We sat down with our partners at Align Impact for a brief history of public markets — and why now is such an exciting time for advisors and investors. 

by Amanda Baker, Ali Motroni, Alex Cote

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Key Takeaways:

• Navigating a Changing Era: In the vast landscape of available strategies, advisors may benefit from understanding how we arrived at our present moment and practices for communicating that evolution to clients.
• The Emergence of Direct Indexing: Direct indexing leverages advanced technology to offer unprecedented levels of customization and personalization.
• Not Just a Trend: Aligning portfolios with values is no longer a niche approach. Driven by the recognition that good governance and sustainable practices can lead to long-term financial performance and reduced risk, it has become a mainstream client expectation that is here to stay.

Public market equity investing has undergone a tremendous transformation since the conception of stocks due to adapting to structural economic metamorphosis, shifting investor needs, and technological advancements. Understanding this evolution may help advisors and clients understand and appreciate the vast landscape of strategies available today, particularly those that appeal to modern, sustainability-focused clientele.  So, with this in mind, let’s take a stroll down memory lane.

The Birth of the Stock Market

The origins of public markets can be traced back to 1602 when the Amsterdam Stock Exchange was established. It provided a structured platform for the buying and selling of shares of the Dutch East India Company, thus laying the groundwork for modern equity markets.

As time progressed, other stock exchanges emerged, such as the London Stock Exchange in 1698 and the New York Stock Exchange (NYSE) in 1792. These institutions played pivotal roles in facilitating capital formation and enabling businesses to raise funds from a broader pool of investors. The accessibility of these markets democratized investing, allowing individuals to participate in their country’s economic growth.

The Rise of Mutual Funds

The next significant milestone in public equity investing came with the creation of mutual funds in the early 20th century. The Massachusetts Investors Trust, established in 1924, is widely regarded as the first modern mutual fund. This new structure allowed investors to pool their money in a single vehicle, providing broader diversification through professional management.

Mutual funds gained popularity because they offered several advantages:

• Diversification: Spreading investments across a wide range of securities reduces individual risk.
• Professional Management: Experienced fund managers made investment decisions, relieving individual investors of the need for extensive market knowledge.
• Accessibility: Lower minimum investment requirements made it easier for average investors to participate in the stock market.

Socially responsible investing (SRI) began to emerge as an early brand of impact-related investing in the 18th century when Methodists integrated screens into their investments, and ramped up in the 1960s when “Vietnam war protestors demanded that university endowment funds no longer invest in defense contractors.” The social movements of the era provoked questions about the ethical implications of investing. This early approach typically utilized the mutual fund structure to exclude companies involved in defense, alcohol, and gambling.

The Advent of ETFs

The investment landscape witnessed another revolutionary development with the introduction of exchange-traded funds (ETFs) in the 1990s in the United States. The first ETF, the SPDR S&P 500 ETF (SPY), launched in 1993, revolutionized investing by combining the diversification benefits of mutual funds with the flexibility of trading individual stocks.

ETFs offered several key advantages:

• Liquidity: Unlike mutual funds, which are priced at the end of the trading day, ETFs trade on exchanges throughout the day, allowing for real-time buying and selling.
• Lower Fees: ETFs typically have lower expense ratios compared to mutual funds, making them cost-effective investment options.
• Tax Efficiency: The structure of ETFs generally results in fewer capital gains distributions, providing tax advantages for investors.

The Emergence of Direct Indexing

Today, we are witnessing another transformative shift in the rise of direct indexing. This approach allows investors to directly own the individual securities that make up an index rather than buying shares of a commingled mutual fund or ETF that tracks the index. Direct indexing leverages advanced technology to offer unprecedented levels of customization and personalization.

Key benefits of direct indexing include:

• Customization: Investors can tailor their portfolios to align with their personal values and financial goals, including incorporating granular, issue-specific concerns into their portfolio construction. 
• Tax Efficiency: Direct indexing enables tax-loss harvesting, where investors can offset gains by selling underperforming securities, optimizing their tax situations.
• Transparency: The approach taken by ETFs is often opaque, with little information provided about what companies they hold and why. With direct indexing, investors maintain control and can actively screen for certain product areas or companies that they deem antithetical to their values. 
• Shareholder status: As opposed to owning a share of a pooled vehicle, as is the case with ETFs and MFs, direct indexing allows investors to hold individual stocks. Investing directly in the underlying stocks means investors are shareholders and can participate in proxy voting - another important lever in sustainable investing.

Because of the flexibility direct indexing creates, we are also seeing a shift from “one size fits all” sustainability approaches to the deep integration of personal values in investments. With the emergence of customizable direct indexing and the continued refinement of sustainability data practices, clients can now build portfolios that strongly mirror their values.

Embracing Sustainability and Personalized Investing

Throughout this evolution, a growing focus on sustainability and values-aligned investing has emerged. Investors are increasingly seeking ways to align their portfolios with their values, supporting companies that prioritize environmental stewardship, social responsibility, and good governance practices.

Aligning portfolios with values is no longer a niche approach. It has become mainstream, driven by the recognition that investors want to see their values reflected in their portfolios for various reasons, including managing risk, achieving impact, and building a more sustainable future. Tools like direct indexing allow for a high degree of customization, enabling investors to exclude companies that don't meet their values or to overweight those that do. It can also be a low-cost way of allowing investors to maintain exposure to the full market to advocate as a shareholder through proxy voting and filing resolutions to push corporate behavior toward long-term thinking for communities and the world.

Conclusion

The history of public market investing reflects the continuous pursuit of innovation to meet investors' evolving needs. From the establishment of the first stock exchanges to the rise of mutual funds, ETFs, and now direct indexing, each development has provided greater access, efficiency, and customization.

As we move forward, integrating sustainability factors, coupled with technological advancements, will likely drive the next wave of investment innovation. Through Align Impact and Ethic’s partnership, we are excited to help our clients navigate this dynamic landscape, leveraging these tools to create portfolios that reflect their values and financial goals.