Rise of personalized stock index

IN 2001 Andrew LO, A professor at the Massachusetts Institute of Technology, predicts that technological advances will one day allow investors to create their own personal indicators to meet their financial goals, risk preferences and tax considerations. Such ideas are “science fiction today,” Mr. Lowe writes, but “it’s just a matter of time.” More than 20 years later, that time may have come.

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A revolution in passive investment that began in the 1970s led to the introduction of funds that track the effectiveness of an index, e.g. S.AndP 500, low cost investors diversification capability. Now a growing number of American fund managers and brokers are offering more personalized products to retail clients that combine the benefits of passive investing with greater customization. Direct-indexed accounts, such as products known, promise to track the performance of a benchmark index. But unlike off-the-shelf mutual funds or exchange-traded funds (ETFs), an investment vehicle monitored by portfolio managers, investors own underlying securities in a directly-listed account, and can tailorize their portfolios as needed.

The concept is not new. “Individually Managed Accounts”, a custom portfolio of securities managed by professional investors, since 1970. But such products have historically only been available to institutional investors and “ultra-high-net-worth” clients with millions of dollars invested. Today direct-indexed accounts are within the reach of the “larger rich” with liquid assets in the thousands. “That’s what organizations have been doing for years,” explains Martin Small, its head Us Asset-consulting business at BlackRock, an asset manager. “But with technology and scale and more automation, we can deliver it in the form of small accounts.”

Analysts point to three forces behind this trend. The first is the advancement of technology, which includes sophisticated algorithms and computing power required to continuously analyze and run a business across several thousand portfolios simultaneously. The second is the rise of zero-commission trading, which dramatically reduces costs. The third is the emergence of fraction-share trading, which allows investors to buy securities in bite-sized pieces, making it easier to build small diversified portfolios. Companies like Amazon, with a share price of more than $ 3,000, can be included without breaking the bank.

Direct indexing is still a small part of the asset-management industry. By the end of June 2021, approximately $ 400bn had been placed directly on the indexed account, according to Cerulli Associates, a research firm. But Morgan Stanley, a banker, and Oliver Wyman, a consultant, estimate that number could be $ 1.5 trillion by 2025. , Represents a growth rate of about 40% per year. Industry executives are bullish. “Private investment is coming to us all like a freight train,” said Walt Bettinger, boss of Charles Schwab, a broker, in October.

Such stimulus has increased the shock of acquisition. In October 2020, Morgan Stanley acquired Parametric Portfolio Associates, the largest provider of direct-indexing services. A month later, BlackRock snatched another major provider, the Aperio Group. Several other large fund managers and brokers, including Charles Schwab, Vanguard and Franklin Templeton, have made similar acquisitions. “No one wants to be left behind,” said Kevin Maeda, chief investment officer at Natixis, a bank’s direct index. “There’s a gold-rush mentality,” recalls Tom O’Shea of ​​Ceruli.

Direct indexing has both advantages and disadvantages. Its main selling point is its ability to reduce tax bills. This is achieved primarily through a process called “tax-loss harvesting”, in which lost stock is sold and replaced so that profits can be offset in case of a win, thereby reducing capital gains subject to tax. While this strategy can generate returns in the order of 1-1.5% per year, the benefits are negligible for individuals in low tax brackets or for investors who keep a lion’s share of their assets in retirement account, such as 401 (k). The plan, which suspends taxes on investment profits until the funds are withdrawn.

Another advantage of these accounts over conventional mutual funds or ETFs is customization. For morally thoughtful punters, this could mean the exclusion of fossil-fuel producers, tobacco companies, or arms manufacturers. The more customization, the more likely the portfolio return is to deviate from the benchmark return.

Direct-indexed accounts are often identified as a disruptive threat to mutual funds and ETFs In fact, they are part of the same long-term trend. “It’s really about index growth,” said Mr Small of Blackrock. “Direct index growth and ETFTogether, they’re just different ways of gaining index exposure, “he says.” The primary driver of direct indexing is not low cost or fractional shares, but a shift to decades of passive investment. ” It’s the same as years ago, “he said,” and five years from now. 3

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This article was published in the section “Finance to Economics” under the title “Direct to Market”.

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