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How Direct Indexing Helps Clients Cope With Market Volatility, Taxes

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Direct indexing is a hot investment strategy that seems new but has actually been around for decades. Why is it growing so quickly now?

Look no further than the broad trend of customization and new technology that makes the process easier. For clients who opt for direct indexing, “Every investor is going to want their own [particular] customization. To have that agency is really powerful,” says Monali Vora, a partner of Goldman Sachs Asset Management and its head of custom equity and direct indexing, in an interview with ThinkAdvisor.

Over the next five years, direct indexing will grow at a faster rate than ETFs, mutual funds and separate accounts, Cerulli Associates forecasts — and Vora enthusiastically concurs. The customized strategy lets investors buy individual equities in weights comparable to those that make up a chosen index.

“The outcome is aligned with the investor’s goals and values,” explains Vora, who describes her focus as “the intersection of quant finance and technology.” Direct indexing can be tailored to specific goals, such as tax advantage, diversification, and investor values such as betting on an ESG strategy.

Vora builds strategies and portfolios for clients’ individual objectives. In the interview, she discusses how financial advisors can effectively suggest direct indexing to clients.

Goldman has a range of such strategies, including custom transition of assets from a brokerage account or active manager, a move that affords tax advantages. In addition, advisors can offer direct indexing using GSAM’s proprietary software — accessible online — to present clients with a variety of investment opportunities.

Vora, who won a ThinkAdvisor 2021 LUMINARIES award for executive leadership, heads a team of 15. The certified financial analyst joined Goldman Sachs in 2000, directly after graduating from the University of Waterloo In Ontario, Canada, with a bachelor’s degree in mathematics.

She has worked in Goldman’s quantitative investment strategies business from day one — a perfect fit. “I was a quant in high school. I was in a quant program in college,” says the daughter of a computer programmer who was formerly a math professor.

ThinkAdvisor recently interviewed Vora, who was speaking from Goldman Sachs’s downtown Battery Park City headquarters in New York. She points out that technology allows “every part of our lives [to be] customized to an individual’s preference — and investing is no different.”

Here are highlights of our interview:

THINKADVISOR: What’s the aim of direct indexing?

MONALI VORA: Giving investors exposure to the market by directly investing in individual stocks so that we can create custom baskets and custom portfolios.

What’s a good way for advisors to present the idea of direct indexing to clients?

[They could tell them], “It’s a great investment opportunity for you to get market exposure, and you can have control for your capital gains and losses.

“You can customize around your values and align your values with the portfolio.

“You can determine what your income levels are.”

How else can direct indexing benefit an investor?

When a client says: “I have appreciated assets in brokerage. No one is really managing them. Can you help me think about how to diversify them?” 

Why is customization a trend in the asset management industry?

Every part of our lives is being curated and customized to an individual’s preferences: how we order food, shop in the retail market [and so on].

We have access now to technology that allows for such customization, and investing is no different.

We’re able to offer our investors ways of customizing around their individual goals and values.

Is the strategy of direct indexing heating up?

[At Goldman] we’ve been growing [this business] quite a bit over the last five years [having made it available since 1999]. We’re now at $130 billion in assets across 25,000 different accounts [nationwide]. Last year alone, we opened 7,000 accounts.

Also, there’s been a lot of M&A activity in the indexing business. Over the last 14 months, there have been 10 potential transactions in the space.

People view [customization] as a [business for which] technology is going to become more and more accessible.

How fast is the space expected to grow over the next five years?

Cerulli [Associates] projects that the direct indexing industry will grow at a faster rate than ETFs, mutual funds and separate accounts. 

That’s my expectation too. This will be a big growth area in the next five years because of technology and the need and demand for customization in every part of our lives and the benefits to the individual investor.

What is direct indexing’s biggest benefit to clients?

The benefit that accrues to each investor is determined by how we construct the strategies for them.

Because we’re buying the individual stocks directly to deliver a market return, we can customize so many different elements — around tax goals, aligning values, providing more income, managing various risk levels.

