Content Provided by Shana Sissel, CAIA – Portfolio Manager

Change is coming to the ETF marketplace. ETFs once seemed unstoppable as industry trends evolved from closed-end products to mutual funds to ETFs. But the evolution isn’t over yet. Now, while the industry continues to rake in an impressive $1 billion each day, some ETF players have become complacent, and their products are ripe for disruption.

Given their low costs (zero-fee ETFs hit the market in February) and tax-efficiency, ETFs may appear to be the perfect investment vehicle. But they still have vulnerabilities. Namely, ETFs are not tax-maximized. In other words, trade activity isn’t always done in the best interest of tax-sensitive investors.

Enter direct indexing! Matt Hougan, CEO of Inside ETFs, calls it the “Great Unwrapping” – a solution for investors who are looking for their own personal index within a certain band of tolerance, using a customized approach to maximize tax-efficiency.

The Advantages of Direct Indexing

So, what makes direct indexing a strong option for constructing portfolios? There are three main advantages to implementing direct indexing:

  1. Tax-Efficiency: ETFs are tax-efficient, but direct indexes may even be more tax efficient. Tax-loss harvesting, gain deferrals, and transition management are all benefits offered by direct indexes that are not available through a typical one-size-fits-all ETF.
  2. Risk Customization: Unlike traditional ETFs, direct indexes may offer investors a better fit for their risk tolerance. We believe that direct indexes can manage around concentrated stock positions, avoid making outsized sector bets, and generally better control the risk associated with the portfolio by setting parameters to meet a specific investor’s needs.
  3. ESG/Social Criteria Customization: As with any rules-based approach, direct-indexed portfolios may meet client-specific desires to avoid certain industries or to seek out companies that meet a preferred ESG (environmental, social, governance) framework.

Direct indexing isn’t new. Firms such as Wealthfront, Privé, Optimal Asset Management, Parametric, and Aperio have been doing it for years. With almost $100 billion in direct-indexed assets, if Parametric were an ETF issuer it would be the sixth largest and fourth fastest growing. But improvements in technology have made it possible for new entrants that offer direct-indexed solutions at lower minimums and lower fees than the legacy firms.

How You Can Use Direct Indexing

As this disruptive technology shakes up the industry, it is essential to stay ahead of the curve. In January 2019, Orion Advisor Services launched its proprietary optimization solution, ASTRO. This technology has changed the game for financial advisors who want to harness the power of direct indexing in their portfolios.

The initial launch of ASTRO gave advisors access to the software tool that helped them create an in-house, direct-indexed solution for their clients. The advantage was obvious; advisors could now offer high-net-worth clients an institutional-quality service without having to pay a big investment firm to do it for them. However, it soon became clear that there remained a strong desire by many advisors to outsource the solution if the fee was reasonable enough. So, last week, CLS launched a suite of Tax-Managed, Direct-Indexed SMA Beta strategies available exclusively on the FTJ FundChoice platform. Utilizing Orion’s ASTRO technology, CLS has created five new models, each replicating a different broad-market index to help create tax-efficiencies. The models represent a separate portfolio for each client, not a commingled vehicle. These models are designed for clients seeking tax-efficient rebalancing and direct ownership of securities. With an initial minimum account size of just $50,000 and a fee of 25 basis points, these portfolios provide advisors an option unavailable through established competitors.

At CLS, we strive to empower financial advisors to help their investors succeed. Using a high-tech portfolio customization tool, these five tax-managed portfolios will utilize direct indexing with the goals of delivering a better after-tax experience for investors and enable advisors to stay ahead of the direct-indexing curve. The ETF industry brought innovation and transparency to our industry, and it enabled advisors to better serve investors. As the next evolution, direct indexing should only make us better.

To learn more about how you can access these new strategies, contact FTJ FundChoice Regional Sales at 800.319.2513 or by emailing sales@ftjfundchoice.com.

We would also like to invite you to our upcoming webinar where we will be further discussing direct indexing and the possible benefits of these strategies. That webinar is set for May 15th. You can register here.

Stay tuned to find out more about the next phase of direct-indexing solutions CLS will be launching in the coming months.

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