Expert insight

Portfolio construction for direct indexing

May 04, 2022

Tax-loss harvesting analysis
Personalization costs can vary with direct indexing
Average TLH alpha by harvest frequency
A pair of bar charts shows the average 10-year tax-loss harvesting (TLH) alpha for each mode and investor type. The lefthand chart shows that for Investor A (high-net-worth investor), average TLH alpha rises from 4 basis points for a market index fund-based investor to 38 bps with direct indexing–annual to 107 bps with direct indexing–quarterly to 123 bps with direct indexing–monthly to 136 bps with direct indexing–daily. The righthand chart shows that for Investor B (ultra-high-net-worth investor), TLH alpha rises from 84 bps for a market index fund-based investor to 164 bps with direct indexing–annual to 264 bps with direct indexing–quarterly to 284 bps with direct indexing–monthly to 310 bps with direct indexing–daily.
Portfolio outcomes: High-alpha versus low-alpha investors
Line chart shows that the high-net-worth or low-alpha investor (Investor A) has to give up returns for the entire portfolio with any level of additional direct indexing, with the maximum return difference reaching 57 basis points with tracking error of 275 bps. Direct indexing is far less costly for the ultra-high-net-worth or high-alpha investor, and costs have a negligible impact on returns up to 200 bps of tracking error and reach just 17 bps even with 275 bps of tracking error.
Portfolio construction implications

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