Thomas Canals, Managing Director of Private Wealth Solutions at O’Shaughnessy Asset Management, joined Keith Black, Managing Director of RIA Channel, to discuss the differences between custom indexing and direct indexing.
Direct indexing seeks to replicate the performance of one or more indices with low tracking error. Because investors own the individual securities, the direct indexing manager can add the benefit of tax loss harvesting.
Custom indexing combines the tax benefits of direct indexing with customized exposures to factor risks or active management and client goals such as ESG. Customized indexing may be appropriate for any investors with taxable accounts, with significant benefits available to investors seeking assistance with unwinding concentrated positions. Advisors can use customized indexing to transition equity portfolios from legacy exposures to the portfolio desired by the advisor while seeking to minimize the tax consequences of the transition.
Canals notes that advisors and their clients may need to come up a learning curve on custom indexing. Rather than seeing a small number of ETFs and minimal trading activity on their statement, the SMA will hold a much larger number of individual securities with a higher level of trading activity. Custom indexing is relatively early in its growth curve, perhaps in the first or second inning. The growth is likely to continue, especially as advisors see how technology can help scale the tax loss harvesting process.
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