Direct indexing is a bad name. We need to stop using it.
Direct indexing is a dumb name. There, I said it.
Don’t get me wrong, I am not a creative naming maestro. I decided on “Quorus” for our company after cracking a beer and spending an hour on the couch looking at available domain names with my wife.
Still, the name direct indexing has become so ubiquitous and, in my opinion, misleading that I am taking a stand. Buckle up.
What’s direct indexing again?
“Direct indexing” is usually understood to mean directly investing in stocks and applying quantitive portfolio management tools to mimic the performance of a target index.
It works by selecting a target index and applying any desired customizations, including values-based screens, to remove companies or underweighing specific companies when a client has exposure to a particular industry or stock elsewhere in their portfolio.
Once implemented, the account is tax loss harvested to improve after-tax returns. Direct indexing is implemented through a separately managed account (SMA).
If you want to get the basics down before we proceed, there are several great primers on direct indexing, including a one-pager we developed that provides a product overview. (Shameless founder self-promotion.)
Now that we’ve got a definition to work with, it’s time for me to climb onto my soapbox.
The name direct indexing is misleading
Direct indexing is misleading because it implies two things: First, you can invest in securities directly — we agree on this point. The second implication is that it’s an index product. That’s where we’ve got a problem.
While these types of SMA accounts can replicate returns for a target index, they can also replicate returns of an active strategy, including factors, quantitative active, and fundamental active strategies.
Addressable Investment Strategies
Put simply, it’s not “indexing.” It’s a customization engine for many different investment strategies. A custom separately managed account is a 3D printer that can create anything — unlike mutual funds and ETFs, which are more like big factories that produce a single, standard widget. An SMA can do indexing, but that’s only a small, non-exclusive use case.
Names matter; just ask the Securities and Exchange Commission.
Would you create an exchange-traded fund running an actively managed investment strategy and call it an index fund? You could, but I wouldn’t advise it.
For one thing, it's terrible marketing. More importantly, it's misleading to investors, and the investment industry has rules about this stuff. A lot of rules. Just ask the SEC. They have an entire rule about accurately naming investment products.
Having talked to advisors for years about direct indexing, the name is a barrier to understanding and adoption. When I bring up direct indexing, advisors often have a set of preconceived notions about the product based on the past 20 years:
It only applies to clients who invest in popular indices
The value of tax loss harvesting is only for the ultra-wealthy
The advisor experience is clunky, which makes the product time-consuming to manage
The product is hard to explain to clients
Some advisors even question if a custom SMA replicating an index counts as indexing. (We think so, but digging into why is a topic for another blog post.)
The reality is very different. Separately managed accounts can be (and with Quorus, they are):
A wide range of investment strategies, not just indexing
Sophisticated tax loss harvesting vehicles that can create value for mass affluent clients net of fees. (Our portfolio manager, Kyle Brimingham, wrote a great post diving into tax alpha for those interested in going deeper on the investment case.)
Modern and intuitive
Transparent, with on-demand reporting
Easy to explain to clients
Put simply, it’s not the investment product many advisors think they know, even though their confusion is justified.
A stand for clear, transparent messaging
Calling this product direct indexing draws on our industry’s shared understanding of what the product has been and fails to convey its full potential. As a result, advisor confusion and, in certain cases, skepticism is understandable.
At Quorus, we have moved away from referring to the product as direct indexing because we provide custom investment portfolios, which can implement index strategies, active strategies, or the gray space in between them. Is this a brilliant marketing move? Probably not, because direct indexing is a hot topic, and we’d be happy to ride the wave. But the way we talk about it is clearer for advisors and their clients, which matters more than a buzzy title.
As an aside, a marketer we’re friends with thought we should call it SMAC Investing — for Separately Managed Account with Customization.
Regardless, we think a more expansive view will help everyone in the long run.
But if you want to learn more about custom investing or direct indexing and how it can fit into your practice, drop me a line at john@quorus.io.
And if you violently agree or disagree? Call me out on X (@JohnHill_12), and we can get into it.
Disclosures
Investing in securities involves risks, including the risk of loss, including principal. Quorus Inc., is an RIA registered in the States of Connecticut and Pennsylvania. Neither regulator has approved this message.
Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Quorus has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation.
This content is provided for informational purposes only, as it was prepared without regard to any specific objectives, or financial circumstances, and should not be relied upon as legal, business, investment, or tax advice. References to any securities are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not intended as a recommendation to purchase or sell any security and performance of certain hypothetical scenarios described herein is not necessarily indicative of actual results. Any investments referred to, or described are not representative of all investments in strategies managed by Quorus, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
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