What if investors disagree with index providers?
The heart of passive investing is the idea that investors might be better off trying to be the market instead of trying to beat the market. But this style of investing requires the investor to think about what the market actually is. Most default to a major index, typically from one of the mainstream index providers like S&P Dow Jones, MSCI, or FTSE Russell. These firms offer a variety of market-based portfolios that capture various aspects of the equity markets, built using a transparent and rules-based approach. But investors in an index-based mutual fund or ETF are completely at the mercy of the index provider.
This case highlights the central appeal of customization. Investors might want a certain company in their market exposure and find it odd to have such a large company excluded from the index. They could decide to look for an alternatively defined index that does include their stock of choice—or, if an investor generally agrees with the methodology of their current index but would like to include or exclude some constituent companies, they could switch to a customized SMA. This enables them to own stocks in the index directly instead of owning a share in a fund that holds all the constituent stocks. This approach offers maximum control over the investor’s individual definition of the market.
A customized SMA offers a rules-based investment experience in which the individual investor sets the rules themselves. Investors who still like S&P’s definition of large-cap US stocks but think TSLA should be included can create their own personal benchmark that adds the stock no matter what the committee decides to do. On the flip side, investors who think TSLA is an overvalued fever dream with no place in their portfolio can create a version of the Russell 1000 that excludes it.
The bottom line
The intensified emotion surrounding TSLA demonstrates that investors have strong opinions about which names should be included in their market exposures. For clients who want to act on these views, a customized SMA allows a venue to include and exclude names according to their own criteria. They can go even further by adding factor tilts, ESG guidelines, and tax management to their portfolios—all ways to take customized investing beyond direct indexing.
References to specific securities and their issuers are for illustrative purposes only and are not intended to be and should not be interpreted as a recommendation to purchase or sell such securities. It should not be assumed that any of the securities referenced will be profitable in the future or will equal their past performance. All investments are subject to risks, including the risk of loss.