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Making Portfolios Personal

Matt and Julie interview Cindy Galiano and Zach Hamilton about direct indexing. Cindy is the head of product, investment management at Morningstar. Zach serves as a financial advisor at Alterra Advisors.


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In This Episode, You’ll Hear...

00:54 – The Fuel Behind Direct Indexing’s Recent Popularity

While the direct indexing capability has been around for a couple decades, it’s historically been an option mostly for institutional investors and high-net-worth clients. But over the last few years, direct indexing has become a hot topic. Technological advancements have made it possible to personalize a client’s portfolio at scale, at lower account minimums.

2:41 – The Demand for Personalization

When someone sees a financial advisor’s business card, they automatically think they’re going to explain what stocks to buy. But to do that, advisors must understand the client’s goals—when they want to retire, whether they need to pay their kids’ college tuition, what they hope to do with their money. That’s the role of personalization.

With technology, advisors can customize clients’ portfolios with more detail. Personalization still starts from understanding the client’s goal (for example, diversification), and working backward from there. According to Zach Hamilton, investors are increasingly asking whether they can exclude a particular sector or industry from their portfolios. They’re asking for a higher level of personalization, which is much easier with a direct-indexing platform.

6:16 – Direct Indexing for Tax Optimization

Direct indexing gives investors the ability to either replace or remove certain exposures to, for example, equity risks. But it also supports optimization at the tax level. This is where advisors add a lot of value in terms of asset allocation and asset location, by being more nimble and more granular as they effectively manage taxes, more than they could with mutual funds or ETFs.

However, Cindy Galiano thinks that direct indexing can work in harmony with other investment options to fulfill certain asset class exposures such as fixed income or alternative investments.

11:22 – Decision Criteria for Using Direct Indexing

As advisors determine when direct indexing might be appropriate for their clients, some considerations include their charitable plans and tax income bracket. But ultimately, the question goes back to the client’s intended outcome.

One complaint about direct indexing is that it can significantly complicate a client’s portfolio. However, while tax strategies and tools are not necessarily unique to direct indexing, direct-indexing demand has accelerated the technology to be more automated. For example, advisors can perform tax-loss harvesting without triggering wash sales.

So even though direct indexing adds complexity to taxes, the potential value add makes direct indexing a key contender in the arena of investment approaches.

16:27 – A Point of Controversy: Direct Indexing at Low Minimums

According to Zach Hamilton, more options are better than fewer, so having the flexibility to access direct indexing at low minimums is a benefit. In his opinion, part of direct indexing’s value is its ability to offer customization without gatekeeping.

Cindy Galiano’s feelings are more mixed. While she also appreciates the democratization of direct indexing, she’s also wary of the potential costs for investors with low balance amounts, including fees and opportunity cost.

19:03 – The Biggest Challenges to Direct Indexing

Automation has accelerated direct indexing’s accessibility, but it can also be dangerous if done wrong. While technology is crucial to aligning a client’s portfolio to their goals, the approach needs a human element to understand tax budgets, preferences, values, and impact. The continual growth of direct indexing requires a solution that balances technology and the human element.

19:50– How Direct Indexing Affects Client Profiling

Zach Hamilton compares managing investor expectations about returns to premarital counseling. Frustration comes from unmet expectations—so the more granular that advisors can get in their advice, the more confident they can be that clients will end up in their predicted financial situation.

Advisors will need to be able to construct personalized portfolios at scale and manage those on an ongoing basis, as well as gather clients’ values, ESG considerations, and other customization needs, such as tax management.

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