Ethos ESG's Direct Index Optimizer empowers you to build and maintain direct indexes on behalf of your clients, combining traditional portfolio construction with advanced ESG metrics starting at a flat annual fee.

Ethos ESG Direct Indexing running

Manage portfolios with direct indexing:

  • Build and maintain direct indexes on behalf of your clients instead of outsourcing portfolio management to third parties.
  • Wealth managers gain access to the Optimizer for a flat annual fee, allowing them to construct an unlimited number of direct indexes.
  • Construct new direct indexes or use the Optimizer to rebalance existing portfolios.

Optimize for impact:

  • Combine traditional portfolio construction metrics with advanced ESG data.
  • After setting tracking error, security weighting, and tax-oriented constraints, use the Optimizer to seek to maximize the portfolio’s impact on various causes such as climate action, health and well-being, or gender equality.
  • Or create portfolios that are uniquely tailored to the value set of a person, family, or organization.

Analyze and backtest:

  • Before executing a single trade, have the autonomy to test the ESG profile and historical performance of any direct index constructed by the Optimizer.
  • Don’t like what you see? Revisit and rerun the Optimizer as many times as needed. Have the power to test and iterate to help facilitate the optimal outcomes for clients.
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How it works

The Ethos ESG Direct Index Optimizer takes your input on impact, performance, and tax and works to build a model matching your criteria:

1. Set starting index and available stocks

The first step is to select an index to build the Optimizer around. Indexes are available from multiple sources and cover various strategies and geographies.

Note that each index has an associated pass-through charge from the index provider (typically 0.75 to 2 basis points on AUM using the Optimizer). Ethos ESG does not charge a basis points fee above the index provider's fee. Consult your agreement with Ethos for a list of available indexes and associated index fees.

You also have the option in this step to choose to start with the full index universe (trade in cash) or start with an existing model (optimize an existing model or portfolio). Note that if you choose to start with an existing model, the Optimizer will prompt you to upload the model.

Optimizer step 1

2. Set tracking error preferences

Next you'll select the maximum tracking error to the index that you're willing to accept. This can range from 0.2% (tighter tracking error) to 5% (looser tracking error).

How Ethos ESG calculates tracking error

We calculate tracking error using annual returns for the previous 10 years for the index and for each stock in the index. For each of the 10 years, we first calculate the variance of weighted-average returns for the model compared to returns for the index. Ethos then calculates tracking error as the square root of the variance divided by n - 1, where variance is the total variance across the 10 years and n is the number of years (10).

In this step you'll also set the maximum difference you want to target between the weight of any one sector in the Optimized model and the weight of the corresponding sector in the index.

3. Set number of stocks and weight range

Next you'll set the number of stocks you want the Optimizer to produce, from 25 to 100. Note that if you're optimizing an existing model and the model you import has more than 100 stocks, the Optimizer will use the number of stocks in your imported model.

In this step you'll also set the minimum and maximum weight you want to target for any one stock in the Optimizer model, as well as indicate whether or not you can trade in fractional shares.

Optimizer step 3

4. Set tax preferences

The Optimizer can help harvest tax losses or realize tax gains, depending on your goals. In this step choose among three options:

  • Harvest tax losses
  • Realize tax gains
  • Do not consider tax losses or gains (default)

If you choose to harvest tax losses or realize gains, the Optimizer will also ask you the maximum amount you want to target for loss or gain, as a percentage of the account value.

5. Set ESG causes and minimum rating

Next you can select a specific cause or a client for the Optimizer to focus on. If you select a cause (e.g., Climate Action), the Optimizer will seek to maximize impact for that cause. If you select a client, the Optimizer will seek to maximize impact for that client's set of causes, i.e., the weighted-average rating of the client's causes.

In this step you'll also set the minimum target rating (from 0-100) for your selected cause(s) for any security to be included in the Optimized model.

Optimizer step 5

6. Set negative screens

Here you can select as many ESG screens as you would like to screen out companies from the available set that the Optimizer will consider.

For example, you could select Fossil Fuel, Alcohol, Gambling, and Prison Involvement to exclude companies that fail any of those screens.

7. Exclude or include specific stocks

In this step you can include or exclude particular stocks from the Optimizer model. This is useful if, for example, you're building an optimized model around an existing position or set of positions, or if a client would like to exclude particular stocks from their portfolio.

8. Ethos runs the Optimizer

When you start the Optimizer, Ethos starts iterating through many combinations of stocks from your selected index, attempting to build a model that fits all of your criteria.

Throughout the process below, the Optimizer creates and updates draft transactions to your model, so that when it finds a solution to your criteria, you can export the results as transactions, lots, securities, or other formats for your trading platform.

