An interview with Ken Lassner, CFA, direct indexing lead product strategist, Northern Trust Asset Management.<\/p>\n
Assets managed using a direct indexing strategy\u2014one based on owning shares directly in companies that constitute a particular stock-market index[1]\u2014are projected to more than double to over $2 trillion by 2028 from the roughly $865 billion managed at the end of 2024. To find out what\u2019s driving this growth and why advisors are increasingly turning to direct indexing as a solution for their more affluent clients, Wealth Management recently sat down with Ken Lassner, direct indexing lead product strategist at Northern Trust Asset Management (NTAM). Highlights of the conversation follow:<\/p>\n
Despite the market\u2019s recent record highs, we\u2019ve also seen a lot of volatility and uncertainty. Against this backdrop, what do you see as the key driver or drivers of direct indexing\u2019s increasing popularity?<\/p>\n
Two things: First is tax efficiency, because many clients live in high-tax environments, and second is the customization or personalization that direct indexing offers.<\/p>\n
For clients and advisors who lean toward having some degree of passive exposure in their investment portfolio, direct indexing can be more advantageous than owning an equity index ETF[2] or an equity index mutual fund.[3] That\u2019s because by directly owning some or all of the stocks that constitute an index rather than a single index fund, investors can take advantage of the market\u2019s natural volatility in which there are always some stocks that go up and some that go down no matter the direction of the market as a whole. When stocks are owned in a separately managed account, or SMA, which is the vehicle most often used for direct indexing, you can sell the stocks that went down and create a tax credit. And that credit can be used to offset capital gains from other investments, which means that more of your capital is working for you over time. Also, an SMA allows the investor and the advisor to customize an index by underweighting, overweighting or eliminating certain companies to suit unique circumstances or preferences.<\/p>\n
Customization, of course, implies that the SMA portfolio doesn\u2019t precisely track its index. Is that a problem?<\/p>\n
It\u2019s actually an opportunity. At Northern Trust, our tracking error tends to be between 50 to 75 basis points, compared to something like 2 basis points for an ETF. The difference arises because when we track the S&P 500,[4] for instance, we hold only about 300 to 350 stocks, not all 500. But the 150 or 200 stocks we don\u2019t hold create a replacement universe, so that if Coca-Cola goes down, for example, we can replace it with PepsiCo. Tracking an index with greater leeway enables us to do tax-loss harvesting, which generates 100 to 200 basis points of excess return after taxes versus an ETF with a very similar exposure. For investors, tax-loss harvesting is a much more consistent generator of alpha than stock picking, because it takes advantage of the natural volatility that happens no matter what the market is doing, and from which you can\u2019t benefit if you own an ETF. What\u2019s more, customization allows an investor to modify a portfolio based on unique concentration or investment philosophy considerations.<\/p>\n
How involved are advisors in making these customization decisions when they use NTAM?<\/p>\n
We have a very consultative approach, so an advisor can be as involved as they want to be. Some like to do the customization themselves, but very frequently advisors ask us to help them figure out the best way to diversify a concentrated position over time in a way that is tax efficient without taking on too much risk. Since we\u2019ve had experience managing institutional direct indexing portfolios for more than 35 years and are now the third largest direct-indexing manager, we\u2019ve addressed pretty much every challenge an advisor might face.<\/p>\n
What new trends or shifts in the direct indexing market have you seen recently?<\/p>\n
With this year\u2019s greater volatility, it\u2019s very important for an advisor who manages a direct indexing portfolio to monitor accounts daily and possibly rebalance them more frequently. To do that, technology can be very helpful, so we introduced desktop tools recently that give advisors greater control and visibility into their direct indexing portfolios. At NTAM, we monitor accounts every day and typically rebalance them about once a month. But during periods of significant volatility, we rebalance more frequently. This year, through March, when the S&P 500 was down 5%, our loss-harvesting volume was double the average of the previous 24 months.<\/p>\n
Do this year\u2019s IPOs change anything vis-\u00e0-vis direct indexing?<\/p>\n
Not per se. When an initial public offering (IPO) makes its way into an index, we include it. But because of the tax impact, how much of an IPO we put in individual positions will vary. Still, the float that\u2019s being generated by IPOs is relatively small, and indexes have different rules about inclusion. Take SpaceX as an example. FTSE Russell[5] and MSCI[6] will be a little quicker with inclusion than S&P, which says it won\u2019t put the stock in its S&P 500 Index for 12 months.<\/p>\n
Research seems to suggest that advisors using direct indexing are likely to see stronger retention and wallet share. Has the strategy\u2019s success made using it table stakes or is it still a differentiator?<\/p>\n
When I started in direct indexing over 20 years ago, there were very few advisors who had even heard of it, and minimums were $5 million. Today, most minimums are $250,000 and some are as low as $100,000. Investor demand and technology have made the strategy available to a much wider audience, and advisors are finding that direct indexing leads to much more meaningful conversations about investing, as well as about taxes, charitable giving and estate planning. Among more affluent investors, those issues are very important.<\/p>\n
Are tax-managed long\/short strategies complementary to direct indexing or a potential alternative?<\/p>\n
I view them as complementary. Long\/short strategies can make sense in some cases, such as when a client sells a business and needs help offsetting as much of the gain as possible, or when someone receives a significant amount of stock and wants to diversify quickly because they\u2019re worried about concentration risk. But there are many issues to consider. IRS rules regarding long\/short sales are complex, and the agency looks at transactions very carefully. Also, cost of carrying and unwinding short positions can add up. In the vast majority of cases, I think clients can find direct indexing to be a more effective solution.<\/p>\n
