Please click the image above to view the table of contents for Tiburon's new research report A Comprehensive Overview of the Market-Linked Products Industry

This is Tiburon's second draft of this report. It is 359 pages in length. Tiburon’s first draft of this report was published in 2006; that draft organized all Tiburon research on the market-linked products industry into one report. This second draft of this report focused on fleshing out the history chapter, adding structure to the appendix, and reformatting the underlining Power Point pages.

This release shares some of the report's highlights regarding the six key drivers of the market and five related utilization strategies.

• Focus on Modern Portfolio Theory & asset allocation
  
• Difficulty in beating returns
  
• Lower expense ratios
  
• Less turnover & more tax efficiency
  
• Volatile market
  
• Stock analysts & mutual funds scandals
  
  

#1: Market-linked products continue to grow in popularity because of the focus on Modern Portfolio Theory and asset allocation. Modern Portfolio Theory asserts that all relevant information is already factored into the market price of securities, therefore investors should invest based on indexes. The famous Brinson Beebower study focused many advisors and clients on asset allocation and the belief that the majority of portfolios’ performance is determined by asset allocation.

#2: Market-linked products continue to grow in popularity because of the difficulty of beating market returns. Many actively managed mutual funds do not beat their indexes. Active managers may outperform indexes by 1% to 2% per year, but expenses often eat up the differential. The fact that market-linked products beat active management over the long haul is accepted wisdom in the academic world. Over a twenty-five year period, it can be demonstrated that the percentage of equity mutual funds outperforming the S&P 500 is, on average, less than half. The vast majority of actively managed mutual funds have underperformed their Russell Indexes over the past ten years. Small-cap mutual funds do better than most, as only 56% of them fail to beat their benchmarks, but even these are not good odds for most investors. Large-cap mutual funds have done particularly poorly; only 10% of large-cap funds performed better than their benchmark indexes.

#3: Market-linked products have lower expense ratios than actively managed mutual funds. Actively managed mutual funds’ expense ratios, on average, are at least double, if not more, than those of market-linked products. The average expense ratio of actively managed mutual funds is 150 basis points; the average expense ratio of market-linked products is no more than half of that. Specifically, the average index mutual fund expense ratio is 75 basis points and the average exchange traded fund expense ratio is less than 30 basis points. But investors must be cautious - market-linked products are not all bargains.

#4: Market-linked products have less turnover and more tax efficiency. Market-linked products buy and sell securities less frequently than actively managed funds. Turnover is created when the underlying indexes are impacted by events such as rebalancing, corporate actions, or mergers & acquisitions. As a result, investors have less capital gains to be taxed on as compared to actively managed mutual funds. For example, the average annual turnover for the S&P 500 index is less than 5% as compared to 100% turnover for the average equity mutual fund.

#5: The volatile stock market made investing with tactical approaches more popular. Tactical-oriented financial advisors use market-linked products because they are betting on asset classes and not on the underlying securities. A volatile market makes betting on asset classes a more popular strategy.

#6: The recent stock analyst and mutual fund scandals have driven an increase in the utilization of market-linked products. Market-linked products utilize quantitative investing methodologies and protect against biased research. Also, the mutual fund scandals have led to some active funds being perceived as having conflicts, driving investments to passively managed investments, or market-linked products.

Five Utilization Strategies
This section of the report looks at strategies for utilizing market-linked products including index portfolio strategies, core & explore, completion strategies, risk management & hedging, holding patterns, long & short strategies, and active sector rotation strategies.

#1: Some investors utilize index portfolio strategies and build portfolios exclusively with market-linked products. Investors desiring complete asset allocation strategies find this appealing, as they merely have to purchase appropriate investments for each market segment with correct weightings and occasionally rebalance. This is especially popular with fee-only financial advisors and in 401(k) plans.

#2: Core & explore strategies are when broad based market-linked products can be used to act as core investments, as well as explore, or satellite, investments using styles such as sector funds.

#3: On the other hand, some investors utilize market-linked products for portfolio completion strategies. Sector and/or style specific market-linked products can be used to compliment core investments. This is especially useful if clients have low cost basis stocks that must be built around.

#4: Another investment strategy that utilizes market-linked products is holding patterns, including investments addressing the wash sale rule, cash equitization, and transition management. In the case of the wash sale rule, market-linked products can be utilized while taking tax losses in asset classes where investors desire to stay exposed. Cash equitization is when investing new monies; market-linked products offer investors the opportunity to put cash to work in the market until they make their investment selections. This is helpful to avoid potential opportunity costs of missing key investment days in the market. Finally, market-linked products can be used for transition management, when switching asset managers.

#5: Finally, active sector rotation strategies can be executed using market-linked products. Sector strategies invest in particular segments or indexes.

To better understand the developments in the indexing industry, executives can purchase the full Tiburon research report where the key learnings highlighted above are covered in greater detail. Please contact Brian Cotter at BCotter@TiburonAdvisors.Com to order Tiburon Research Reports.

More Information
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