The concept of direct indexing has emerged as a promising avenue for portfolio solutions providers. However, debates surrounding the use of Separately Managed Accounts (SMAs) for direct indexing have stirred contention, among wealthtech providers who deliver solutions that use SMAs as a powerful tool for investors seeking tailored, tax-efficient strategies.
Robert Battista, CFA, head of advisory solutions at Vestmark and senior vice president, tells DWN that advancements in technology have paved the way for a more streamlined approach. Unified Managed Account (UMA) technology, such as that offered by Vestmark, challenges current misconceptions by enabling financial advisors to seamlessly manage subaccounts or “sleeves.” In the Q&A below, Robert explains how Vestmark’s UMA technology empowers advisors to achieve greater flexibility and customization while optimizing outcomes within individual subaccounts.
DWN: Portfolio solutions providers differ on the benefits of using Separately Managed Accounts for direct indexing (DI) because the subaccount-based approach supposedly adds unnecessary complexity and cost to the management process. Explain why this is not true.
RB: The argument against using Separately Managed Accounts (SMAs) for direct indexing (DI) due to added complexity and cost doesn’t hold up when there are platforms that allow financial advisors to easily manage sleeves or subaccounts.
Those who argue against SMAs may not be aware that the right Unified Managed Account (UMA) technology allows subaccounts to be managed easily. With UMA technology, an index does not have to be managed separately from the portfolio. Advisors can rebalance, tax-loss harvest, manage wash sales, substitute securities or impose restrictions at the account level in an automated way. Additionally, an advisor can report against individual aspects of the portfolio to provide clients with more transparency into the individual investment vehicles within the portfolio.
DWN: What is your definition of a holistic approach to tracking portfolio performance and tax efficiency, and how does Vestmark make it possible for this type of optimization to be feasible with separate subaccounts/SMAs?
RB: A holistic approach to tracking portfolio performance and tax efficiency involves considering multiple factors such as personalized tax management, alignment with client preferences and values, and addressing unique financial situations. We believe managing portfolios containing direct indexes holistically – utilizing UMA technology – is the preferred approach. By leveraging subaccounts or ”sleeves” of direct indexes, SMAs and other vehicles, Vestmark’s technology helps streamline portfolio management and enhance personalization at scale.
Vestmark’s UMA technology allows for sophisticated tax management and optimization capabilities. We store individual tax rates, tax budgets, and perform ongoing tax optimization at the individual level. Features like tax-loss harvesting are seamlessly integrated into Vestmark’s platform, helping advisors to potentially reduce taxes on investment gains and enhance after-tax performance for clients.
DWN: What are the disadvantages of a sleeveless approach in portfolio management , and how can greater flexibility and customization be realized using SMAs for direct indexing? Can advisors still expect precise asset-class rebalancing, tax loss harvesting, and gains deferral within individual subaccounts?
A sleeveless approach, where all assets are commingled within a single account, can have several disadvantages compared to utilizing UMA technology with SMA subaccounts for direct indexing. SMAs facilitate precise asset-class rebalancing within individual subaccounts, helping to ensure that portfolios maintain their target allocations over time. They also allow for more accurate performance tracking of each individual investment.
This level of granularity may be challenging to achieve in sleeveless portfolios, where assets are grouped together, making it difficult for advisors to rebalance efficiently without triggering unintended tax consequences. Proponents of the sleeveless approach say eliminating partitions makes it easier to manage after-tax, tracking error-adjusted returns. It’s simpler and less expensive, they claim.
But we believe that with the right platform, it’s possible to manage portfolios easily, keep the integrity of data in sleeves and also offer sophisticated account level optimization.
