Investors Turn to Direct Indexing for Taxes and Personalization | ETF Trends

Direct indexing has been an option for ultra-high-net-worth investors for some time now. But interest in this investment option has surged in recent years, as many now see it as a way to reduce their taxes or customize their portfolios.

A white paper issued by Morningstar notes that advancements in trading technology have also increased the efficiency of direct indexing offerings and upped investor appetite. At the end of 2022, more than $260 billion was following direct indexes, according to a survey of some of the largest providers. Morningstar expects assets to continue growing at a steady pace.

Per the paper, tax management is the main reason why investors turn to this option, with personalization being the second-most popular reason. “The two biggest drivers of direct index adoption are taxes and personalization, with the former attracting most of the interest,” wrote Jason Kephart, director of multi-asset ratings, global manager research, and lead author of the report. “Investing directly in the underlying stocks of an index in lieu of a mutual fund or ETF tracking the same benchmark allows for individually tailored tax management.”

See more: “4 Use Cases for Direct Indexing

Direct indexing also “allows investors to exclude certain stocks and industries or emphasize stocks with characteristics like low environmental, social, or governance risk or high exposure to traditional investment factors like value,” Kephart added.

At Exchange 2023, Ben Hammer, head of client development for Vanguard Personalized Indexing, said that direct indexing provides “some added advantages because you own the individual stocks, and any time the market is up while some of those stocks might be down, [you] tax-loss harvest those, use those to offset gains somewhere else in your portfolio.”

Also at Exchange, Vanguard CEO Tim Buckley said that the use cases for direct indexing could expand to a broader investor base beyond “the ultra, ultra high net worth” investor, and is something the company will “be investing heavily” in.

For high-net-worth clients with significant capital gains, Vanguard Personalized Indexing can automatically scan portfolios each day for tax-loss harvesting and rebalancing opportunities. More information on Vanguard Personalized Indexing can be found online.

For more news, information, and analysis, visit the Direct Indexing Channel.