Direct Indexing Isn’t Niche Anymore

Direct indexing isn’t just for ultra high net worth individuals anymore. In fact, any investor with more than $150,000 can benefit from these custom portfolios of individual stocks, according to Randy Bullard, global head of wealth management at Charles River Development. 

Speaking at a conference in Miami Beach, Florida, Bullard said that today an advisor might use direct indexing for clients with complex and unique investment policy requirements, but in the future, direct indexing won’t be such a niche thing.  

Ben Hammer, who is the head of client development for Vanguard Personalized Indexing, agrees that what his company calls “personalized indexing” can benefit many investors.  

To him, direct indexing is simple: It’s an individual account that’s managed to track an index. The individual owns the securities, which gives them flexibility to do things that they can’t with a fund. 

For example, when individual stocks are down, the investor can tax-loss-harvest them to offset gains elsewhere in their portfolio.  

They can also tilt their portfolio in certain ways, customizing it based on criteria such as environmental, social and governance, or factors.  

For advisors, direct indexing gives them “an additional edge” in their practice, noted Hammer. 

“They can utilize this to establish an excellent tax profile for their client, or give them an extra bit of customization that creates the perfect puzzle piece that fits right around [the rest of their portfolio],” he said. 

Direct Indexing vs ETFs  

While many see the merits of direct indexing, there is often disagreement on whether it was a replacement for traditional diversified investments like exchange-traded funds.  

Hammer, whose firm Vanguard is the No. 2 issuer of U.S.-listed ETFs, said that ETFs “will always be a great solution because they're so useful to so many investors.” 

And while he believes that every investor doesn’t need direct indexing, in his opinion, every advisory practice should offer these types of solutions because they will inevitably run into clients who would benefit from them.  

Bullard offered a more controversial perspective, arguing that “every retail investor with more than $150,000 will be better served with direct indexing” versus ETFs or mutual funds.  

But he did temper that by saying direct indexing today is by and large a solution for equities, not other asset classes. 

Broader Is Better  

When it comes to using direct indexing for equity exposure, both Bullard and Hammer pointed out that the specific index doesn’t matter so much as the number of stocks within that index. 

“People use different market-cap-weighted indices’ broad market exposure—whether it’s S&P 500, MSCI, CRSP—it doesn’t really matter,” explained Hammer. 

Bullard agreed: “For the most part, the index matters maybe a little bit less [than with ETFs].”

Sure, if you sample a portfolio, it’s going to introduce tracking error, but investors don’t particularly care about tracking error as long as they get the exposure they expect, he said. 

But while specific indexes might not matter, the number of stocks that a direct indexing strategy employs does.  

With direct indexing, Bullard said, “Broader is better, because you’re going to get more opportunities to tax loss harvest and you’re going to give … the optimizer underneath more choices in saying ‘what did we just sell, and what can we replace it with and still track the index?’” 
 
 

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