I think direct indexing is going to be a major innovation in the world of wealth and asset management. It will help the RIA and wealth management world deliver on the promise of financial planning. It will also help rationalize the business model of many advisors as clients request more specialization around their affairs. The impacts could be enormous and many players are entering the space. To help us understand the concept of “Direct Indexing”, I spoke with LISA GOLDBERG, PhD.

Lisa is the Head of Research at APERIO– a $41B asset manager with 21 years of experience in the space. Aperio was recently acquired by Blackrock. Lisa is the Professor of the Practice of Economics at the University of California, Berkeley, where she directs the Consortium for Data Analytics in Risk (CDAR).

We talk about what “Direct Indexing” is, how it works and why it will be important for investors.

(DISCLOSURE: This podcast is meant to educate around the topic of “Direct Indexing” and is not specific investment advice.)

In your experience, how are portfolios typically implemented in the wealth management industry and what could be improved?

Describe the concept of Direct Indexing- (1.0 Beta portfolios with fewer positions than the index. This allows buy/sell customization around other metrics like tax lost harvesting, ESG considerations or concentration management) 

Why is this important?

While this isn’t a new concept, why is this a step forward and what allows this powerful tool to be available for more investors? 

Direct Indexing vs Index Funds, ETFs, Mutual Funds

How does this work?

(Without revealing the secret recipe!) What goes into the investment process for your direct indexing solutions?

How do your programs systematize prudent tax loss harvesting?

What factors do you focus on?

Certain sectors and securities often make up the lion’s share of out-performance- what is the process to ensure proper sector representation? 

How do you make sure that the portfolio does not fall too far out of whack?  

What happens when a clients’ preferences or situation doesn’t intersect well with your process?

Focusing on tax alpha (and knowing that each person’s tax situation is different)-

Is there a consensus on how much return on a tax-loss harvested portfolio can add?  Or put another way, how much do investors leave on the table with “non-tax aware” investing?

How does this help deliver on the promises of financial and tax planning?

How does this help clients?  

Are there any long-term projections you can share on how much clients could benefit?

How does this help client advisor’s that implements asset allocations?  

How does APERIO work with advisors and clients?  At what asset sizes does it make sense?

Here is the mentioned “Active Management Tax Insult to Injury” link :

https://www.aperiogroup.com/Resources/Papers/Adding%20Insult%20to%20Injury%20-%202015%20Tax%20Penalty%20for%20Active%20Mgmt.pdf

Why loss-harvesting has worked so well:

https://www.aperiogroup.com/blogs/highfliers-drive-market-returns-losers-drive-tax-alpha

Ken Lassner writes about optimal gifting from a direct indexing account:

https://www.aperiogroup.com/blogs/optimal-gifting-for-financial-and-philanthropic-return

Here’s a user’s guide to separately managed accounts:

https://www.aperiogroup.com/Resources/Papers/ETFs%20vs%20SMAs-A%20Users%20Guide.Paper.pdf