(by Andrew Gradus, Senior Director of Consulting at Adhesion)
Direct Indexing has become incredibly popular in the financial services industry in recent years, with industry giants like Vanguard and Morgan Stanley engaging in a monetary arms race to bolster their DI offerings.
Though trendy, Direct Indexing is far from a flash in the pan, and is helping advisors maximize tax alpha, navigate volatile markets, and offer increased customization.
In this blog, we outline some of the main challenges advisors are facing in today’s economic environment, and how advisors can use Direct Indexing to bolster their value proposition during periods of market turbulence.
Why Advisors Need Better Tools to Handle Market Volatility
It’s no secret that new COVID-19 concerns, impending fiscal policy changes, supply chain inefficiencies, and looming inflation have created a great deal of uncertainty and market volatility in recent months.
In November of 2021, Omicron-fueled market swings led to the worst month for global hedge fund performance since the virus first shut down economies at the start of the pandemic. Since many advisors rely heavily on ETFs and Mutual Funds to construct their clients’ portfolios, these dramatic ebbs and flows have led to uncomfortable conversations and increased anxiety at a time when advisors are already under pressure to lower fees. Unfortunately, even as the vaccine and booster shots become increasingly available and widespread, the pandemic is likely to continue affecting market performance for months, if not years, to come.
In addition to pandemic-fueled volatility, proposed fiscal policy changes threaten to place an increased tax burden on investors in the new year. As stakes are raised, clients are putting increased pressure on their advisors to maximize tax savings, even as markets swing back and forth unexpectedly.
How Direct Indexing Can Help
In our view, Direct Indexing is a far superior tool as it relates to navigating volatility and maximizing after-tax returns. Direct Indexing strategies traditionally aim to deliver the pre-tax returns of reference equity indices— such as the S&P 500 or the Russell 3000 — much like a passive ETF strategy, however, with DI, the individual investor directly owns the shares and therefore controls the ability to tailor the specific investments.
DI unlocks opportunities to harvest capital losses at the individual security level, while maintaining a consistent exposure to the intended reference index. As such, Direct Indexing should result in similar pre-tax returns as compared to an ETF strategy, but delivers intermediate realized capital losses, otherwise known as “tax alpha.”
Mutual Fund and ETF investors are, of course, exposed to the risks of price declines, but they also have to bear the consequences of portfolio selling in a stressful market. A Direct Indexing portfolio doesn’t protect your clients from price declines, but it does mitigate against having to incur losses by selling securities to meet redemptions.
Direct Indexing allows advisors to actually capitalize on volatility, leveraging these periods of uncertainty to demonstrate their value. Advisors that enroll their investors in Adhesion Wealth’s Direct Indexing and active tax management programs have historically experienced better after-tax returns as compared to investments into ETFs and Mutual Funds, particularly during periods of market instability. Adhesion’s technology and support systems can help you easily build tax-advantaged portfolios, maximize tax savings, and demonstrate your added value through tax planning, risk profiling, and progress reporting.
Conclusion
Direct Indexing can be an incredibly valuable tool for advisors and investors alike, particularly during periods of market volatility. Adhesion Wealth has been a leading player in the Direct Indexing movement for over a decade, and our integrated platform empowers you to combine Direct Indexes with other customized services related to account opening, proposal generation, rebalancing, and tax-loss harvesting—all through a single interface. Contact us today to learn more.
