Low-cost index funds and exchange traded funds are appropriate for scores of investors. That’s true across both stocks and bonds. That wide audience explains why trillions of dollars reside in these passive structures and why ETF growth remains largely unabated.
However, some sophisticated, affluent investors want to go beyond not being able to invest directly in an indexing. Direct indexing, also known as personalized indexing and custom indexing, can be accessed by registered investment advisors via Vanguard Personalized Indexing.
Given Vanguard’s reputation in the index fund and ETF arenas and its stellar brand recognition, it makes sense that the issuer is a leader in personalized indexing. Those factors also highlight advisor and client trust, potentially making it easier for advisors to articulate the benefits of direct indexing to interested clients.
Examining Direct Indexing Perks
Bespoke investing has appeal to many market participants, including clients who are in the high net worth category. The more sophisticated an investor is, the more they’re likely to understand that a basic index fund doesn’t offer much in the way of flexibility, and delivers returns that mirror of those of the underlying index, minus the fund fee.
However, personalized indexing offers the opportunity for clients to embrace customization that can potentially boost returns. For example, using Vanguard Personalized Indexing offerings, an advisor can create a separately managed account for a client that delivers returns comparable to or in excess of, say, the S&P 500, with fewer stocks.
Personalized indexing also has the flexibility for overweighting individual stocks or sectors relative to the benchmark. The methodology also allows for more (or reduced) emphasis on factors such as growth and value and styles such as environmental, social and governance (ESG).
Those are appealing traits to be sure, but direct indexing, included Vanguard Personalized Index, offers some tax-related perks as well. These include tax-loss harvesting. Tax-loss harvesting is the act of parting with a losing position and rolling the proceeds into a winner to damp some of the impact of capital gains taxes. Personalized indexing has some clear tax-loss harvesting benefits relative to ETFs. And that’s saying something, because those assets are far more tax efficient than actively managed mutual funds.
“Compared to index-tracking ETFs, in both historical and forward-looking testing, the direct indexing strategies with systematic, year-round tax-loss harvesting were more likely to deliver greater after-tax returns,” according to Morgan Stanley. “Direct indexing also tended to perform better than active strategies in certain asset classes, such as U.S. large-cap core equities, over shorter time horizons and with higher-income investors.”
For more news, information, and analysis, visit the Direct Indexing Channel.