  1. Remove exclusions. Starting with your selected index, Ethos first removes any stocks that rate below your minimum rating, fail screens you've set, or do not meet other criteria you've set. Ethos also adds in any stocks you've set for inclusion in this step.
  2. Determine tax potential. If you've uploaded an existing model and set a preference for harvesting tax losses or realizing tax gains, Ethos will then check for opportunities to meet your tax goals, based on purchase prices, purchase dates, quantities, and current prices for the stocks in your existing model.
  3. Add top-rated stocks by sector. Ethos starts with the n top-rated stocks for your selected cause or client within the sector distribution of your selected index, where n is the number of stocks you set for your model.
  4. Find optimal weights. For each stock in the model, Ethos checks increments of weight between your specified min/max thresholds to find the weight that minimizes tracking error for the model overall.
  5. Substitute max/min contributors to sector error. Ethos finds stocks in the working model that contribute the most to sector error (the max difference between the weight of any one sector in your model and the corresponding sector in the index) and removes them. Ethos replaces these with stocks from your remaining pool (stocks that pass the filters you applied above, such as removing fossil fuel companies) that do the most to reduce sector error.
  6. Substitute max/min contributors to tracking error. Ethos finds stocks in the working model that contribute the most to tracking error and removes them. Ethos replaces these with stocks from your remaining pool (stocks that pass the filters you applied above, such as removing fossil fuel companies) that do the most to reduce tracking error.
  7. Repeat. The Optimizer calculates the tracking error, sector error, tax loss/gain, and impact rating and, if all criteria are met, stops the iteration and finalizes your model. If all criteria are not met, the Optimizer repeats the above steps 4-6 above.
Ethos ESG Direct Indexing complete

If after 20 attempts through the above process your tracking error or sector error is still above your thresholds, Ethos will finalize the current version of the model and tell you that it was unable to meet your criteria. If this happens, try relaxing some of your criteria or contacting us for support.

9. Export files

After the Optimizer is finished, export the optimized model or account to CSV files of securities, tax lots, or transactions:

  • Securities: securities in the model, including total weight (across all lots), quantity, value, and identifiers such as symbol/ticker.
  • Lots: individual lots of assets in the model. If you start with an existing model or account, this file will include information such as purchase date, purchase price, lot quantity, whether it is an existing or new lot, etc.
  • Transactions: list of suggested transactions output by the Optimizer. Contact us if you would like help transferring the transactions into a trade file for your custodian or trading service (such as Veo One or Charles Schwab). Please check the transactions carefully before proceeding with any trade suggested by the Optimizer. The Optimizer is based on automated algorithms. See full disclosures at the bottom of this page.
  • Other integrations: interested in an integration with another one of your software providers? Let us know and we'll work on the integration.
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Unlimited access starting at a flat annual fee *

Your subscription to the Direct Index Optimizer includes access to Ethos ESG's Impact Assessment. This enables your clients and prospects to tell you the causes they care about, and enables you to build portfolios around those specific causes.

Other features that are part of the Ethos ESG Reporting, Analytics and Data platform are not included (such as client reporting).

* Ethos ESG has negotiated terms to enable you to provide best-in-class ESG direct indexing for your clients, for a flat-fee. As part of our agreement with index providers, we require that you report your AUM that uses the Optimizer at least once per quarter to Ethos ESG. Once the total AUM managed through Ethos across all clients exceeds thresholds (typically $1B), our agreements with index providers will require us to start charging a pass-through basis points fee on AUM, generally 0.75-2 basis points. Full terms and conditions available with a demo.

Important disclosures

Direct indexing is typically more appropriate when utilized in a taxable brokerage account and not tax-advantaged accounts. Direct indexing may offer the greatest value to clients who are in a higher tax bracket, have a long-term focus, value ESG-related customization, and/or are able to fund a portfolio with existing securities as opposed to selling all positions and reinvesting in a comingled fund. Indexes are unmanaged. It is not possible to invest directly in an index. As with any investment decision, you should ensure that it aligns with your clients' specific goals, risk tolerance, liquidity needs, tax considerations, and any other factors that might be relevant to their situation.

Keep in mind that investing involves risk. The value of investments will fluctuate over time, and your clients may gain or lose money. Tax-smart (i.e., tax-sensitive) investing techniques, including tax-loss harvesting, are applied in managing certain taxable accounts on a limited basis, at the discretion of the portfolio manager, primarily with respect to determining when assets in a client's account should be bought or sold. Assets contributed may be sold for a taxable gain or loss at any time. There are no guarantees as to the effectiveness of the tax-smart investing techniques applied in serving to reduce or minimize a client's overall tax liabilities, or as to the tax results that may be generated by a given transaction.

Ethos ESG does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. EthosESG cannot guarantee that the information herein is accurate, complete, or timely. Ethos ESG makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.