00:00 - When I first started in direct indexing over 20 years ago, the minimums were $5 million and it was quite an expensive endeavor. >> Welcome to InvestmentNews. I'm Greg Greenberg. Today we'll explore how direct indexing and tax managed long-short strategies can expand the toolkit for building more flexible, tax-efficient portfolios. Joining us today is Ken Lassner, direct indexing lead product strategist at Northern Trust Asset Management. Welcome, Ken. >> Thank you, Greg. Good to be here.
00:34 - >> Okay, so starting off, how should advisors think about tax efficiency as a portfolio design discipline, not just a tax loss harvesting tactic? >> Yeah, I think it gets back to the old saying, it's not what you make, it's what you keep after taxes. That's very important for investing for the long term and not just for the immediate, but also for things like estate planning, charitable planning, and family planning. >> So, what's the portfolio problem advisors are trying to solve today that
01:05 - they weren't 5 years ago? >> I think the biggest problem that we're seeing here at Northern Trust Asset Management or the biggest solution that we're trying to provide is around concentrated stock. With the run-up in the markets and especially in stocks like the Mag 7, we're seeing a lot of clients that have a significant amount in a single holding or a couple of holdings that have a large unrealized gain. And for many reasons, they might be reluctant to sell the stock. Mostly
01:33 - because of the tax implications of writing that hefty check. So, direct indexing can really help with that issue. >> But why do you think direct indexing on its own isn't always enough? >> Yeah, because you know, on its own, direct indexing is a vehicle that really helps other investments, right? As I said, it's not what you make, it's what you keep after taxes. So, if you're paying a significant amount of taxes from your other investments and you don't have direct indexing, that can
02:01 - be very costly. >> And you've described some direct indexing portfolios as becoming, quote and quote, ossified. So, what does that exactly mean and why is it becoming more common? >> Yeah, so what ossification means is that there's not as many losses in a lot of these direct indexing portfolios as they used to because losses tend to be front-loaded. Why does that happen? Because markets generally go up over time. And if we're taking losses on the stocks go down and deferring gains on
02:30 - the stocks that go up, there's going to be less and less loss to take um in in the future. So, with the run-up in the markets that we've seen over the past number of years, we were seeing a lot more ossified portfolios. >> As markets become more dispersed, why does that matter for tax-aware portfolio management? >> Yeah, so that just creates opportunity for portfolios in separately managed accounts um and direct indexing specifically because there's going to be a more opportunities for loss
02:59 - harvesting. So, the more kind of idiosyncratic risk you have in the market or single stock risk or, as you say, dispersion, that's where you're going to have more opportunities. No matter what the market environment is, whether the market's going up, flat, or down. >> And what's changed in market structure that makes pairing these two strategies more compelling today than in the past? >> Um quite a bit, actually. Um when I first started in direct indexing over 20 years ago, the minimums were $5 million
03:28 - and it was quite an expensive um endeavor and really only for, you know, the upper high net worth um channel of investors. But now, you know, through technology, automation, lower or in in a lot of cases no commission costs and fractional shares, um we're able to really significantly lower the minimums um for direct indexing to make more widely available for um for more investors. >> And if customization is becoming the new standard in wealth management, what does meaningful customization look like in
04:01 - practice? >> Yes, so we call it customization in um in scale, really. So, for portfolios as low as $250,000, we give every single client their own in effect custom benchmark. So, we can customize around their ESG values, around their other investments if they had significant holdings outside the portfolio, and we're able to do that much more at scale than we used to be able to. Back when I was just starting out, we did customization with sticky notes on the side of a computer. Now, we have all the technology, we can
04:34 - run portfolios that that take care of that for us. >> And finally, what outdated assumption about tax-efficient investing should advisors reconsider? >> I think it's the ossification one. Um I hear that quite a bit. Um that, you know, well, after 7 years or 10 years of a direct indexing portfolio, uh I have an expensive index fund. And that's absolutely not true because the strategy in a separately managed account continues to deliver value, or what we call tax alpha in the
05:06 - industry, over the very long term because you're deferring taking gains on the tax savings that you made from using the losses to offset capital gains. And those tax savings compound over time. The longer you can make that go, the better in terms of your after-tax return. >> All right, well, thanks very much for coming on and talking about it. >> Thank you, Greg. Great to be here. >> I'm Greg Greenberg from InvestmentNews. >> [music]
