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How to Generate Tax Alpha Using Direct Indexing

By Andrew Gradus, Senior Director, Consulting

direct-indexing

In light of impending fiscal policy changes, particularly a proposed increase in the capital gains tax, advisors are looking for ways to highlight their value proposition and reduce their clients’ tax burden more than ever. Combined with today’s increased market uncertainty and volatility, it is a challenge and opportunity for advisors to demonstrate their value. One way to take advantage is to begin a recurring program of tax-loss harvesting to help improve clients’ overall investment outcomes. Generating tax alpha can be one of the most compelling ways to demonstrate your value to clients as an advisor, especially when raising the stakes for high-net-worth individuals.

Our blog explores why Direct Indexing, when combined with tax overlay services, is a potentially superior tool that advisors can utilize to navigate volatility and maximize after-tax returns.

Where Direct Indexing Comes In

Advisors can use Direct Indexes as vehicles to provide tax alpha in ways not available with ETFs or mutual funds, such as tax-loss harvesting individual securities, capital gains deferment, tax lot optimization, reducing unnecessary trades and tax expenses, and incorporating current holdings into an index-based portfolio.

Traditional ETFs and mutual funds typically don’t account for an investor’s unique tax profile and will generate capital gains distributions, even for long-term investors. With Direct Indexing, the securities within the ETF or mutual fund being replicated are held as individual equity positions, allowing a loss posted by any individual security to be leveraged for a tax benefit, even if the portfolio performs well in the aggregate.

To potentially take full advantage of the benefits of direct indexing, advisors should employ opportunistic, year-round tax-loss harvesting to offset capital gains liability whenever market conditions warrant. Unfortunately, the stock market’s trajectory has consisted of large declines and rebounds since the onset of the pandemic. So, an advisor who considers tax-loss harvesting only at the end of the year, particularly during times of market volatility, may end up missing out on significant potential tax value.

The Adhesion Difference

Advisors that enroll their investors in Adhesion Wealth’s Direct Indexing and active tax management programs have historically experienced better after-tax returns. Adhesion’s technology and support system can help you easily build tax-advantaged portfolios, maximize tax savings, and demonstrate your added value through tax planning, risk profiling, and progress reporting. In addition, our platform helps you clearly show clients how net dollars could be saved, expressed as a percentage of their overall portfolio valuation.

Our tax management capabilities are enabled through the combination of Adhesion Wealth’s sophisticated UMA platform, a centralized overlay portfolio management service, and a series of parameters defined by the Separate Account Managers (SMA) available through our award-winning manager marketplace, the Adhesion Wealth Manager Exchange.


Conclusion

Direct Indexing is a powerful tool that can unlock tax alpha opportunities for clients that simply are not available from mutual funds and ETFs — allowing you to demonstrate your value through minimizing tax liability. In addition to its tax alpha maximizing capabilities, Direct Indexing can be an efficient and effective means of portfolio construction. In previous blogs, we’ve outlined how Direct Indexing is the best approach to creating a firm-level portfolio tailored to clients’ ESG requests and preferences in an efficient, scalable, and profitable manner.

To learn more about Adhesion Wealth’s direct indexing capabilities, request a consultation and demonstration today.

By Andrew Gradus, Senior Director, Consulting