Dimensional's ETFs, Private Equity, and Prescribed Rate Loans (EP.105)

Episode Summary

Executive Summary: In this episode, Ben Felix and Cameron Passmore discuss Dimensional Fund Advisors' entry into the ETF market, analyze private equity's expected returns, and explore spousal loan tax strategies. They conclude private equity offers no unique benefit over leveraged small-cap value stocks, while spousal loans become more attractive with the prescribed rate dropping to 1%.

Main Topics: Dimensional Fund Advisors' ETF Launch (Priority: 5/5): Dimensional filed for three actively managed ETFs (US, non-US developed, emerging markets) using custom basket creation, enabling broader access to their factor-tilted strategies. Private Equity Analysis (Priority: 5/5): Deep dive into private equity returns, showing they can be replicated with leveraged small-cap value stocks, no illiquidity premium exists, and high fees (5.7% annually) erode returns. Spousal Loan Tax Planning (Priority: 4/5): With the prescribed rate dropping to 1%, spousal loans become highly effective for income splitting, but require careful execution to avoid attribution and debt forgiveness issues. Bad Investment Idea: Thematic Funds (Priority: 3/5): Critique of CI Investments' Global Longevity Economy Fund as a gimmicky product reminiscent of 1990s thematic funds, with poor expected returns due to overpriced growth narratives. Market Misinformation Correction (Priority: 2/5): Correction of a viral claim that 33% of Fidelity investors over 65 sold all equities; actual figure was 7.4% making changes, with only a third of those moving some money.

Key Arguments: Private equity returns are fully explained by a leveraged portfolio of small-cap value stocks, with no illiquidity premium. Investors overpay for private equity due to artificially smoothed returns, reducing expected returns. Spousal loans at 1% prescribed rate offer significant tax savings but require meticulous documentation and professional advice. Thematic funds like the Longevity Economy Fund are likely to underperform due to overestimated growth and high fees. Dimensional's ETF entry is methodical, not reactive to competitors like Avantis, and benefits from custom basket creation.

Data Points: Private equity new assets in 2019: $301 billion - Broke previous record of $267 billion in 2007. Estimated private equity fees (annualized): 5.7% - Includes 2% management fee, 20% carry, and other costs. Expected return for US private equity (net of fees): 3.9% - Versus 3.1% for US public equities. Prescribed rate for spousal loans (next quarter): 1% - Down from 2% in the current quarter. Percentage of Fidelity investors over 65 who made changes: 7.4% - Correction of viral claim that 33% sold all equities.

Pivotal Quotes: "Our analysis suggests that private equity does not seem to offer as attractive a net of fee return edge over public market counterparts as it did 15 to 20 years ago from either historical or forward-looking perspective." — Ben Felix (paraphrasing AQR paper): Summarizing the decline in private equity's relative attractiveness. "Investors who agree that the risk match between the private equity index and the two replicating portfolios is appropriate, are considerably underperforming the feasible alternative of investing in similar passive replicating portfolios." — Ben Felix (quoting Eric Stafford paper): Highlighting that private equity underperforms a leveraged small-cap value strategy. "The idea of prescribed rate planning and spousal loans... it's a simple concept that a lot of people are aware of. Whether it makes sense for you is not simple." — Cameron Passmore: Emphasizing the complexity of implementing spousal loans correctly.

Implications: Investors should avoid private equity due to high fees and no unique return source; instead, use leveraged small-cap value ETFs. Spousal loans at 1% are highly beneficial for high-income couples but require professional execution. Thematic funds remain poor investments.