Direct indexing allows advisors to build customized portfolios based on their client’s individual investment goals. As Morningstar’s Karen Wallace wrote: “When you own the stocks directly, you are ultimately the portfolio manager.”
Wallace added: “That means you can customize the index if you want to.”
While a great deal of digital ink has been spilled detailing the benefits of ETFs, there are some drawbacks. For one thing, passive ETFs are package deals: you get exposure to every stock within that fund. Plus, when investing in an index ETF, you indirectly own the stocks in that fund.
And indirect ownership does have its downsides. You won’t be invited to shareholders’ meetings. You won’t have a say in board member elections. And you can’t buy or sell the underlying securities within the ETF or rebalance its holdings.
Not so with direct indexing. Through direct indexing services like Vanguard Personalized Indexing, the investor directly owns the stocks in an index.
See more: “Who Direct Indexing Is Ideally For”
Tailoring Indexes to Meet Specific Needs
From an ESG perspective, direct indexing lets advisors sell or avoid securities that don’t align with their client’s values. Environmentally conscious investors can avoid companies with high carbon emissions, for example. Or if an investor has too much exposure to a certain stock, direct indexing can diversify around that position. Advisors can adjust the portfolio as they monitor, update, and rebalance the investments.
“What direct indexing does is it tailors an index to meet an investor’s specific circumstances, and optimizes for things like taxes, or ESG exposure, or factor exposure,” said Morningstar’s head of client solutions Ben Johnson.
Vanguard Personalized Indexing offers a range of screens and tilts to allow investors to customize their portfolios. Advisors can also request custom options on their client’s behalf. Once investors select their options, advisors can generate impact and performance reports on demand. That way, their clients can have a clearer picture of the impact of their customizations.
Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing. More information about Vanguard Personalized Indexing can be found online.
For more news, information, and analysis, visit the Direct Indexing Channel.