Can direct indexing counter market volatility?

One way we’re able to take advantage of equity volatility is by harvesting losses. For investors who want this capability, in periods of higher volatility we’ll sell stocks at a loss and buy replacement stocks.

What’s another plus to direct indexing?

A lot of our clients transition portfolios from brokerage or active managers. They want to diversify with a basket of stocks, but they want to be thoughtful about the tax consequences.

For example, if you own a highly concentrated basket of stocks that’s very appreciated and have very large unrealized gains and want to diversify and get market exposure, you’ll have to sell them, [resulting in] capital gains.

Then you’d [likely] buy an ETF or a mutual fund, but that’s not always aligned with what you want.

How can direct indexing improve that picture?

We can create custom transitions for investors. We customize and diversify around the stocks they give us. They provide us with capital gains budgets or risk targets, and we manage the customized portfolios.

Direct indexing seems like a new thing, but you say that Goldman Sachs has been offering it since 1999. Why is direct indexing so appealing now?

The demand was always a use case, and the benefits were always there. Now the technology is making it easier — more accessible — to invest in these strategies.

How much has direct indexing changed since you started working in the space in 2000?

Five years ago, we saw a lot more interest and engagement from investors to align portfolios with individual values. 

So we put a lot of work into making sure we’d offer a wide menu because every investor is going to want their own customization.

To have that agency is really powerful for the investor.

Why is customized indexing better than investing in individual equities using a typical active strategy?

We hold a very diversified portfolio in which we may have hundreds of positions in individual stocks, but the outcome of [each] investment is aligned with the individual goals and values of the investor.

We’re investing in individual equities, but we’re not an active manager in the sense that we say, “The 30 stocks that we hold are going to outperform the market.”

If a client wants to construct a portfolio that aligns with their values, we offer the ability for them to pick and choose different levels of customization.

What’s another approach to direct indexing that GSAM offers?

We’ve created digital software that an advisor can access on the web and with which they can run analyses and capabilities, then present different opportunities to a client that they can invest in.

[That way], the advisor can upload securities and run different optimizations using our back end. 

Please tell me a bit about your background.

My parents emigrated from India. I was born in Canada and grew up in Toronto. My dad was a math professor in India. In Canada, he became a computer programmer, and he’s now retired. My mom is a retired social worker.

When you were in university majoring in math, what were your career aspirations?

I had no idea. I was a quant in high school. I was in a quant program in college. I just liked math, and I liked finance. 

My university had a co-op [paid work experience] program, and I worked in consulting, finance, business development. I liked finance the most.

How did the job offer from Goldman Sachs come about?

I was an intern in the Goldman Toronto office. It’s a small office, and there were no full-time positions. So I applied to Goldman in New York — and this was the job that I got. It was a great match!

In the male-dominated quant area, have you ever encountered any challenges because you’re a woman? Or have you met with any obstacles in the industry generally simply because you’re female?

For any group that’s underrepresented, there are always challenges. In financial services, women are historically underrepresented. But the industry has made a lot of progress. It still has more to do, though. 

Our custom equity business is quant, but we are 50%/50% male/female on my team, and we come from all parts of the world. We’re ethnically diverse and from different socioeconomic backgrounds.

At Goldman, we believe that diversity is the driver of [better] performance, and that’s also my lived experience.

In what way did your responsibilities increase when you were named partner last year?

Becoming a partner really validates the business [you’re working in] and the growth of that business historically.

As a partner, you focus on the culture of the firm, bringing up the next generation, in addition to growing the business and developing new capabilities and new solutions for investors.

You won a ThinkAdvisor 2021 LUMINARIES Award for executive leadership. What’s the value of industry recognition awards?

Recognition of the contributions of individuals. So, for me, it validates what I’ve accomplished — and it validates me. 

It also validates the team. When we think about our success as a business, it’s really the team and everything we’re doing together.