How Direct Indexing Can Transform Your Investment Strategy: A Must-Have for Australian Financial Advisers.

In the ever-evolving landscape of financial advice, a differentiated client offering is one of the best ways to stand out from the crowd. Technology is rapidly changing how advisers not only manage their practice, but also deliver client centric investment management solutions at scale and low cost.??

One of the most compelling advancements in recent years is the rise of direct indexing. For Australian financial advisers, incorporating a direct indexing offering into their services is not just a trend but a necessity. Here’s why:?

1. Personalisation and Customisation: Direct indexing allows financial advisers to tailor investment portfolios to the unique needs and preferences of their clients. Unlike traditional index funds, which are one-size-fits-all, direct indexing enables advisers to customise portfolios based on individual client goals, preference, and values. This level of personalisation can significantly enhance client satisfaction and loyalty, as clients feel their investments are truly aligned with their personal objectives.?
2. Enhanced Control and Transparency: Clients today demand greater transparency and control over their investments. Direct indexing provides this by allowing clients to see exactly which securities they own and make adjustments as needed. This level of control can be particularly appealing to clients who are concerned about specific sectors or companies and want to avoid them for ethical or personal reasons.?
3. Tax Efficiency: One of the standout benefits of direct indexing is its potential for tax optimization. By owning individual securities rather than a fund, advisers can implement tax-loss harvesting strategies more effectively. This involves selling securities at a loss to offset gains elsewhere in the portfolio, thereby reducing the overall tax burden for clients. As every Australian financial adviser and investor knows, tax efficiency is a critical component of wealth management. The importance and benefit of tax optimisation within clients' taxable accounts cannot be overstated.?
4. Cost-Effectiveness: Historically, direct indexing seemed like a premium service, only available to a very small subset of the High-Net-Worth market. Due to rapid advancements in technology, coupled with lower fees for brokerage and custody, direct indexing is now more accessible and cost-effective than ever. Automated platforms and sophisticated algorithms can now manage direct indexing portfolios at a fraction of the cost it would have taken a decade ago. This means that even clients with smaller portfolios can benefit from the advantages of direct indexing without incurring prohibitive costs.?
5. Competitive Edge: As has been seen in the United States, having a direct indexing offering for any financial advice firm is table stakes. Incorporating direct indexing into an advisers' service offering can provide a significant competitive edge. As more clients become aware of the benefits of direct indexing, they will seek out advisers who can provide this service. By being an early adopter, financial advice firms position themselves as forward-thinking, leveraging the latest in portfolio management technology, committed to offering the best possible solutions to clients.?
6. Future-Proofing Your Practice: The financial advisory industry is rapidly changing, and those who fail to adapt risk being left behind. Financial advisers who embrace direct indexing are future proofing their practice. This innovative approach not only meets the current demands of clients but also positions these firms to take advantage of future trends and developments in the industry.?
7. Rapid Growth and Adoption: The growth of direct indexing has been nothing short of remarkable. According to a Morningstar survey, more than $260 billion USD was following direct indexes as of the end of 2022, growing faster than ETF adoption.??

Key Challenges in Offering Direct Indexing: ?

While the benefits of direct indexing are clear, there are also several challenges that financial advisers must navigate:?

Client Education?

Educating clients about the benefits and intricacies of a new investment strategy can be time-consuming. Advisers must feel comfortable to effectively communicate how direct indexing works and the benefits to their clients.?

Operational Efficiency?

Managing multiple customised portfolios can be operationally intensive. Advisers either need to have efficient processes in place to handle portfolio rebalancing, tax-optimisation, and client reporting, or have a technology provider that can automate these processes seamlessly into an existing technology stack.?

Case Study: Charitable Foundation Avoiding Tobacco Exposures??

A notable example of the successful implementation of direct indexing is clear in the recent case of an Australian charitable foundation that wanted to avoid tobacco exposures in their Australian equity portfolio. The foundation had previously invested in an ASX listed ESG ETF until realising that the fund held tobacco shares, which conflicted with their ethical guidelines and contravened their investment policy statement. This created issues not only at the board level, but also at the donor level as well.??

After working closely with the financial adviser who managed this charitable foundation, Briefcase technology was able to successfully build a custom direct index portfolio that provided the same market exposure without including tobacco stocks as per the foundation’s guidelines. This solution allowed the foundation to align their investments with their values, while still maintaining the desired performance and transparency required of an index replication strategy. The portfolio was seamlessly executed on the foundation’s existing platform and custodian, thereby making the transition frictionless, with daily monitoring and scheduled rebalancing managed entirely by the Briefcase team and technology stack.??

Briefcase’s proprietary optimisation and portfolio management technology that enables the exclusion of specific sectors and companies, provided the foundation?the ultimate flexibility and control that they required, all delivered at?low cost.??

In summary, direct indexing offers a range of benefits that make it an essential tool for financial advisers. From personalisation and tax efficiency to cost-effectiveness and enhanced control, direct indexing can significantly enhance the value proposition for clients and provide a competitive edge in the market. The successful implementations by firms like Briefcase, along with the above case study, demonstrate how direct indexing is transforming the investment landscape and delivering a truly differentiated offering for financial advisers.?