Can retirees benefit from direct indexing?<\/p>\n
It\u2019s funny, one of the criticisms of direct indexing is that as the portfolio ages, it \u201cossifies,\u201d meaning that there aren\u2019t as many losses to take as there were in its early days. But the irony is that during the time an investor uses tax savings to offset capital gains, their capital stays invested and continues to grow. Essentially, the tax savings are compounding, and the longer the deferral and compounding go on, the better off you are from a wealth perspective after taxes. If you never sell the direct indexing portfolio, it goes to your beneficiaries and gets a step-up in basis. For children or grandchildren, that can be a wonderful inheritance.<\/p>\n
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Permission to distribute this content does not constitute or imply any endorsement or sponsorship of any third party\u2019s product, service or organization.<\/p>\n
This document may not be edited, altered, revised, paraphrased, or otherwise modified without the prior written permission of Northern Trust Asset Management (NTAM). The information contained herein is intended for use with current or prospective clients of Northern Trust Investments, Inc (NTI) or its affiliates. The information is not intended for distribution or use by any person in any jurisdiction where such distribution would be contrary to local law or regulation. NTAM and its affiliates may have positions in and may effect transactions in the markets, contracts and related investments different than described in this information. This information is obtained from sources believed to be reliable, its accuracy and completeness are not guaranteed, and is subject to change. Information does not constitute a recommendation of any investment strategy, is not intended as investment advice and does not take into account all the circumstances of each investor.<\/p>\n
This report is provided for informational purposes only and is not intended to be, and should not be construed as, an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Recipients should not rely upon this information as a substitute for obtaining specific legal or tax advice from their own professional legal or tax advisors. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. Indices and trademarks are the property of their respective owners. Information is subject to change based on market or other conditions.<\/p>\n
All securities investing and trading activities risk the loss of capital. Each portfolio is subject to substantial risks including market risks, strategy risks, advisor risk, and risks with respect to its investment in other structures. There can be no assurance that any portfolio investment objectives will be achieved, or that any investment will achieve profits or avoid incurring substantial losses. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Risk controls and models do not promise any level of performance or guarantee against loss of principal. Any discussion of risk management is intended to describe NTAM\u2019s efforts to monitor and manage risk but does not imply low risk.<\/p>\n
Past performance is not a guarantee of future results. Performance returns and the principal value of an investment will fluctuate. Performance returns contained herein are subject to revision by NTAM. Comparative indices shown are provided as an indication of the performance of a particular segment of the capital markets and\/or alternative strategies in general. Index performance returns do not reflect any management fees, transaction costs or expenses. It is not possible to invest directly in any index. Net performance returns are reduced by investment management fees and other expenses relating to the management of the account. Gross performance returns contained herein include reinvestment of dividends and other earnings, transaction costs, and all fees and expenses other than investment management fees, unless indicated otherwise. For additional information on fees, please refer to Part 2a of the Form ADV or consult an NTI representative.<\/p>\n
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[1] A statistical tool typically created and managed by an asset management firm or financial information company that is used to measure and track the performance of the entire stock market, a segment of the market or a particular group of companies.<\/p>\n
[2] An equity index exchange-traded fund (ETF) is a closed-end investment company whose fixed number of shares trade on an exchange. Its portfolio consists of shares in companies that are components of a specific stock-market index, and it is designed to track, or mirror, the performance of that index.<\/p>\n
[3] An equity index mutual fund is an open-end investment company, which issues and redeems shares based on buyer and seller interest. Like an equity index ETF, its portfolio consists of shares in companies that are components of a specific stock-market index, and it is designed to track, or mirror, the performance of that index.<\/p>\n
[4] The S&P 500 (officially, the Standard & Poor’s 500 Composite Stock Price Index) tracks the stock performance of 500 leading U.S. companies, accounting for about 80% of the total market capitalization<\/a> of U.S. public companies<\/a>.<\/p>\n [5] The FTSE Russell Group is a provider of global financial indexes, data, and analytics.<\/p>\n [6] MSCI is a financial research firm that builds and manages benchmark stock indexes. It was formerly known as Morgan Stanley Capital International.<\/p>\n","protected":false},"excerpt":{"rendered":"An interview with Ken Lassner, CFA, direct indexing lead product strategist, Northern Trust Asset Management. Assets managed using…\n","protected":false},"author":2,"featured_media":556286,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[14],"tags":[114,268,85,46,266,267],"class_list":["post-556285","post","type-post","status-publish","format-standard","has-post-thumbnail","category-personal-finance","tag-business","tag-finance","tag-il","tag-israel","tag-personal-finance","tag-personalfinance"],"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/posts\/556285","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/comments?post=556285"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/posts\/556285\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/media\/556286"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/media?parent=556285"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/categories?post=556285"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/il\/wp-json\/wp\/v2\/tags?post=556285"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}