In an article for WealthManagement, Iraklis Kourtidis shared his persepctive on direct indexing and what it precisely means. He says that there are two components to direct indexing. The first is that it helps an investor create a custom and personalized index. The second is that it can help with portfolio management to ensure that it tracks a specific benchmark.
With direct indexing, investors hold the actual securities themselves in a portfolio rather than an ETF or mutual fund which tracks an index. One advantage of this is that it enables an investor to create their own index. Previously, this wasn’t possible as index investing was only possible through ETFs and mutual funds which follow well-known indexes.
Some investors want the benefits of index investing in terms of diversification and low costs. But, they need greater personalization. One approach is to modify an existing index. Another is to create an index from scratch.
In terms of portfolio management, there are some additional challenges. For one, index holdings need to be constantly rebalanced especially when tax losses are being harvested to offset gains in other parts of the portfolio or when factor scores change.
Finsum: There are two parts of direct indexing, and each is crucial for success. One involves constructing a custom index, and the second is portfolio management.