Partnership with Purpose

Index mutual funds and ETFs are reasonably tax-efficient, but investors must still pay taxes on their dividends and periodic capital gains distributions. For tax-sensitive investors, there may be a better way to index, using direct indexing through a separately managed account, also known as an SMA.

Direct indexing using an SMA has several distinct benefits over index funds and ETFs. It can still provide diversified stock exposure, but instead of holding a single position in a mutual fund or ETF, investors own perhaps hundreds of underlying stocks directly. The advantage of direct stock ownership is that it allows investors to benefit from tax loss harvesting.  

Loss harvesting involves selling selected investment positions at a loss and reinvesting the money back into the portfolio. These realized capital losses can then be used to offset capital gains from other investments – which reduces current taxes paid to the IRS. Natixis Investment Managers Solutions has specialized in tax loss harvesting since 2002. 

Now let’s compare this approach to index funds and ETFs. 

When you put them side by side, index funds, ETFs and direct indexing SMAs all seek to track an index on a pre-tax basis over time. 

All will have about the same dividends and dividend taxes. 

But the difference is that at the end of the year, the ETF or mutual fund may have zero capital gains, whereas the direct index may have net capital losses. 

On an after-tax basis, index funds and ETFs will always underperform their pretax returns, due to taxes on the dividends. But with direct indexing SMAs, investors have the potential for higher returns after taxes, thanks to the ability to use tax loss harvesting. 

Direct indexing from Natixis Investment Managers Solutions can help generate better returns because it lets investors keep more of their investment earnings after taxes.