Morningstar launches direct indexing as stock-market investors seek to personalize portfolios

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Morningstar’s wealth group has launched direct indexing to help stock-market investors customize their portfolios in a tax-efficient way, providing a type of investment offering that the firm says has risen in popularity among financial advisers. 

The new offering has become available after engaging a council of advisers for almost a year and starting a pilot program in June, according to a Morningstar statement expected to be released Tuesday. It will help advisers assist their clients in building personalized portfolios tied to a broad index and a subset of its holdings.

“Generally, they’re going to own a subset of the stocks in the index,” said Daniel Needham, president of Morningstar Wealth, in a phone interview. “You can build a broadly diversified portfolio of a subset of the companies in the index that’ll track pretty closely” to it.

Direct indexing allows individual investors to directly invest in shares of companies according to their “specific preferences,” said Needham. That may mean excluding certain securities and industries, or expressing views tied to “ESG,” he said, referring to environmental, social and governance criteria.

“Personalization is just everywhere,” said Needham. “People just want things to be more personalized,” and “financially planning and investment management is no exception.”

Needham said that Morningstar will work with financial advisers to deliver direct indexing, helping them construct portfolios on behalf of their clients. According to the firm, interest in direct indexing has been accelerating among advisers.

The “approach makes direct ownership of underlying securities practical for more individuals,” Morningstar said in the statement, as investors may customize their holdings plus select additional services such as “tax-loss harvesting.” 

“You’re able to manage the portfolio in a tax-aware way,” said Needham. “Tax management is really a key driver for the adoption of direct indexing.”

Opinion: Is direct indexing really the next big thing?

Morningstar’s announcement comes about a week after Fidelity Investments said Oct. 24 that it was expanding its direct-indexing capabilities with the launch of the Fidelity Institutional Custom Separately Managed Account offering for certain wealth-management firms and institutions. In June, Fidelity had announced that it was launching Fidelity Solo Fidfolios to bring “a new direct-indexing capability to do-it-yourself retail investors.”

Morningstar’s direct-indexing portfolios include Morningstar U.S. Target Market Exposure, Morningstar U.S. Small-Mid Cap, Morningstar U.S. Large Cap Broad Growth, Morningstar U.S. Large Cap Broad Value and Morningstar Global Markets ADR, according to an email from a spokesperson for the firm.

On the sustainability front, Morningstar U.S. Sustainability Dividend Yield Focus, Morningstar U.S. Sustainability Moat Focus and Morningstar Women’s Empowerment will also be available as portfolio options for direct indexing on Tuesday, the email from the spokesperson shows.

As for excluding particular securities from the various indexes, some investors may desire to do so based on their values and “political beliefs,” said Needham. That may mean eliminating areas such as alcohol, tobacco, firearms, fossil fuels or animal testing from their portfolios, according to Morningstar. 

U.S. stocks remain in a bear market this year, with major benchmarks such as the S&P 500 index mired in losses. For example, shares of the SPDR S&P 500 ETF Trust slid about 0.7% Monday for a 2022 loss through October of almost 19%, according to FactSet data. 

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