Direct indexing is a type of investment that allows investors to hold individual stocks, creating an index directly in their own account, instead of using a ETF or a mutual fund.
Direct indexing is expected to grow at an annualized rate of over 12% over the next five years, faster than traditional financial products, such as mutual funds, ETFs, and separate accounts.
Eleven major investment companies including Goldman Sachs, BlackRock, Fidelity and JP Morgan—make 12 big acquisitions in the direct indexing space.
The main advantages of direct indexing
The main goal is personalization. Investors are free to customize portfolios as they see fit.
Direct indexing portfolios can be shaped through ESG factors, or exclude securities that do not fit with one’s personal values or create a multi-thematic selection of securities.
This is the whole point of direct indexing: you will not need compromises as you build your portfolio.
If you are an ESG-focused investor, probably some of your most specific standards cannot fit within ETFs and mutual funds. This is why Direct Indexing is a great alternative, since it can pick specific companies, sectors, or industries from a portfolio: for example focusing on companies that are committed towards a lower carbon footprint.
The other main advantage is tax harvesting, since investors directly own the stocks within and they can sell individual securities in the portfolio at a loss, even when the benchmark index’s return is positive. Harvesting tax losses in this way can help offset capital gains at tax time — and help increase their after-tax returns.
Since you are purchasing individual stocks, you can actually tax-loss harvest each position to help manage your tax bill.
This can mean 1% or more in additional after-tax returns, according to recent research from Vanguard.
Which kind of investor can benefit of direct indexing
Direct Indexing used to be managed mostly through financial advisors, for an investment of at least $250,000 or more. However, in recent years this strategy has become more broadly accessible, with minimums at or even below $5,000 in some cases, making their benefits available to investors of any level of wealth, thanks to no-commission trading and fractional shares.
Today, they are considered a good alternative tool to Exchange-Traded Funds (ETFs), especially for they can provide a broad-based diversification.
For those investors who want to tilt their portfolios toward companies with specific factors such as value or momentum, prepackaged ETFs solutions often are not that flexible, so direct indexing can help an investor to use a combination of factors or to apply them in a different way.
The role of AI in direct indexing
AI helps investors build their own index from scratch, within minutes, by automatically filtering all the parameters that matter or to create an index according to the client’s request by entering the required parameters into the algorithm which can build the index within minutes.
With FinScience investors can choose AI-selected stocks, through a thematic product construction (ESG oriented, thematic association, etc..) with a scalable and tested methodology, monitoring performances and fine tuning their strategy according to them.