Direct (Custom) Indexing

Interesting piece from Nick Maggiulli which mentions custom index investing and ties in with some news on Vanguards acquisition of Just Invest

Vanguard to offer direct indexing capabilities through acquisition of Just Invest

From Nick's article We Are All Investors Now – Of Dollars And Data

In other news, BlackRock announced a $1 billion takeover of Aperio, and Morgan Stanley’s $7 billion purchase of Eaton Vance Corp. is all about direct indexing - the latter’s Parametric Portfolio Associates

 

Just remember that ALL of the people espousing custom indexing rely on it in some way and have huge conflicts of interest. The Ritholtz team of which that guy is a member are talking it up a lot because they are financial advisers who can use it to make it look like they are doing something. For a DIYer or someone who wants a one off financial advice session these things seem like psychology traps to me. I feel like an old man shaking my fist at clouds but personally I have serious doubts about whether the juice is worth the squeeze, if I want to pick stocks I'd pick stocks. I don't want to. And yes I understand the tax loss harvesting angle of it, but if you want to go down that route you can do it without these things and the fees that come with them. Seems like advisers finding a way to increase their margin for selling advice. Happy to be proven wrong but they need to show me some damn good evidence with data.

 

Seems to contrary to the original concept of index investing. Then my brain has fossilised so I know nothing.

 

Brilliant idea. An index fund that gives you the ability to turn it into an actively managed fund to give you an opportunity to mess it all up and underperform.

Where do I sign up?

 

"We can generate 50 basis points of tax alpha for you using this!"

....but our fee is 150.....

 

Aside from any fee aspect, my feeling is the providers are reacting to consumer demand "I like indexing but I want to include this but not that."

Looks like they will get their wish. Many wise words on blogs will ensue.

It'll be fun to watch.

 

Seems like a great way to pick up a few more points in fees.

 

Looks like M1 Finance is doing something like this, you can invest directly in stocks using fractional or whole shares, as well as several commission-free ETFs, automatic re-balancing is available and, no fees or commissions .....BUT, they are using the Robinhood payment for order flow model

link

They also charge fees for subscriptions for their premium service, interchange fees, interest on cash loans, and fees for stock lending

 

Interesting article. Thanks for sharing. Whilst I agree that it will be great for financial advisors and other coupon clippers, I think there might be something in there for the rest of us to ponder about. It is extremely common to think that the future has arrived and this is how it will forever be. For example, most people believe that they have evolved all they can and their present state is how they will be for the rest of their lives. However, history has shown that people change significantly decade to decade - almost to the point of not recognising themselves when they look back. It is certainly true for me.

Accordingly, it is likely that broad based index ETFs (as we know it now) will not be the only sensible way to invest in 15-20 years’ time. Just looking back over the last 20 years, there has been so much change that we have been exposed to. 20 years ago, indexing, even in the US was mostly undiscovered. I think this kind of change has always happened and will continue to happen. That is how progress is made. It is how it has always been; even if those of us being in the midst of it all thinking the future has arrived and settled.

Also, having seen how counter-intuitive the human brain is, custom indexing will provide all the right dopamine hits to the nerdy tinkering investor (and an overwhelming majority of us are the tinkering type). It will give chat forums like ours a fresh lease of life. Oh the debates on Reddit about which industry to leave out, which tilt to overweight – it will go on for pages! It will sustain an entire generation of blogs, podcasts etc.

So I am not writing it off as I think it might be the way things go in the medium-longer term. If it is not custom indexing, it will be something else. And then it will change again.

 

This will be huge with the current generation of young adults to pre-teens who want ethical options for investing.

What's ethical for me is different to a vegan cyclist. This provides market coverage without over-saturating with 50 different versions of "ethical" ETFs

 

From Ben Carlson

 

I wish robinhood would come to Australia. They let you buy fractional shares, so if you have $50, you buy exactly $50 worth of shares, rather rounding down to the closest (ie 2x$24 shares). Free brokerage helps too.

 

Ha. If you want to see optimizing, take a look at the Rational Reminder community…sweet baby Jesus!!

I understand the value of direct indexing, in particular the discrete tax management. Alas, I’m locked into the ETF/Fund structures now.

 

Interactive Brokers also supports fractional shares without selling your order flow. When something if free, you are the product.

 

You're not joking. This thread is a doozy with 5000+ posts discussing factor percentages
Rational Reminder Community

It was the rational reminder podcast where I first heard about direct indexing

Episode 71: Everything that you could ever know about ETFs with Dave Nadig — Rational Reminder

Episode 131: David Booth: The First Index Fund, Competing Fiercely, and Keeping it Simple — Rational Reminder

 

Yeah me at RR ;

 

Yup, in this case Robinhood is selling your data to the market makers. When you load up a buy/sell, robinhood forwards that potential transaction onto the market makers so that they can price in advance. Quite clever really.

 

@The Falcon

And me..

 

I have WAY too many questions that cannot be answered about direct indexes. For example:

1. Can I get out of it without generating a big tax hit? Tax loss harvesting seems only really beneficial when there are plenty of flows going in (i.e. buying more shares after you sell). If I'm in drawdown mode on a large portfolio in retirement with modest reinvestment can I switch to a lower fee plain ETF without selling everything? Or will the manager match fees with a plain ETF and just leave it be? If not I'm paying extra fees for maybe 30+ years for tax loss harvesting which is of little use to me at that stage. Sure I could try and be tricky and drawdown on individual stocks to minimize tax, but this is the opposite of rebalancing where you sell the high performers to invest in the poorer performers. And how do I explain the process of this to my missus who cares little for investing when I'm going senile?

2. For someone who has a few different ETFs spanning different currencies, countries etc. where correlation is moderate in "normal" times how beneficial is this really? During global crashes you can tax loss harvest everything because it's all crashing. During global booms everything is going up so it's very hard to harvest anything worth the effort. In normal times I'd expect drawdowns of 10+% every year in at least one part of my portfolio which I might be able to harvest. There's so many ETF options you can tax loss harvest effectively, albeit maybe not as as effectively, without this sort of product I think.

3. If I harvest out of a stock (eg. CBA) into another similar one (eg. ANZ) when do I buy back into CBA? Do I rebalance equally with each new deposit? Isn't that a wash sale? Do I have to wait a year before buying CBA? But aren't I selling CBA because it has dropped relative to other banks - so isn't that when I should be buying not selling it?

Like others I see the potential benefits of direct indexing for tax loss harvesting, but for the complexity and extra fee burden I just can't see it for me. It smells too much like financial parasites trying to take my money and justify their existence for now until I can see a clear picture of how it works.

For anyone interested in the nuts and bolts of tax loss harvesting this is worth a read:

https://static.vgcontent.info › ......: A portfolio and wealth planning perspective

 

If it's complicated..........

I just answered my own unasked question.