berkin and Ye (2003) used a 35% tax rate, acknowledging that taxpayers with a higher marginal rate should care more about the impact of taxes than the authors’ results suggest and taxpayers with a lower marginal tax rate should care somewhat less.
6. For interested readers, our colleagues discuss why we believe investors can achieve their dual objectives of social responsibility and long-horizon outperformance using a thoughtfully designed strategy (Treussard, Li, and Sherrerd 2018).
7. The total market value of US firms involved in corporate crisis incidents that have become public since 2016 is over $1.5 trillion (The Economist, 2019).
8. In his Presidential Address to the American Finance Association in 2017, Cam Harvey (a Research Affiliates partner and senior advisor) asserted that we as an industry must establish the economic plausibility of why a strategy will produce a higher return. For practitioners, an interesting thought experiment related to economic plausibility is “Who’s on the other side of the trade?”
9. More information is available on the Smart Beta Interactive tool on the Research Affiliates website.
10. John can attest. As a coauthor of the Fundamental Index: A Better Way to Invest (Wiley, 2008), he sees the book proudly displayed on his retired parents’ bookshelf. They have the time to spend and the interest in learning more about their son’s work, but they have yet to read the book cover to cover since its publication 11 years ago!
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