Duration: 10:03
Level: Beginner

Our Custom Indexing tool allows advisors to quickly build portfolios modeled after Index ETFs, and easily customize them to accommodate client investment goals. Unlike ETFs, clients own fractional shares of each component stock, so financial advisors can adjust weightings and exclude stocks or sectors in accordance with client needs.

Study Notes:

Use Interactive Brokers’ Custom Indexing feature to create models from a wide selection of popular index-based ETFs. Advisors may replicate the actual weights and holdings in a variety of popular broad-based ETFs and then customize the selection by changing individual sector weights or by excluding stocks based upon fundamental financial criteria. This allows the Advisor to create a unique investment strategy for their clients while retaining the flexibility of adjusting the criteria over time and through changing market cycles and conditions.

Unlike investing in the underlying ETF, direct indexing or Custom Indexing results in the Advisor investing in the underlying securities that comprise the index. The client then actually owns the stock.

Investors adopting a customized index approach may have several advantages over traditional ETFs:

  • no expense ratios
  • low minimums, and
  • the ability to customize and personalize as per your clients’ needs.

How to enable fractional shares?

While there are advantages to using customized indexes, custom index modeling also involves a higher level of risk compared to investing in traditional market indices. This is because custom indices are often constructed using subjective criteria and rely heavily on the expertise and judgment of the investment managers who design them. Some risks to custom indexing include concentration risk, liquidity risk, model risk, manager risk, and tracking error. It is important for investors to carefully consider the risks associated with custom index modeling before investing in these types of indices.

In order to use IBKR’s Custom Indexing tool, the advisor must first be enabled to trade fractional shares because index investing often involves the purchase of a small number of shares of many individual stocks. Fractional Shares are enabled from the Advisor Portal by selecting the Head & Shoulders icon then selecting Settings. Within the Account Settings section, navigate to Client Settings and under “All Clients” click Trade in Fractions. Check the box to Trade in Fractions, click Continue, and read the Fractional Share Trading Disclosure. When ready, electronically sign in the box and click Continue to reach the confirmation page.

Where is IBKR’s Custom Index feature located?

Within TWS, the Custom Indexing feature is accessed by clicking the Advisor Setup button then selecting the Custom Indexes tab. Here, users may view and edit previously customized benchmarks. To get started, click Create Customized Index to the upper right. Add a Description if you wish, but you must assign a Name in the resulting input field.

The Advisor can click Create and a dialogue box appears displaying the most popular ETFs along with their underlying Benchmark index. For example, the top-listed SPY for the SPDR 500 index ETF Trust, has an underlying benchmark of the S&P 500 total return index. The funds are listed in order of Total Net Assets from largest to smallest. Determine which ETF you wish to replicate by clicking on it and then clicking Select Fund at the bottom of the box.

Next, the selected fund’s constituents will appear in alphabetical order along with quote details and price information. To the right of the window are columns containing the weighting of each stock within the benchmark, and an intended Target percentage that each stock should comprise based on the ETF. At the very bottom, the final row shows a default cash amount as part of the target allocation, which is by default set to approximately 1%.

As a result of this default cash allocation, each individual Target allocation is proportionately smaller than the actual benchmark weighting. The Advisor can increase or decrease the cash allocation amount should they choose. Again, this would impact the weighting of all individual holdings proportionately.

The Advisor can choose between the default view or turn on the Advanced view by clicking on the Advanced toggle in the upper right-hand corner of the screen.

If the Advisor would like to change the ETF replicated in the model, they can click on the button next to Benchmark ETF and the dialogue box will reappear and the advisor can choose another ETF.

Changing the cash allocation and other parameters for the model portfolio can be managed by clicking the Custom Rules button at the top of the page next to the ETF button.

How to adjust and customize the index holdings?

When clicked, the Advisor is faced with four ways to adjust the index holdings. Each of the sections has a blue question mark icon for additional information when hovered over.

  1. Cash Target – The cash target as noted earlier is set to 1% by default, but this can be adjusted here by inputting a new value into the field. Increasing the value would result in a proportionate reduction in component weightings. Decreasing its value would result in a proportionate increase in individual weightings.
  2. Exclude Symbols – Enter a symbol into the input field and click Add to build a list of members whose representation will be excluded from the Index. The excluded symbols are listed in the space below. If the Advisor excludes a company, its weight is set to zero and the weighting of the remaining members is increased proportionately.
  3. Exclude List – there are 10 socially responsible groups, which when checked would filter out companies from the index that are determined to be involved in that practice. Weightings of companies associated with a selected practice are set to zero. Check Fossil Fuels, for example, to remove all oil producers from the index. The weightings of remaining companies are increased in the custom index.
  4. Custom Criteria – Expand the dropdown menu to see a list of available terms which can be used to filter by and exclude or rescale securities that meet the selected criteria. Here the Advisor may select a single financial variable, such as EPS Change % and exclude companies by further filtering using the dropdown menu to the right containing greater than, less than, or in the range. The Advisor could implement the change by entering such criteria to reduce the number of component members held within the Custom Index. Note that the Exclude function also applies to Sectors or industries. Alternatively, the Advisor may use the same financial criteria and filters to adjust the weight of component companies by clicking the Rescale button rather than the Exclude button. This time, the Advisor can change the relative weight of a group by entering a new rescale factor in the input field. While the default weighting of any member is 1.0, it can be underweighted by adding a value of less than 1.0 and overrepresented in the index by entering a value greater than 1.0.
    • For example, by selecting Dividend Yield greater than 10 and entering a weight of 2.0 into the Rescale input field, the Advisor is doubling the weight of companies whose dividend yield happens to be more than 10%.
    • Conversely, by selecting a normalized P/E of less than 5.0 and entering a weighting of 0.5 would allot a weighting half the actual index weighting.
    • Note that a series of rules can be added, such as these two examples, to be used to further customize the custom index selection.

When the Advisor is satisfied, they click Save and Apply Custom rules. The Target %’s will adjust accordingly, and the Advisor can save the custom index by clicking Save Targets. To remove the custom rules and start from scratch, click the Set from Benchmark ETF button.

The Advisor can also adjust the weights manually by editing the values in the far-right column. The cash component will adjust automatically as the weights are changed to keep the total Target at 100%. The adjusted weights will display in white font. To save the adjusted weights the Advisor clicks on the “Save Target” button and the font will turn from white to purplish blue.

In the bottom right corner of the screen the advisor can clear all targets by clicking on the ‘Clear Targets button or restore target to the last previously saved weighting by clicking on the “Restore Targets.”  

The Advisor can rebalance the target percentage using the benchmark ETF composition weights or the weights or the actual composition weights by clicking on the corresponding buttons when in advance mode or using the drop-down menu next to “Set Target From” in the normal view.

Now that the custom index is created, the next step is for the advisor to invest a client into the custom index model. We will review this process in another video lesson.


IBKR Custom Indexing

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The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

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Disclosure: ETFs

Any discussion or mention of an ETF is not to be construed as recommendation, promotion or solicitation. All investors should review and consider associated investment risks, charges and expenses of the investment company or fund prior to investing. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.