According to a report from Cerulli Associates, account managers say that direct indexing SMAs are the product they want most to incorporate into portfolios. In areas ranging from capital gains taxes to fixed income, direct indexing solutions can benefit many different investors in many different ways. In addition to the right products—and the right provider—the right technology can help unleash the power of direct indexing.
Technology is key to building direct indexing solutions that meet different investors’ needs, even in volatile markets, and it shows in everything we do at Parametric. We focus our technology on the scale and customization that’s core to our business. Along with the voluminous research behind our customized investment solutions, our state-of-the-art investment tools and in-depth reporting empower clients to make informed decisions and manage their portfolios’ performance. We believe the focused, investor-centered technology we’ve developed over more than three decades of experience sets us apart.
As it continues to evolve, technology can also help shape how advisors work with their clients. With our scalable technology, Parametric can help advisors introduce direct indexing solutions to a growing number of investors and facilitate those allocation adjustments and customizations, saving time and helping reduce fees. Our proprietary, cloud-native technology platform Radius helps meet demand and stay ahead of client needs, while our direct indexing experience enable a high level of dedicated service.
How do you build portfolios in direct indexing?
One of the first steps in building a client’s portfolio is deciding on the best mix of asset classes—including equities, fixed income and alternatives—that suit their financial goals. Advisors and clients can then blend benchmarks to get the precise exposure they seek. That’s just the beginning, though. When fully implemented, for investors who want broader market exposure, direct indexing can take them beyond what an index provider decides should be in their portfolios to build a completely custom SMA.
While direct indexing allows investors to personalize their portfolios based on their priorities, those priorities can change over time. Once they decide on their initial allocation, a client may not be eager to alter it, even as their investments perform well and their wealth increases. But they might ultimately find change preferable to sitting still. For example, if the investor starts seeing higher taxes on their appreciated positions, it might be time to look at adjusting their mix of assets. That’s where the technology behind direct indexing can help. Direct indexing can add new dimensions of flexibility and tax management to an existing portfolio. It’s helpful to view direct indexing simply as a different investment approach to adjusting an investor’s asset mix.
Direct indexing gives investors individual ownership of each stock in their chosen equity benchmark. Through their customized mix of assets, investors not only enjoy the potential benefits of active tax-loss harvesting, but that customization can help reduce concentration risk. Tools like transition analysis can help investors build a customized, tax-managed SMA that balances their personal preferences with their investing goals, ensuring that each investor’s returns come by each investor’s rules.
How do you customize exposures in direct indexing?
Customization using direct indexing relies on in-depth information-gathering to accurately capture how a particular investor might wish to reshape their portfolio, using data to implement their desired restrictions, weightings, and so on. The right reporting tools can help evaluate a portfolio’s asset mix and how it performs over time. The ability to look at an individual account and anazlye its realized gains and losses, country exposures, sector weights, portfolio characteristics and more will help you identify where you can make adjustments. And client-ready reports help make ongoing advisor-client communication clearer to help them understand what they’re getting from their portfolios and how to better meet their needs.
The technology behind direct indexing gives you access to other advanced tools beyond reporting, such as:
- Transition analysis. Even when their current portfolio isn’t performing as they’d like, clients might worry that transitions could trigger a large tax bill. Transition analysis allows you to identify potential scenarios and different tax and tracking error outcomes, then discuss their options with them and help them choose the right approach.
- Estimated tax benefit and customized exposure. With a simulator that compares potential pre- and after-tax returns, you can help clients actively harvest losses and defer gains. A simulator can also show potential after-tax performance in different market environments with varying volatility and returns, as well as the impact of adding cash, providing one more way to ensure that your client’s customizations meet their needs.
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Values-based investing. Tools that show clients the metrics around their values-based investing can help them understand how their choices are affecting their portfolio’s performance. And if they’re considering including or changing a screen in their portfolio, you can help them see how that might impact their exposure.
But direct indexing goes beyond customization. A technological approach can help free advisors’ time, allowing them to maintain a personal touch with their clients. With the in-depth reporting direct indexing empowers, advisors can show clients how they’re helping realize their investing goals. Personalizing portfolios at scale and tracking performance in real time allows advisors to stay engaged with their clients’, while growing a more efficient and, ideally, a more profitable business.
How do you manage a direct indexing portfolio?
Direct indexing is geared toward helping streamline portfolio management. The technology behind it can efficiently manage tasks like trading and reporting, helping reduce cost and the time you spend actively managing portfolios, allowing you to instead focus on your client relationships. The rules-based models at the heart of our direct indexing approach help automate portfolio construction and management, beginning with customizations and continuing through tracking and reporting.
Direct indexing also enables systematic tax-loss harvesting through an active tax-management process that includes:
- Building portfolios for specified exposure
- Identifying securities held at a loss
- Selecting replacement securities
- Managing sector, industry and security biases
Through active tax management, clients can harvest tax losses year round—systematically—potentially maximizing their portfolio’s value. Direct indexing is about more than taxes, however. It also helps manage risk and tracking error, helping investors keep exposures aligned with chosen benchmarks, trading when the increased value justifies the cost while staying mindful of IRS wash-sale rules. And its tracking and reporting tools provide clients with a more complete view of their portfolios’ performance, as well as transparency around how they’re being managed.
The bottom line
Managing portfolios with direct indexing isn’t easy. It’s a data-intensive process that requires research and experience. And our decades of experience have helped us develop a direct indexing approach, which covers a broad range of solutions for investors. It’s a systematic approach that drives us to continuously develop and improve industry-leading technology solutions that enhance our quantitative processes, facilitate greater customization and better manage risk. The investing tools we’ve developed along the way can help advisors build, evaluate and manage portfolios for each investor’s unique needs. In the end, through its use of technology, direct indexing helps streamline advisor-client communication, in turn helping clients better understand their current portfolios and make informed decisions that help them work toward their long-term financial goals.
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The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.
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