How we invest money in discretionary accounts

The vast majority of our business is using discretionary managed accounts. In these types of accounts, we agree with clients on a time frame and a risk level based on his or her financial goals, and once that decision is made we make the investment decisions including portfolio construction, security selection, and rebalancing. We are bound by fiduciary duty in these accounts which means we are required to work in a client's best interest (believe it or not that is not always the standard in our industry). Our strategies have evolved over the years from using mutual funds, then exchange traded funds (ETFs) to now using direct indexing, which allows us to directly own individual securities of an index rather than investing in a mutual fund or ETF that tracks an index. Direct indexing can align with our clients' needs and preferences, offering advantages that traditional investing methods often may not. These include tax efficiency, customization, cost-effectiveness, transparency, and alignment with clients' values.

One of the biggest benefits is tax efficiency. Traditional index investments such as ETFs and mutual funds can lead to unintended tax consequences due to capital gains distributions. When a fund manager sells a security within the fund, any resulting capital gains are passed on to investors, often leading to significant tax bills over which the client has no control, especially in a bull market. With direct indexing using individual stocks, we can manage capital gains and losses more directly and with more control. Selective selling allows for tax-loss harvesting—selling losing positions to offset gains in winning positions—thereby reducing the overall tax burden.

Another compelling advantage of direct indexing can be the control we have of investment selection. Direct indexing allows us to make choices and increase or reduce or even eliminate exposure to securities or sectors. With a traditional mutual fund or ETF portfolio you may not even be able to know what you own much less exclude unwanted investments. This flexibility can enhance returns and better align the portfolio with the client’s preferences and long-term investment strategy.

By holding individual securities, we are eliminating a layer of cost. Traditional index funds and ETFs charge additional management fees, which can eat into returns over time. Using individual securities in lieu of funds or ETFs where possible can result in a lower fee structure as well as more transparency. When clients invest in traditional funds or ETFs, they often have limited (or old) visibility into the underlying holdings and the fund manager's decision-making process. Direct indexing and using individual securities can allow clients to see exactly which securities they own and how their portfolio aligns with their investment goals. This transparency can result in clients feeling more engaged and informed about their financial decisions and allows for open conversations about performance and adjustments based on changing market conditions.

Market volatility is an inherent aspect of investing. Because we can manage individual securities, we have the flexibility to make real-time adjustments to the portfolio based on market conditions. During periods of heightened volatility, we can quickly rebalance the portfolio, which can help us either mitigate risk or take advantage of downturns, depending on the situation. Movements of individual securities can be greater than those of an index, which further enhances these changes. We can also take quick action to replace securities that are no longer performing the way we want or are no longer a fit relative to other investment options, as opposed to having no control of this when using traditional funds or ETFs.

Adding to the transparency, we periodically communicate with clients about what they own and changes we are making and why (this also can include transparency about decisions that have gone well and not as well). Clients love the knowledge the gain and the transparency of the process.

To manage large amounts of money, scalability is essential. Direct indexing is scalable, as it allows us to streamline processes and leverage technology to manage multiple portfolios without sacrificing personalization.

As the landscape continues to evolve and based on our past performance, I anticipate direct indexing will continue to play a critical role in how we approach portfolio management.