Direct indexing seeks to closely track the performance of a market index while creating tax saving to increase returns in taxable accounts. Additionally, portfolios can be customized to reflect an investor’s goals and values in taxable and non-taxable accounts.
The direct indexing process starts by selecting the benchmark an investor seeks to track. Exposures to that benchmark can be customized to align with account-specific needs as well as personal values. The portfolio optimization process divides the index into a series of factor exposures and builds a sample subset of securities that still closely represents the exposure of the full index. The result is a customized portfolio of individual securities that investors own via a separately managed account (“SMA”). The tax-optimized portfolio uses continuous tax-loss harvesting to seek to increase after-tax returns.
Tax-loss harvesting is selling securities to realize capital losses and replacing them with similar securities. The realized capital losses can offset capital gains, reduce taxes paid, and enhance after-tax returns.
Tax alpha is the value created through tax-loss harvesting techniques and is a measure of the after-tax excess return an investor achieves compared to the pre-tax excess return vs. their selected benchmark.
Investors in taxable accounts need to consider potential tax liabilities when transitioning appreciated securities with unrealized capital gains. Selling the securities may trigger undesirable tax consequences. However, a direct index SMA can be funded in-kind without creating a taxable event. The tax-aware portfolio optimization process can be used to achieve a tax-efficient portfolio transition and potentially minimize, delay or avoid net taxes.
Transition alpha is the excess return attributable to tax savings versus liquidation of the appreciated security.
Investors can express their view through traditional factors, risk management strategies, or values-based investing. Our platform offers a vast amount of preset options to add or eliminate companies, industries and sectors. We also offer the ability to blend indexes and build custom solutions.
Although exchange-traded funds (“ETFs”) and mutual funds can deliver broad market exposure, direct indexing does so with a key difference: a portfolio can be tailored to an investor’s specific needs and incorporate tax-loss harvesting strategies. Direct indexing portfolios can also be funded with either cash or an existing portfolio of securities (in-kind), including appreciated stock, which may create tax advantages beyond what ETFs and mutual funds may offer.