Displaying items by tag: direct indexing

In an article for ETFTrends, James Comois discusses how direct indexing can lead to increased customization of portfolios which isn’t possible to the same extent as with ETFs and mutual funds. However, it’s important to note that the primary benefits of index investing are retained with direct indexing as it comes with lower costs and diversification.

The major differentiation is that investors own the actual components of the index in their portfolio in order to replicate its performance. At one time this would be too unwieldy for the vast majority of investors, however direct indexing is increasingly available to all investors due to technology which makes its implementation and management simple for any advisor.

In addition to tax benefits, another major positive is that it can result in increased customization of portfolios. For instance, an investor can track the S&P 500 but negate stocks or sectors that they would like to avoid. Many investors are not comfortable holding stocks that are related to gambling or tobacco, while others are unwilling to invest in fossil fuel companies. However, the index can still be tracked as these stocks are replaced with other stocks that have similar factor scores. 

Finsum: Direct indexing is growing in popularity due to the increased flexibility and customization it allows for investors while retaining the benefits of index investing..

In an article for ETFTrends, James Comtois discusses 3 benefits of direct indexing as laid out by Vanguard. The asset manager sees the trend continuing to grow in popularity in the coming years and is investing heavily to capture market share in the space.

Direct indexing combines the benefits of index investing such as low costs and diversification while allowing for greater personalization. Rather than gaining exposure through an ETF or mutual fund, investors own the individual stocks in the index. This allows for more flexibility, transparency, and potential tax savings. 

In terms of returns, tax savings is the biggest benefit. According to research, it can add between 20 and 120 basis points annually. Losing positions can be sold to offset gains from profitable positions. Then, these positions can be replaced with other stocks that have similar factor scores to continue tracking the underlying index. 

Direct indexing allows for customization to reflect an individual’s circumstances and values. This could mean ESG investing or reducing exposure to a particular industry because of outside holdings. Finally, direct indexing leads to increased transparency as the holdings are always visible while avodiing complications of conentrated positions. 

Finsum: Direct indexing has 3 benefits for advisors and clients: tax savings, increased customization, and greater transparency.

Every year, there are countless innovations in wealth management but only a few prove to have staying power and become a disruptive force. It’s increasingly clear that direct indexing is here to stay given its massive growth over the last couple of years.

It also serves a unique niche, because it offers the benefits of index investing with more customization and tax savings. According to a report from Cerulli Associates, direct indexing is expected to continue growing at a similar pace over the next decade due to these reasons. And, it’s especially useful for investors who want to prioritize tax loss harvesting and ESG. 

The report also shows that there’s considerable room for growth given that only 14% of advisors are aware of it and recommending it to their clients. However, the firm is confident in its growth especially as fee-based models continue to take market share. It forecasts 12.3% growth over the next 5 years.

Given its usefulness and newness, direct indexing is one way that advisors can differentiate themselves. It can also help create a more personalized experience for clients which can lead to more loyalty and retention. 

FinSum: Direct indexing is expected to continue rapidly growing over the next decade, and it’s particularly beneficial for tax loss savings and ESG investing. 

Regulation Best Interest (Reg BI) was passed by the SEC in 2019 and implemented in 2020. It essentially requires brokers to only recommend products to customers that are in their best interest. It also requires that brokers must inform clients of any potential conflicts of interest and financial benefits they may accrue. 

Until recently, enforcement of Reg BI has been lacking, but this is clearly now changing as authorities are stepping up. The most recent incident is FINRA fining five broker-dealers for failing to comply with regulations including Reg BI and Form CRS. 

These firms were cited for a lack of guardrails and protocols that would lead their registered brokers to adhere to Reg BI. Relatedly, these firms were also penalized for missing deadlines related to Form CRS and/or providing incomplete information. Form CRS is an overview of a broker’s services, fees, conflicts of interest, prior disciplinary action, and other information to increase transparency and minimize fraud risk. 

The five firms did not admit or contest FINRA’s decision. Like previous Reg BI enforcement, the penalties and citations were minor. In contrast, the SEC has only filed one major Reg BI case, but it pursued much harsher penalties. 

Finsum: Reg BI is a new regulation which mandates that broker-dealers must inform clients of any conflicts of interest and recommend products that are in their best interest. Recently, regulatory authorities are stepping up enforcement. 

In an article for WealthManagement, Iraklis Kourtidis shared his persepctive on direct indexing and what it precisely means. He says that there are two components to direct indexing. The first is that it helps an investor create a custom and personalized index. The second is that it can help with portfolio management to ensure that it tracks a specific benchmark. 

With direct indexing, investors hold the actual securities themselves in a portfolio rather than an ETF or mutual fund which tracks an index. One advantage of this is that it enables an investor to create their own index. Previously, this wasn’t possible as index investing was only possible through ETFs and mutual funds which follow well-known indexes.

Some investors want the benefits of index investing in terms of diversification and low costs. But, they need greater personalization. One approach is to modify an existing index. Another is to create an index from scratch. 

In terms of portfolio management, there are some additional challenges. For one, index holdings need to be constantly rebalanced especially when tax losses are being harvested to offset gains in other parts of the portfolio or when factor scores change. 

Finsum: There are two parts of direct indexing, and each is crucial for success. One involves constructing a custom index, and the second is portfolio management.