Riding the Direct Indexing Wave

ESG funds have been in the news lately, with Elon Musk reacting badly after Tesla was dropped from one prominent ESG index. Meanwhile, SEC regulators have been gearing up for a crackdown on funds that stray from their declared ESG goals.

Both developments point to one of the enduring problems with ESG investing: There’s no one definition of what “ESG” means or unified standard to determine if a fund should invest in a particular company. It’s easy for funds that call themselves ESG to wind up investing in companies that might not seem suitable to most investors interested in the sector (or not investing, as Musk raged about). How can an investor be sure they’re putting their money where their values are?

Direct indexing may fit the bill. How does it work? Thanks to fractional share trading and the push toward zero-fee trades, it’s now possible for individual investors to mimic a given index, even if they don’t want to invest the hundreds of thousands of dollars it would take to purchase a whole share of, say, each member of the S&P 500. Instead, you can apply your own personal criteria to exclude firms from your self-created index, allowing you to assemble a portfolio with risk and return characteristics similar to those of your model but more closely aligned with your personal values.

Formerly a niche product, big fund firms like Fidelity and Vanguard are now offering direct indexing options. (Vanguard only offers it if you’re working with an adviser on its Financial Adviser Services platform.)

Fidelity’s version, Fidelity Managed FidFolios, launched last month. It carries a $5,000 investment minimum and doesn’t allow for complete customization. Instead, it offers a pre-pruned version of some of its most popular index strategies and allows clients to further tweak them. The FidFolios Environmental Focus holds only 150 stocks, compared to 250 in the Fidelity U.S. Large Cap Index it’s based on. Investors can then choose to screen out a further five companies or two industries from their portfolios.

Direct indexing has another advantage as well. Investors in a mutual fund or ETF can only harvest tax losses when the fund experiences a price decline. If you’re direct indexing, however, a loss for any stock in the index presents a tax-loss-harvesting opportunity.

Though ESG investing is a common-use case for direct indexing, it’s far from the only one; the reasons for customizing a portfolio can be as varied as each investor’s needs.

Chart of the Week: Bulls Outrun Bears

Director of Research Jeff DeMaso:

The S&P 500 index has managed to dodge bear country recently, but I think we can all agree that it’s felt like a done deal for weeks.

While bear markets are challenging, one way I “bear” them is by not thinking of them as punishment. Bear markets are the fare we pay to ride the long-term compounding train that is the stock market.

In my opinion, it is a ride worth enduring because bulls have easily outrun bears over time.

To put some stats behind the chart: The average bull market ran for about five years and returned 158%. In contrast, the average bear market (peak to trough) lasted a little over a year, with an average decline of 36%. The average return one year after the bottom? 43%.

So, if this is an “average” bear market, then we are roughly halfway through—both in terms of length and drawdown. Of course, no bear market is average. What is clear is that if we are, in fact, in a bear market, then we are much closer to the bottom than we were five months, or even five weeks, ago. And history tells us that, as much as possible, we should stick around to participate in the returns coming out of a bear market.

Podcast: Analyzing Market Turmoil

Both stock and bond markets have been in a tumultuous drawdown for most of 2022. Is there any light at the end of the tunnel? Or do inflation, high interest rates and a slowing economy mean more pain is in store for investors? Portfolio Manager Charlie Toole, Portfolio Manager Steve Johnson and Director of Research Jeff DeMaso lead you through the trends they’re seeing in today’s markets, including:

• Whether we’re in for bear market turmoil
• The resurgence of fundamentals
• Why inflation has proven so sticky

There have been more downs than ups so far in 2022. But staying the course is still the savvy move. Listen now to find out why!

Adviser Investments’ Today’s Market Takeaways

In our recent Market Takeaways, Vice President Steve Johnson offered his thoughts on the inflation debate happening on Wall Street.

We hope you find these episodes engaging and accessible, and please let us know if there are any topics you’d like us to address by sending an email to info@adviserinvestments.com!

About Adviser Investments

Adviser is a full-service wealth management firm, offering investment management, financial and tax planning, managed individual bond portfolios, and 401(k) advisory services. We’ve been helping individuals, trusts, institutions and foundations since 1994. Adviser Investments and its subsidiaries have over 5,000 clients across the country and over $8 billion in assets under management. Our portfolios encompass actively managed funds, ETFs, socially responsible investments and tactical asset allocation strategies, and we’re experts on Fidelity and Vanguard mutual funds. We take pride in being The Adviser You Can Talk To. To see a full list of our awards and recognitions, click here, and for more information, please visit www.adviserinvestments.com or call 800-492-6868.