Segment has always run its own strategies. We build portfolios out of individual stocks and exchange-traded funds because they have exceptionally accommodative tax results. What we generally don’t buy is open-end mutual funds. These investment products with five digits in their ticker symbol are typical of what you would find in a retirement account like a 401(k).

Not only are the expenses often high in these funds, but they also use commingled accounting, which causes investors to lose control of their tax basis. In open-end funds, all shareholders own the fund’s content assets, and one shareholder’s sell action can cause taxes for those remaining in the fund. This can be particularly problematic when shareholders move en masse. 

Last week, Vanguard agreed to settle a lawsuit resulting from just such an en masse movement that caused tremendous amounts of taxes for shareholders. The taxable event was prompted by Vanguard making the institutional share class of a target date fund available to more investors. The investment minimum for the institutional share class dropped from $100 million to $5 million. The resulting stampede of investors moving to the lower-cost share class caused unprecedented net redemptions in the Vanguard Target Retirement 2030 Fund. Vanguard was forced to sell securities to accommodate the redemptions. In the prior 10 years, this fund had never realized more than $285 million of gains in one year, and in 2021, the same fund had $5.6 billion worth of realized gains. The realized gains were distributed to shareholders’ 1099s, causing tremendous tax problems for the remaining shareholders who held the fund in taxable accounts. The class action suit says that Vanguard had other options to achieve the same effect, including merging the two share classes, and should have foreseen this outcome.

This lack of control is one reason among many that Segment builds portfolios for clients rather than relying on third-party fund companies to package these strategies up as products like mutual funds. We have full control of the taxes to match what clients want to happen. When clients don’t express an opinion, we default to the lowest tax outcome as a matter of course. Additionally, in-house management eliminates a layer of fund fees that clients would otherwise pay. 

When we control the individual components, we can control when clients realize taxes. We also have the ability to cherry-pick losses that might be especially helpful to clients in certain situations, and we can scrape the higher gain positions into charitable accounts, avoiding further realized gains and enhancing the net benefit to both the client and the charities they support. A fund’s commingled accounting would forfeit both of these processes. 

Our process gives clients opportunities for much more efficient outcomes and reduces the likelihood of surprises on 1099s. 

Please see IMPORTANT DISCLOSURE information.