Wealth Management
Advisors can use direct indexing to optimize their clients’ portfolios, reduce tax bills, and offer more customized solutions. It also offers an opportunity for an advisor to differentiate themselves and increase their appeal to high net worth prospects with specific needs.
Direct indexing offers more flexibility and solutions than traditional passive investing while retaining the major benefits. One example is that it can be used to reduce concentrated stock positions in a manner that can offset capital gains taxes and help lead to a more diversified and balanced long-term portfolio.
With direct indexing, tax losses can be harvested and set aside. This effectively turns them into assets which isn’t possible with investing in index funds. It could be especially of value to clients expecting a future financial windfall who are interested in proactive steps to reduce the future tax burden.
Indices can also be modified to offset a large allocation to a specific stock or sector in another part of the portfolio. For instance, someone who works in the tech industry with a large number of stock options may not want tech exposure in their personal portfolio.
Advisors can start this conversation with prospects by discussing matters like future windfalls, concentrated positions, reducing capital gains taxes, and more personalized solutions.
Finsum: Direct indexing is a way to optimize clients’ portfolios especially those with large capital gains taxes, concentrated positions, and expectations of a future financial windfall.
LPL Financial topped analysts’ estimates for Q3 earnings despite a slight 3% decline in earnings. It also reported a strong quarter in terms of recruiting and asset growth. It also laid out its growth plan for the future which involves expanding its capacity to serve all types of advisors.
LPL added 462 advisors on a quarterly basis and 1,360 on an annual basis. It attributed this growth in part to its new affiliation models and to boosting its offerings to serve a wider variety of advisors. CEO Dan Arnold remarked that LPL’s goal is to eventually be able to compete for all 300,000 advisors on the marketplace.
Q3 was LPL’s best quarter for asset growth since Q2 of last year when it added $43.5 billion. In Q3, the firm added $31.2 billion in assets with $12 billion from Bank of the West and Commerce. However, the company believes that its current growth is higher quality and more durable.
Richard Steinmeier, managing director of business development, said “We are strengthening in the way that individual advisors and groups of advisors are choosing to come to [LPL] in a much more material way even than Q2 2022.”
Finsum: LPL Financial reported strong Q3 results in terms of recruiting and asset growth. The firm has ambitious growth plans for the future.
According to a report conducted by Hearts & Wallets, high net worth (HNW) investors are favoring separately managed accounts (SMA) over mutual funds. The report surveyed 6,000 people. About 22% of US households were invested in an SMA, which is a significant gain from 13% in 2020. In the same timeframe, mutual fund ownership increased from 38% to 39%.
Among HNW investors with investable assets of $3 million or more, SMA ownership went from 22% in 2020 to 41% in 2022. In terms of portfolio allocation, SMAs climbed from 22% in 2020 to 29% last year.
At one time, mutual funds were the only way for retail investors to get access to many markets and the expertise of portfolio managers. Now, there are a multitude of products that offer these features, often with more liquidity and lower costs.
One reason for the growing popularity of SMAs is that they are becoming more affordable and now require lower account minimums. Another factor is the growing interest in personalized investing which is more easily facilitated with SMAs rather than mutual funds. For instance, an investor passionate about protecting the environment could avoid fossil fuel companies in their holdings.
Finsum: Separately managed accounts are gaining traction among high-net-worth investors and are displacing mutual funds.
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Earlier this year, the Carlyle Group was close to completing a $15 billion deal to takeover healthcare software company Cotiviti at $15 billion. However, the deal fell apart as Carlyle was unable to raise $3 billion from investors due to the yield of 12% being nearly equivalent to the return on equity.
At first, many speculated that this was a Carlyle issue, but in hindsight, it’s an indication of the pressures faced by the private equity industry amid the highest rates in decades. Many of the strategies employed by private equity managers are simply not viable in a world with higher interest rates.
As flows into new funds have slowed and pressure to refinance, private equity firms have started borrowing against assets to make dividend payments, while others are shifting away from making interest payments in cash.
The industry still has $2.5 trillion in cash, and many dealmakers believe there will be some attractive opportunities to capitalize upon. Still, others believe that operators will have to adapt to a new environment and can no longer rely on the tailwind of falling rates which lifted asset prices higher, while keeping financing costs low.
Finsum: Private equity is struggling amid higher rates. Here are some of the ways.
In an interview with Bloomberg, Salim Ramji, Blackrock’s global head of iShares and index investments, spoke about the growth of model portfolios, and why he believes that assets under management (AUM) are projected to more than double over the next 5 years from $4.2 trillion to over $10 trillion.
Ramji commented that “It’s going to be massive. It’s the way in which more and more fiduciary advisers are doing business, and, as a result, that’s the way in which we’re doing business with them. It’s really just changed from being a cottage industry to being something that’s a real force for every fiduciary wealth adviser in the United States.”
Model portfolios are typically composed of ETFs and other funds that are bundled into pre-built strategies. An indication of the growth of model portfolios is that changes in allocations can be seen in trading volumes and fund flows data. For iShares, model portfolios comprise more than half of flows, while they accounted for a third of flows 2 years ago. The company expects similar traction for model portfolios in its international markets as well.
Blackrock’s bullishness on model portfolios is noteworthy as it is the largest asset manager in the world with $9 trillion in AUM and also the largest ETF issuer.
Finsum: Blackrock is forecasting that assets under management for model portfolios will exceed $10 trillion over the next 5 years.
As the year comes to a close, it presents an opportune moment for financial advisors to revisit strategies and offer valuable advice to clients. A timely topic is tax loss harvesting. And direct indexing is becoming a popular way for investors to accomplish this. Therefore, now is a great time to consider introducing the concept of direct indexing to your clients.
The Value of Tax Loss Harvesting
Tax loss harvesting is a technique that can reduce taxable income by selling securities that have incurred a loss. As we approach year-end, this tax-saving tactic may be appropriate for some of your clients, yet you need a convenient way to make these trades without upsetting their entire portfolio. Direct indexing allows you to accomplish this task.
Direct Indexing: No Longer Just for the Elite
Direct indexing, which involves buying individual stocks directly rather than through a fund, enhances the ability to tax loss harvest. While it's not a new concept, it's becoming more accessible to a broader range of investors. As author Medora Lee pointed out in her recent article in USA Today, "(direct indexing) was once mostly reserved for the affluent with at least $1 million to invest." But things are changing. "With better technology and zero- or low-commission trading now the norm, more people can use direct indexing."
Embracing the potential of direct indexing and tax loss harvesting is another way to demonstrate your value to your clients.