Direct indexing is a separately managed account that attempts to replicate the performance of an index. But unlike an index fund, the investor owns shares of the underlying securities in a direct indexing portfolio. A direct indexing service like Vanguard Personalized Indexing lets advisors build customizable portfolios on their client’s behalf.
Here’s how it works: first, the advisor selects a traditional market-cap-weighted index. Then, they input their client’s criteria for customizing the portfolio. This includes factor or style tilts to include securities or sectors not in the selected index. Or, it can mean adding screens to exclude stocks or sectors from the index.
Once the initial screens and tilts are added to the account, VPI will select which stocks the investor should own. According to Vanguard, direct indexing portfolios tend to have a few hundred securities. But that figure can vary, depending on the client’s needs.
From that point on, VPI will track the strategy and scan the portfolio for tax-loss harvesting opportunities at a set frequency. While that frequency can be daily, monthly, or quarterly, research from Vanguard suggests the more frequent the scans, the higher and more consistent the tax-loss harvesting alpha. In fact, Vanguard found that the difference can range from 20 basis points to more than 100.
Direct indexing has often been seen as a service reserved only for the UHNW investor. However, Vanguard CEO Tim Buckley said at Exchange 2023 that the company was working to change that. He added that the company will “be investing heavily” in direct indexing.
More information about VPI can be found online.
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