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Satisfying Clients’ ESG Needs with Direct Indexing

By Barrett Ayers, President

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The past decade has seen investors become much more cognizant of and specific about their monetary and investing decisions. If you are a financial advisor, you can probably recall many instances in the past year alone when a client came to you to request that you address ESG-related requirements for their investment portfolio. While these types of requests have increased lately, many advisors’ capabilities to meet them without sacrificing time, performance, or fees have not.

In this blog, we run through an example scenario involving myriad ESG and risk requests and how an advisor may be able to adeptly and efficiently create a solution to offer their like-minded clients through Adhesion’s direct indexing platform.

The Scenario

Your client base is filled with environmentally and socially conscious investors. You are tasked with managing and investing millions in assets, while simultaneously adhering to a number of their overlapping - and often conflicting - requirements. This is an incredibly common predicament we hear from advisors - many investors tend to care more and more about a variety of issues that impact their day to day lives, rather than a single topic. For instance, we frequently hear advisors express interest in investing in companies that are dedicated to improving their environmental impact while simultaneously improving racial and gender diversity.

Despite these overlapping preferences and demands, clients will still expect the portfolio to adhere to their risk profile. Creating such a portfolio that can be used across a number of environmentally and socially conscious clients and yet requires a high degree of customizability typically requires an inordinate amount of painstaking research to create — and was once only available to UHNW investors. Additionally, its management may also require further time-consuming measures — time that could be better utilized maintaining and growing client relations.

Why Other Solutions Fail

Traditionally, fulfilling clients’ ESG requests would be next to impossible and would require significant time, energy, and risk. In the absence of direct indexing, some of advisors’ only options are divestment and mutual funds.

Divestment is almost never a good option. By hiring a third-party manager and then eliminating all the companies that do not adhere to your client’s requirements, the resulting portfolio’s composition will not likely demonstrate the risk/reward profile - or the investment objective - as stated by the manager and therefore will likely not match your clients’ risk profiles or performance objectives.

And for those advisors who consider the option of finding suitable replacements for the companies that do not meet the client’s criteria, know that - first off, it’s an incredibly time-intensive and difficult task to achieve. Secondly, it’s not cheap nor is it scalable. And finally, it’s fraught with risk in that the replacement securities you choose today may not be a viable replacement tomorrow - so as an advisor you have, albeit with good intentions, inadvertently stepped into the role of ‘active manager’. You also need to make sure that the replacement securities interact well with the holdings that were not previously screened out - to ensure they achieve the objective of the portfolio. Ultimately, it’s the advisor’s responsibility to maintain a portfolio that is suitable for their clients’ stated risk tolerance. Without a sustainable, repeatable, and profitable means of satisfying client investing preference, including ESG considerations, advisors will find themselves on the wrong side of a trend that they know has been growing over the past decade and flourishing in demand over the last few years.

Finding an ESG-themed mutual fund or ETF tailored to your clients’ preferences is very difficult beyond the most basic of requests. Even if you did manage to find a low carbon intensity mutual fund and a women-led businesses ETF, for example, it would be highly likely that the fund that met one requirement would fail to meet the other. And, how about performance?

Bottom line, clients are expecting you to help them have it all. And, wouldn’t it be great if you could effectively deliver such a solution for your clients? Just imagine having an ESG-themed offering on a firm level that would satisfy a majority of your clients’ ESG investing criteria. You now have an opportunity to do so with Adhesion Direct Indexing.

Why Direct Indexing May Be the Solution

A Direct Index is a portfolio of stocks whose purpose is to track the movement and overall characteristics of an index. The individual investor directly owns the shares and therefore controls the ability to tailor the specific investments. Direct Indexing is one of the few tools that can satisfy the demands financial advisors are encountering on a daily basis without compromising on their fees, time, or performance benchmarks. For example, you can use Direct Indexing to apply the appropriate ESG Modules to an S&P 500 Direct Index in order to align with the performance of the index while simultaneously adhering to your clients’ specific preferences, such as low carbon intensity.

Using Adhesion Wealth’s Direct Index Optimization Algorithm to create an investment portfolio that is suitable for a majority of your ESG conscious investors, you can peg stocks to most indexes, maintaining your clients’ portfolio compositions so they retain their risk profile and alignment to the portfolio’s benchmark. With Adhesion Wealth acting as overlay manager, you can leverage our Investable Index Series to fully replicate major market indexes and provide your clients with real-time risk mitigating tools that seek to achieve minimum deviation from the underlying index. Our integrated platform empowers you to combine Direct Indexes with other customized services related to account opening, proposal generation, rebalancing, and tax-loss harvesting—all through a single interface.


Conclusion

Through our scalable UMA capabilities, Adhesion Wealth’s Personal Indexes program takes Direct Indexing a huge step further by combining a personalized investment experience with the performance of Direct Indexing. To see how you can leverage Direct Indexing to transform your firm’s offering by creating an investment portfolio that can be offered to your like-minded clients and prospects with purposeful ESG investing criteria that champion a majority of the preferences, contact our team today for a personalized demo.

By Barrett Ayers, President