What is an index fund? What is an Asset Class? What is Asset Class Investing?
Mutual funds that try to replicate or track market indexes have gained in popularity in recent years.
These “Index Funds” now cover everything from major market indexes such as the S&P 500 to particular
types of securities such as small cap stocks, value stocks, and REITS, to sectors, even individual countries.
Although, index funds are similar to the overall passive approach behind Structured Investing, we believe
index funds have some drawbacks that may reduce their effectiveness at delivering pure asset-class returns.
Indexes are unmanaged baskets of securities that are not available for direct investment by investors. Their performance does not reflect the expenses associated with
the management of actual portfolios. Past Performance is no guarantee of future results, and values fluctuate. All investments involve risk, including the loss of principal.
The risks associated with stocks potentially include increased volatility (up and down movement in the value of your assets) and loss of principal. Small company stocks
may be subject to a higher degree of market risk than the securities of more established companies because they may be more volatile and less liquid.
The Origins of Asset Class Investing
Rex Sinquefield and David Booth started the first S&P 500 index funds in 1973 — Booth at Wells Fargo and
Sinquefield at American National Bank. In 1981, determined to improve upon some of the problems they’d
encountered with indexing, the two men formed Dimensional Fund Advisors (Dimensional). With the help
of their former professor at the University of Chicago, Gene Fama Sr., Sinquefield and Booth developed what is
known today as asset class investing.
Indexing Asset Class Investing
Portfolio holdings dictated by target index Portfolio holdings dictated by academically
designed asset class
Attempts to deliver target index rate of return Attempts to deliver asset class rate of return
May accept high transactions costs and
turnover in favor of tracking
Attempts to minimize transaction costs and
enhances returns through advanced trading
Manager goal to eliminate tracking error Manager goal to deliver asset class rate of return
The Benefits of Asset Class Investing vs. Indexing
Trading stocks — especially small cap stocks — can be expensive. In Dimensional’s experience, careful
trading may result in cost reductions, with savings accruing directly to an investor’s return.
Historically, there has often been a run up in a security’s price from the date its inclusion in an index is
announced to the date it is actually added. After the effective date, when the security officially becomes part of
the index, the price of the security tends to decline. Since a key goal of index fund managers is to minimize
tracking error, they must purchase the security on the effective date, often at a high price, in order to avoid
tracking error. Dimensional tries to avoid this reconstitution effect by patiently trading securities and not
mechanically following indexes — its goal is to deliver the asset class rate of return.
Dimensional’s trading strategy is also designed to capitalize on block trading and securities lending