E Point Perfect

What is direct indexing? Should you build your own index?


Can you build your own index in Canada?

All these forces also means direct indexing can be attractive in Canada as well, according to the CR report linked above. Because of rising investor demand for customizable personalized portfolios, Cerulli Associates Inc. expects direct indexing assets to rise from USD$462 billion today to USD$825 billion by 2026. That is faster than mutual funds, ETFs or separately managed accounts.

However, an October 2022 article in Investment Executive suggests “not everyone thinks it will take root in Canada.” It casts direct indexing as an alternative to owning ETFs or mutual funds, noting that Boston-based Fidelity Investments Inc. introduced a line of DI products for investors with as little as USD$5,000 to invest. Other players include BlackRock Inc., Vanguard Group Inc., Charles Schwab and finance giants Goldman Sachs Inc. and Morgan Stanley. 

But fees in the 0.25%-to-0.40% range are higher than the 0.10 to 0.15% of many broad-based index ETFs in Canada. So far, IE said, Canadian wealth firms haven’t introduced direct indexing products. It quoted Highview Asset Management Ltd.’s Dan Hallett as saying: “I don’t think there has been any real [client] demand for it.” 

Norm Rothery, publisher of The Stingy Investor newsletter, says the trend seems more advanced in the U.S.: “I don’t know how popular the idea is with regular investors as opposed to being seen as a hot idea for financial firms. It might be one of those ideas that’s a few years ahead of itself.” 

Even so, O’Shaughnessy Asset Management LLC was early in Canada with its DI products, and in 2021 was acquired by Franklin Templeton largely for its “Canvas” custom-indexing platform. 

Rothery adds: “the idea being to allow advisors to brew up their own portfolios for clients using quant/other metrics and pick up the benefits of direct investing like tax loss harvesting.  It’s an interesting way for advisors to add some value.” 

Roger Paradiso, executive chairman of Franklin Templeton’s O’Shaughnessy Asset Management, said: “Advisors are drawn to bending client portfolios to their specific needs, whether it is taxes, values based and/or concentrated stock positions. We believe that trend is only going to grow.”

Wealth manager Matthew Ardrey, a vice president with Toronto-based TriDelta Financial, is skeptical about the benefits of direct indexing for most retail investors. He tells me: “While I always think it is good for an investor to be able to lower fees and increase flexibility in their portfolio management, I question just who this strategy is right for.” First, Ardrey addresses the fees issue: “Using the S&P 500 as an example, an investor must track and trade 500 stocks to replicate this index. Though they could tax-loss-sell and otherwise tilt their allocation as they see fit, the cost of managing 500 stocks is very high: not necessarily in dollars, but in time.” It would be onerous to make 500 trades alone, especially if fractional shares are involved.


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