Why in the world would you recommend an index strategy to an investor that is priced at a premium?
Traditional index funds are designed around a very specific purpose – track an index with as little cost as possible. And it’s an extremely popular strategy. Look at Vanguard’s growth over the years, increasing pressures on advisor fees, and the continual commoditization of financial advice. If indexing isn’t King, it’s certainly in line for the throne.
But we all know the problem with indexing strategies: there is no differentiation – no value beyond the returns created by overarching market movement.
And differentiation is something many advisors are thinking about today. When you come across an investor that seeks indexing strategies, how can you differentiate, in a meaningful way, from the advisor across the street?
Dealing in price alone is a dangerous strategy. It’s a race to the bottom, and as Seth Godin wisely says, “The problem with the race to the bottom is that you might win” – meaning you might win a few accounts now, but there will always be someone (or something – think robo advisor) who is willing to do it for less.
There might be a better way to provide value to the investor in search of indexing. It’s found in a strategy called direct indexing.
Direct indexing is a portfolio construction strategy that seeks to replicate a market index by purchasing the underlying shares, directly. So instead of purchasing a fund that buckets those underlying positions, the advisor purchases each one (or a subset of those positions that is meant to track the performance of the index).
Direct indexing provides a number of benefits, in comparison to traditional fund-based indexing, like:
- Customization – Advisors have control over their clients’ investment strategies. Holdings can be tailored by certain parameters – ESG, sector/industry, and security restrictions, etc. Holdings can also be adjusted to match an investor’s risk tolerance.
- Transparency – Investors know exactly what positions they hold, and in what quantity.
- Tax Management – Advisors can actively minimize clients’ tax implications from capital gains and deploy tax-loss harvesting strategies.
Arguably the most important benefit of direct indexing, in terms of delivering tangible benefits to a client, is
Arguably the most important benefit of direct indexing, in terms of delivering tangible benefits to a client, is the ability to infuse tax management into an indexing strategy.
Capital gains deferral and tax loss harvesting strategies are great ways to generate alpha in an indexing strategy, something that may more than cover the premium associated with the strategy and provide much-needed differentiation – in the form of value, not cost – from competitors who offer more rudimentary indexing solutions.
And as account sizes grow, direct indexing’s relevance grows with it. Tax management is great for all investors. However, the implications of capital gains grow substantially with wealth. The savings realized through tax optimization, available through direct indexing, can quickly outweigh the slightly higher upfront cost of the strategy.
Sound good, but time consuming? No need to worry. Direct indexing is often outsourced and managed by third-party money managers, freeing advisors from the nitty-gritty of executing on tax efficiency opportunities. Through the FTJ FundChoice platform, tax-managed direct indexing strategies are newly available through CLS Investments.
Want to learn more about direct indexing, and how you can implement them in your own investment portfolios? We’d love to talk to you. Contact FTJ FundChoice Sales Team to find out more – email@example.com or 800.379.2513, option 5
0423 – FTJFC – 6/26/2019