Direct indexing is a separate account in which the investor tracks the performance of an index. But unlike with open-end funds like mutual funds or ETFs, the investor directly owns the individual securities tracked by that index.
That means two things: One, the advisor can customize the account’s holdings. Two, the account can be scanned for tax-loss harvesting opportunities at the individual security level.
Regarding customization, securities can be included or excluded based on the investor’s personal preferences, values, and investment goals. An environmentally conscious investor can screen out companies that don’t align with their values. Alternatively, an investor with strong religious views can include faith-based companies that may not be in the chosen index.
“This level of personalization is unparalleled in traditional index funds,” according to Manhattan Ridge Advisors.
See more: Harvest Tax Losses With Ease Through Direct Indexing
Huge Tax-Loss Harvesting Opportunities
Direct indexing also offers huge tax-loss harvesting opportunities. Advisors can sell underperforming securities at a loss to offset other gains in the portfolio. Open-end funds can’t do this.
A service like Vanguard Personalized Indexing automatically scan portfolios for tax-loss harvesting opportunities at a set frequency. That frequency can be monthly, quarterly, or even daily. VPI can also scan for opportunities across dozens of investments and hundreds of investment lots.
The more frequent the scans, the higher and more consistent the tax-loss harvesting alpha. The differences in tax-loss harvesting alpha can be very wide. Research from Vanguard found that the difference can range from 20 basis points to more than 100.
When considering a direct indexing strategy for its tax-loss harvesting abilities, Vanguard wrote that those with daily harvesting scans are "critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments.”
Vanguard CEO Tim Buckley said at Exchange 2023 that the company will “be investing heavily” in direct indexing. More information about VPI can be found online.
For more news, information, and analysis, visit the Direct Indexing Channel.
