Direct Indexing – the next big thing?

One section of the Altor team is living with very limited heat and hot water at the moment (and boy do we hear about it). The root cause is the inability of a major utility firm to dig a trench and lay a cable. A five figure sum has been paid six months ago and the current target date is still twelve months away. Now we could wax lyrical about whether privatisation is effective where national infrastructure is involved or whether you just create a monopoly and allow profit to leak away but this is not that Blog.

Think back to the last time that you had a bad interaction with a big company. I am sure that it won’t require a herculean effort, it could have been a mobile phone provider or insurance company. Afterwards you probably never wanted to have anything to do with them again. And yet, if they are listed on a major stockmarket, you are probably an investor in their company. In the heat of the moment you might feel like disinvesting from their shares, not on the assumption that this would make any difference, but more as a point of principle.

This is where Direct Indexing comes in.

In the UK currently most investors access the return from markets either through active or passive management. Passive management involves buying funds that will replicate an index. To do this they will select an index such as the MSCI All Countries World Index (one of the broadest indices of shares) and buy each of the company shares that make up that index. The benefit of this type of passive investing is that it is incredibly cheap and efficient.

Direct Indexing takes this idea one step further and is gaining ground in the US. It bypasses the fund and buys the shares of the index for the end client directly. Historically this has only been possible for very large investors as some shares have a high price for a single share and it can be expensive to buy the quantity of individual shares needed. However with the introduction of zero cost and fractional share trading, it becoming more and more open to the mainstream investor.

The key advantage with Direct Indexing is that you can choose to exclude certain companies that you don’t want to invest your portfolio in. Whilst it might not be a good idea to exclude a company based on the service you have received (maybe they are hugely profitable) it could be a very good idea not to buy the shares of your employer in your portfolio if you already hold a big exposure to them directly, through their workplace share schemes.

Equally some clients of ours have a particular issue with a single unethical sector but don’t want to exclude all sectors that are deemed unethical by a fund manager. Maybe you have a history of addiction in the family and want to exclude the tobacco or alcohol sectors but don’t want to exclude the arms industry due to the war in Ukraine. Direct Indexing allows you to be more targeted with your exclusions.

The concept isn’t fully developed in the UK at the moment but it is an area that we have been looking at for clients that need it. We hope to be able to offer it to those individuals soon. In the meantime if you want to make your voice heard, it is worth looking at the work of ShareAction.

One thought on “Direct Indexing – the next big thing?

  1. 1. What would the defect on costs be? For instance, stamp duty in the UK and other dealing costs? Zero cost is not zero overhead.
    2. Why do people invest? Achieving moral or political ends can lead to good outcomes, as The Sunday Times campaign against the makers of Thalidomide in the early 1960ies shows. But indexing could be used for racist purposes too. For instance by conspiracy theorists .
    3. How often would re-indexing be permitted? If I wanted to exclude high-carbon producing companies today, but tomorrow wanted to boycott companies involved in HS2, and the day after I wanted to avoid companies controlled by Elon Musk but favour electric battery producers, how would an algorithm reconcile this?
    4. Indexing sounds interesting but it seems to me that this should be permitted to a predetermined group of criteria at inception and not often after that, maybe yearly?

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