High- and ultra-high net worth investors, whose funds are managed by RIAs, have relatively low utilization of index funds, with such funds comprising only 3.8% of total assets held in marketable securities.  Moreover, only 1.0% of total assets are indexed to broad-based US markets, while the other 2.8% are indexed to international markets and to subsets of the US markets.  This data is in stark contrast to data from retail and mass affluent investors.  Burton Malkiel, the author of A Random Walk Down Wall Street (New York, W. W. Norton & Company, 1999-2007) and the early champion of index funds, claims that individual investors, on average, hold 10-15% of their assets in index funds¹. Wealthy investors, when using an RIA or financial advisor, take an active approach to investing, and seek returns in excess of market benchmarks, and employ a combination of SMAs and actively managed mutual funds with 96.2% of marketable assets to achieve performance in excess of market indices.

Industry statistics from the Investment Company Institute (ICI), the trade organization for the mutual fund industry, show that traditional index funds and ETFs now represent 10.6% of mutual fund asset². Within the Advisor Perspectives (AP) universe, index funds (including ETFs) represent 23.8% of mutual fund assets, so wealthy investors are using a disproportionately high share of index funds.  Indexed ETFs represent 78% of all indexed funds in the AP universe.  For the mutual fund industry, ETFs represent 36% of all index funds, so wealthy investors are using ETFs for indexing far more extensively than the market in general.

Funds tied to broad-based US equity indices (the Dow, S&P, or a broader market index) represent 27.6% of index fund usage and, as noted above, represent only 1.0% of total marketable securities.  Traditional index funds and ETFs were used in equal amounts when indexing a broad-based US market index.  A large use of index funds was to index international markets, both broad-based (emerging and developed market indices) and more specific regional international indices.  International index funds (including ETFs) represent 36.7% of index fund usage, with 90% of international indexing done through ETFs.

Barclays, recognized as a leader in ETFs, is the most popular fund company within the AP universe.  Barclays represent 12.9% of mutual fund assets in the AP universe.  Vanguard Funds, also a leader in index funds, represent 9.0% of mutual fund assets in the AP universe.

Indexed mutual funds measured in this study include both traditional mutual funds and exchange traded funds (ETFs).  Since the AP universe measures only the marketable securities held by HNW and UHNW investors, and these investors typically hold substantial investments in alternative assets (private equity, venture capital, and hedge funds), the portion of their total portfolio dedicated to index funds is even smaller than the 3.8% cited above.  This study does not include indexed separately managed accounts (SMAs), which are used by a wide range of advisors, and there may be some indexing done through SMAs.

The data from the AP universe is presented in the four tables below.  The tables show data from the entire universe, the largest accounts (average size $3.7 million), mid-sized accounts (average size $119k), and the smallest accounts (average size $15k).  The methodology used in compiling this data is shown in the footnotes. 

Some additional observations about the data include:

• Malkiel also claims that wealthy investors index more than less wealthy investors, and this claim is supported by our data.  Larger accounts are more likely to use an index fund than smaller accounts.  Index funds are 3.8% of total assets (and 26.5% of total fund assets) for larger accounts, as compared to 3.3% and 7.4% for mid-sized accounts and 1.6% and 3.9% for smaller accounts.  This corresponds with our earlier study (View Study), which provides data showing that larger accounts (and by proxy larger investors) are considerably more risk averse than smaller investors.

• ETFs are used much more extensively in larger accounts than smaller accounts.  ETFs are 3% of total assets for larger accounts (21.3% of fund assets), 1.6 % of total assets for mid-sized accounts (3.5% of fund assets), and .6% of total assets for the smallest accounts (1.6% of fund assets).  ETFs offer certain advantages that are more meaningful to larger investors, such as tax efficiency, liquidity, lower fees, and transparency.  For fee-only advisors, the advantage of lower fees offers a compelling economic incentive for choosing ETFs over traditional mutual funds, and this advantage is amplified for larger accounts and larger investors.  The smaller and mid-sized accounts contain a higher percentage of qualified plans, such as IRAs and 401(k)s, where the tax sensitivity of ETFs do not offer any advantages.

• Larger accounts rely on indexing for international markets (international index funds are 38% of fund assets for large accounts, as compared to 12.2% for mid-sized accounts and 8.2% for smaller accounts), whereas smaller accounts use indexing more for US markets (61.6% of fund assets for smaller accounts are held in broad-based US equity index funds, compared to 53.8% of fund assets for mid-sized accounts and 26.4% of fund assets for larger accounts.  We have already shown that smaller accounts are more heavily invested in international markets (View Study), and the data below shows that smaller accounts are placing an even bigger bet on non-US markets by utilizing fewer indexed funds. 

• Smaller accounts make much more extensive use of non-indexed ETFs (ETFs that are actively managed and not designed to track a particular index or sub-index).  Smaller accounts hold 13.3% of ETF assets in these funds, compared to 9.4% for mid-sized accounts and 1.4% for larger accounts.   Smaller accounts can diversify more effectively through these funds than through individual securities, whereas larger accounts achieve diversification through individual securities.

• Indexing to specific segments, based on market capitalization or style, comprises 19.6% of index funds for large accounts, 16.1% for mid-sized accounts, and 8.7% for the smallest accounts.  These funds are all US equity funds.  Primarily large investors utilize ETFs as a tool to target investments in sub-indices (achieving diversification without selecting individual securities), and find these funds, and the liquidity they offer, an effective way to implement more sophisticated investing strategies.

• Commodity funds make up a significantly greater percent of fund assets for larger accounts (4.8% of index funds and 5.9% of ETFs) than for mid-sized (.5% of index funds and 1.1% of ETFs) or smaller accounts (1.1% of index funds and 2.7% of ETFs).  Similar patterns are seen for real estate and currency index funds and ETFs.

• Very little use is made of hedging ETFs, and these are only used in the largest accounts.  Bullish sentiment exists, with approximately three times more assets held in funds that double a US market index than in funds that provide returns that are the inverse of a US market index.

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Table 2 - Largest accounts (average value $3.7 million)

Table 3 Mid-Sized accounts (average value $119,000)

Table 4 – Smallest accounts (average value $15,000)

Notes:

1. See interview with Burton Malkiel:  http://podcast.streetiq.com/streetiq?GUID=2079914&Page=MEDIAVIEWER
2. http://www.icifactbook.org
3. Our definition of an index fund is a fund that invests passively and is designed to track a market index or sub-index.
4. Index funds and ETFs are overlapping data sets.  Most ETFs are also classified as index funds.  There are index funds that are not ETFs, and there are actively managed ETFs that are not index funds.
5. The Actively Managed category represents ETFs that are not designed to track a specific market index and do not invest passively.
6. Blended funds are index funds that contain both equities and fixed income, with each portion designed to track a separate index.  These are US funds.
7. Cap/Style funds are designed to track a certain market capitalization (e.g., Large Cap stocks) or a certain style (e.g., Growth stock) or a combination thereof.   These are all US equity funds.
8. Sector funds are designed to track certain industries or groups of industries (e.g., health care or technology).  These are all US equity funds.
9. Social funds are designed to track socially-conscious indices.  These are all US equity funds.
10. US Equity funds include those funds designed to track a market index (e.g., the DJIA or S&P 500) or a broader market index
11. US Equity/Doubled are funds designed to provide twice the rate of return of a US market index
12.   US Equity/Inverse are funds designed to provide the inverse of the rate of return of a US market index
13.   Yield Strategy are funds designed to track indices based on stocks with certain dividend characteristics.  These are US and non-US equity funds.