Direct indexing: What is this latest investing fad?

It's the hottest new stock investment concept that's labelled 'ETF version 2'. How does it work and who's offering it in Australia?

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An Australian firm has brought the latest investing fad dubbed ETFs 2.0 from overseas to the local market.

Nucleus Wealth recently launched to allow Australians to invest through "direct indexing".

Direct indexing builds on the concept of a passive index fund, but allows customisations of individual stock holdings according to each investor's tastes.

"Direct indexing involves the investor owning the individual shares that make up an index in a separately managed account," said Nucleus Wealth chief investment officer Damien Klassen.

"Because the investor directly owns each of the shares in their own account, Nucleus Wealth is able to customise their superannuation or investments."

How direct indexing works

For example, if an investor wants their money to track the S&P/ASX 200 Index (ASX: XJO) but wants to avoid the big banks, they could simply sell their shares in Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC) and Australia and New Zealand Banking Group Ltd (ASX: ANZ).

The same goes for those who want to eliminate fossil fuel producers or gambling from their portfolios.

"Where an index mutual fund, an index ETF or traditional superannuation fund merely tracks the index, direct investing allows investors to control their investment decisions," said Klassen.

"Investors can modify their portfolios by creating 'tilts', which is the ability to remove or add certain holdings or sectors according to personal preferences."

The direct indexing product from Nucleus Wealth is charging from 0.11% upwards on a sliding scale based on the amount invested.

Form your own opinions about ethical investing

Nucleus Wealth chief operating officer Shelley George said ETFs are now like Henry Ford's famous quote, "Any customer can have a car painted any colour that he wants, so long as it is black".

"Before direct investing, if you want a red car, you had to go to a stock broker and build the entire car from the base parts," she said.

"Nucleus looks at direct investing as providing a third option: take an already built car and add your own custom tilts."

The direct indexing concept hands the power to individuals to invest ethically, according to their own beliefs and criteria.

"When it comes to ethical investing, the questions become more nuanced and the answers often depend on the individual," said Klassen.

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Westpac Banking Corporation. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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