Your Blueprint to Tres Comas

Earnings season is heating up and so is some light, legal tax evasion. With your uncle's favorite tech stocks wrapping up their Q3 earnings announcements this week, it's time to roast the biggest losers and meager winners. Regardless of the market ahead, we'll then deep dive into one way you can copy some big whales' strokes to protecting your profits.

Bottom Line Up Front

Contribute something new to the news you’ll coffee chat over

• Adidas terminated its partnership with Kanye West, who will go down in history as the first hypebeast to design and fumble the bag.  

• Draymond Green name-dropped the well-known investors he's working with in the tech space. When asked onstage at TechCrunch Disrupt whether he was looking to start an investment fund, Green mentioned his work with prominent VCs, including Chamath Palihapitiya,Bill Gurley, Jason Calacanis and Bill Lee.

• Rishi Sunak became Britain's latest Prime Minister after winning the race for leader of the Conservative Party. It’s a move that signals just how bad the economy has gotten, considering he’s worth more than the King. As a former Goldman man, additions to the House of Commons will be as follows:

But first, a quick note from The Information.

If you're looking for high quality tech / VC reporting beyond TechCrunch and The Verge, I highly recommend signing up for The Information, where they get a lot of exclusives on major VC fundraises, startup funding rounds, and layoffs. They also have detailed company org charts for those who are looking to breakdown major tech firm corporate structures. Sign up here.

Deep Dive: Your Roadmap to Tres Comas

Traders are preparing for fresh turmoil that’s about to hit in the world’s biggest stock market.

This year’s historic equity rout has already erased $13 trillion in market value, flushing out both retail and institutional investors. Some household names in the S&P 500 down 50% or more from all-time highs:

• Facebook: -66%

• Tesla: -50%

• Nvidia: -65%

• Disney: -51%

• Nike: -52%

• Netflix: -62%

Losses exist in all markets (below). This has led some to question if not their job, then the general thought: In five years time, who’s the better performer – a basket of stocks or the S&P 500?

In the options marketplace, the relative cost of contracts that pay off if the S&P 500 Index sinks another 10% has collapsed to the lowest since 2017. Appetite for bullish wagers is on the rise. Meanwhile, the Fed is still delivering aggressive rate hikes just as recession risk snowballs.

Back on Wall Street, traders are getting tired of bearish mantras. Equity exposures have been slashed to historic lows, while elevated inflation and monetary hawkishness haven’t been new threats for decades.

Let’s deep dive on the latest strategy that’s still making many* money: direct indexing.

*Who know what they’re doing, are licensed and not on TikTok

Overview of direct indexing:

Direct indexing is the latest trend that used to be limited to the pros and the very wealthy. For decades, it was only available to ultra-high-net-worth investors via boutique asset management firms. Since 2020, direct indexing has exploded onto the scene amongst large wealth management firms. Their profits have exploded too.

Conversely, if you own an index fund, you don't have a choice which stocks are included, and you wouldn't be able to sell individual stocks within the fund; instead, you're stuck with the whole bunch. Assets in direct indexing are expected to grow more than 12% over the next five years, outpacing traditional products like ETFs and mutual funds, and cross the $1 trillion threshold by 2025.

Direct indexing lets investors decide which stocks to own and which ones to skip. For all our ESG fund managers, direct indexing allows you to avoid stocks that don't align with your values, like gun stocks or factory farming.

But the money maker, or profit protector, we’re here to talk about is direct indexing’s ability for tax-loss harvesting.

Benefits to tax-loss harvesting:

Tax-loss harvesting is a way to cut your tax bill by selling investments at a loss in order to deduct those losses on your taxes. Deducting those losses can offset some or all of the capital gains tax you might owe on other investments that you sold for a profit.

Tax-loss harvesting can help investors reduce taxes by offsetting the amount they have to claim as capital gains or income. But it's highly dependent on just how big a whale you are. Since the idea behind tax-loss harvesting is to lower your tax bill today, it's especially beneficial for people who are currently in the higher tax brackets. In other words, the higher your income tax bracket, the bigger your savings.

