How Custom Indexing Can Help Clients With Complex Tax Needs

Right now — tax time — clients may be wishing that last year they’d designed a portfolio for themselves with a tax strategy tailored specifically to their individual needs. A new software-based tool, Canvas, makes that possible. 

In test mode by nine RIAs since late 2019 and launched last month, the platform for portfolios of publicly traded equities was created by O’Shaughnessy Asset Management. It lets advisors build custom indexes for investing in separate accounts tailored to clients’ preferences. 

Custom indexing is “the next evolution of indexing and direct indexing,” Patrick O’Shaughnessy, the firm’s CEO and portfolio manager, tells ThinkAdvisor in an interview. He expects “a majority of all advisors in the U.S.” to use web-based software to design and manage custom indexes by 2025.

OSAM now manages $1.2 billion in assets for about 600 clients through Canvas.

In the interview, O’Shaughnessy, 35, describes how Canvas can greatly help clients with complex tax needs, including harvesting losses and reducing a concentrated stock position.

The front-end system has proven particularly popular for environmental, social and governance investing since it allows clients to design portfolios based on their personal preferences.

The tool screens for company names, industries and sectors, among other criteria, as well as for factor exposure.

The platform has roots in quantitative research conducted by OSAM’s founder, and Patrick’s father, Jim O’Shaughnessy, now chair and co-chief investment officer. A pioneer in quantitative analysis, he wrote the bestseller “What Works on Wall Street.”

ThinkAdvisor recently held a phone interview with Patrick, whose popular twice-weekly podcast, “Invest Like the Best,” has 7 million listeners. The CFA said OSAM named the platform Canvas because “investment strategy should start with a blank canvas. It shouldn’t be, ‘Here’s something off the shelf that we’ve modified a little bit for you.’”

In creating the software, the firm “took heavy inspiration” from car-design websites, where one’s ideal auto can be personalized according to key features, price, speed and so on, to, O’Shaughnessy said, “make it your own.”

Here are highlights of our interview:

THINKADVISOR: How does custom indexing differ from direct indexing?

PATRICK O’SHAUGHNESSY: Direct indexing uses a top-down model. It starts with something off-the-shelf from a third party, which you can modify slightly. Custom indexing goes several steps beyond that. It’s bottom-up and allows you to build whatever you want.  

What are your expectations for widespread use of custom indexing?

It’s the direction that direct index platforms will have to go in. They’ll have to build the ability for clients to get exactly what they want versus an approximation of it through some third-party index.

Is your platform useful for tax strategies? 

Taxes is a huge one. Very complex tax transition is one of the most popular features. You can run a tax transition analysis based on holdings and see the expected tax cost/benefit [and other metrics] in seconds.

How else can Canvas help with clients’ complicated tax needs?

For example, “I want to generate as many losses to my portfolio as possible this year because I’m selling a company and want to offset my gain with losses.” Or, they’ll say, “Next year I can only pay $100,000 of capital gains tax. So in trading activity, put that as a limit.” 

What’s another scenario related to tax management?

If a client has a concentrated position, the advisor can say, “Here’s how we can work out of it and how much we think it’s going to cost to do so.” That puts [the FA] on the same side of the table as the client because they’re designing the strategies together, with the client’s goals in mind. 

Is Canvas’ capability something an advisor can talk up with clients?

Yes. This is a front-end system designed to be seen and used by the advisor with their clients. They can show it to them and walk them through designing a strategy. 

What can Canvas screen for?