Passive investors may find an index provider’s definition of the market out of step with their own. Find out how custom direct indexing can help them reach a compromise.
How are stocks selected for index inclusion?
What if investors disagree with index providers?
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 custom direct indexing portfolio. 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 custom direct indexing portfolio 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.