So if you’re still reading, congrats on making money moves, here’s how you can tune up your loss harvesting. That is, you “harvest” investments to sell at a loss, then use that loss to lower the taxes you have to pay on gains you made during the year.

For example, if an investor buys a stock at $400 and sells it for $500, they realize a capital gain of $100. This will trigger a capital gains tax. But if the investor sells another security at a $100 loss, they can use that realized loss to offset the gain from the sale of the other stock. As a result, the net realized gain is reduced and the investor’s overall tax bill is lowered.

Who is actually doing this, and how well are they doing

In short: pretty decent. Some bulge bracket banks have opted to build their own product, while a dozen large financial institutions have bought their way into direct indexing. Here are the moves that brought the formerly obscure strategy into the mainstream.

May 2020 - Charles Schwab and Motif: Digital advisor Motif, which used direct indexing and fractional shares to deliver thematic investment portfolios, was sold for parts. Folio Financial got the client accounts, Goldman Sachs Asset Management took over the proprietary ETFs and Charles Schwab became the new owner of Motif’s technology and intellectual property.

May 2020 - Goldman Sachs and Folio Financial: Just days after Motif’s direct indexing technology went to Charles Schwab, Goldman Sachs acquired Folio Financial — the first custodian to offer fractional share trading and the new owner of Motif’s accounts.

October 2020 - Morgan Stanley and Eaton Vance: The direct indexing market started to significantly heat up when Morgan Stanley acquired Eaton Vance for about $7 billion. The deal brought along Parametric, one of the pioneers of direct indexing, which sold to Eaton Vance in 2003.

November 2020 - BlackRock and Aperio: BlackRock paid $1.05 billion in cash for Aperio, a Parametric rival and fellow pioneer of direct indexing.

December 2020 - JPMorgan Chase and 55ip: Just two months after J.P. Morgan Asset Managed partnered with 55ip, which applies tax management technology to model portfolios, the parent company decided to bring the fintech startup in-house by buying it for an undisclosed amount from the TIFIN group.

June 2021 - JPMorgan Chase and OpenInvest: The company took the next step over last summer with OpenInvest, a startup that specializes in providing values-based investing via direct indexing.

July 2021 - Vanguard and Just Invest: After four decades of championing passive investing through funds, Vanguard made its first-ever acquisition to obtain Just Invest, which at the time managed about $1 billion with direct indexing.

September 2021 - Franklin Templeton and O’Shaughnessy Asset Management: Franklin Templeton Investments, a long-time active asset manager, acquired another trailblazer of direct indexing, O’Shaughnessy. The firm reported that direct indexing accounted for 28% of its $6.4 billion in assets under management.

October 2021 - PGIM and Green Harvest Asset Management: The move from Prudential would expand PGIM's capabilities, hoping to support after-tax incomes in an era of all-time market highs and tax increases on the horizon.

December 2021 - BNY Mellon Pershing and Optimal Asset Management: Pershing acquired Optimal, which uses software to create personalized investment portfolios using direct indexing, to form the core of Pershing X.

January 2022 - RiverFront, Baird and GAMMA Investing: Baird, courtesy of BairdGAMMA, was founded in 2020 by industry veteran Lorraine Wang to offer a custom index SMA platform. RiverFront and Baird purchased a minority ownership of the firm.

February 2022 - UBS and Wealthfront: After the bank spent $1.4 billion to acquire one of biggest independent robo-advisors, UBS CFO said Wealthfront’s tax-loss harvesting and direct indexing technology were of particular interest.

In Summary

Tax-loss harvesting is best leveraged in volatile environments, as in this entire year. U.S. equities are rallying at the moment, despite a “growing acceptance” that monetary policy will likely remain restrictive for longer than expected. This is the optimal time to offset the capital gains taxes from both large and small wins with your (even if rarely) losers.

Earnings will remain in focus, with investors still on edge over which S&P 500 companies can be key profit-growth engines and deliver profits with inflation crimping margins. But it’s not about what you make, it’s about what you can keep. Tax-loss harvesting could be one roadmap to cash out more and bro down sooner.

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