Direct indexing > Long short
Using ETFs to fund a direct index handbook
15 min read
Summary
- You can now use ETFs you already own to fund or add to a Frec Classic or Long short direct index—no need to sell them first.
- ETFs can make up to 70% of your total portfolio, with any single ETF capped at 50%.
- In Long short, contributing ETFs can help scale the strategy and create more opportunities to harvest tax losses over time.
- In Classic, funding with cash generally offers greater efficiency if maximizing tax-loss harvesting is your main goal.
- You can move a contributed ETF back to a self-managed account anytime (Long short strategies may require deleveraging first.)
If you’ve been investing for a while, you’re likely holding an ETF position like VOO, VTI, or SPY that’s now worth two or three times what you paid for it. Until recently, using that position to fund a Frec direct index meant selling it first and investing the proceeds, potentially realizing significant capital gains before you’d harvested a single loss to help offset them. That’s changed.
You can now fund or add to a Frec Classic or Long short direct index with ETFs you already own, while keeping as many of your original shares intact as possible. How much you’re able to keep comes down to how closely your ETF overlaps with the index you’re tracking, which we cover in the Matching ETFs to your index section below.
This handbook walks through how it works: why you might fund with ETFs, what happens to your ETF once it’s inside your index, which ETFs qualify, and when it might not be the right move for you.
(Note: ETF funding is available for Classic and Long short direct indices only, not Diversify.)
Why transfer existing ETFs to a Frec direct index?
Using existing ETFs to fund a Frec Classic or Long short direct index helps reduce the upfront cash needed to reach strategy minimums, unlocks more granular tax-loss harvesting opportunities than holding the ETF outright, and provides a tax-efficient path for consolidating outside holdings, including robo-advisor portfolios, into a single benchmarked strategy without having to sell first and realize the associated capital gains, or split your holdings across platforms.
If you already have a funded Frec Long short direct index strategy, contributing ETFs lets you increase your total funded portfolio value and market exposure using assets you already hold, supporting larger long and short extensions and potentially generating more tax losses over time as a result.
How ETF funding works
To fund or contribute to a direct index, your ETFs must first be on Frec. Bringing them over is simple—you can transfer a full or partial portfolio from another brokerage with your cost basis intact by clicking Transfer on your account dashboard.
Once transferred, you can add your ETFs directly into your index strategy. From there, our risk model analyzes the market exposure inside your ETFs to see how closely it overlaps with the index you’re funding. Where there’s overlap, we incorporate your existing ETFs directly rather than selling it and rebuilding that exposure with cash.
To keep your portfolio balanced and closely tracking its benchmark, two primary allocation caps apply:
- ETFs can make up to 70% of your direct index
- No single ETF can make up more than 50% of the total portfolio value
The remaining balance can be funded with cash, stocks, or a mix of both. For example, for a $500,000 Classic or Long short direct S&P 500 index, you could fund it with $150,000 of VOO, $125,000 of SPY, and $75,000 of VTI, plus $150,000 in cash.
If your contributed holdings exceed the caps above, we’ll sell the excess and show you the breakdown of any estimated capital gains before you confirm. As with any tax-related estimate, we recommend consulting a qualified tax advisor about how this may affect your specific situation.
Matching ETFs to your index
Our goal is to retain as much of your original ETF position intact as possible, and how much we’re able to keep comes down to how closely it overlaps with the index you’re tracking.
Overlap reflects how closely an ETF’s risk exposures match the index in our risk model, not just whether they share holdings. For example, nearly all of QQQ’s holdings are in the S&P 500, but its heavy concentration in large tech stocks makes it a low match for the index as a whole.
The sensitivity of this overlap depends heavily on how you fund your strategy. When you’re funding for the first time, there’s more flexibility because you are adding ETFs and cash simultaneously. That fresh cash allows for more opportunity to balance your portfolio around your ETF positions, which can help minimize the need to sell off your contributed shares.
When you contribute ETFs to an already funded strategy, tracking accuracy becomes much more sensitive. Because your existing cash has already been deployed into individual index stocks, adding an ETF that doesn’t closely match the benchmark limits our ability to balance around it. In those cases, selling off a portion of the ETF or performing a broader portfolio rebalance may be necessary to keep your portfolio properly tracking the index, both of which can trigger taxable gains.
Before you confirm any funding or contribution, we’ll run your holdings through our risk model and show you a full breakdown of any estimated capital gains from shares that may need to be sold.
Here’s what that typically looks like in practice:
| ETF and index overlap | Example | What usually happens |
| High overlap | An international ETF funding an international index | Usually kept in full, up to the 70%/50% caps |
| Low overlap | A tech-heavy ETF making up 50% of a Russell 1000 portfolio, or an emerging markets ETF funding an S&P 500 index | A portion of the ETF is sold, and the proceeds are used to buy other stocks to track the index while the remaining ETF position is kept. |
To help you visualize which of your ETF holdings match to specific indices, here’s how some common positions line up against popular indices:
Classic direct index
| ETF | S&P 500 | S&P Info Tech | Nasdaq 100 | S&P ADR Emerging Markets |
| VOO | High overlap | Low overlap | Low overlap | Low overlap |
| SPY | High overlap | Low overlap | Low overlap | Low overlap |
| VTI | High overlap | Low overlap | Low overlap | Low overlap |
| QQQ | Low overlap | High overlap | High overlap | Low overlap |
| VB | Low overlap | Low overlap | Low overlap | Low overlap |
Long short direct index
| ETF | S&P 500 | Russell 1000 | MSCI World ADR | MSCI ACWI ADR |
| VOO | High overlap | High overlap | High overlap | High overlap |
| SPY | High overlap | High overlap | High overlap | High overlap |
| VTI | High overlap | High overlap | High overlap | High overlap |
| QQQ | Low overlap | Low overlap | Low overlap | Low overlap |
| VB | Low overlap | Low overlap | Low overlap | Low overlap |
Don’t see your ETF or preferred index listed above? Overlap is evaluated for any ETF you contribute. To see how your position would be treated, first transfer the ETF into a Frec self-managed account. From there, you can start the funding process for your direct index and review the full breakdown of any estimated tax impacts before confirming.
Will my ETFs be sold over time?
Once your ETF is inside your index, the goal isn’t to sell it down over time (that’s what Frec Diversify does), it’s to keep tracking the benchmark. If the ETF falls below its cost basis, we may sell it to harvest the loss and replace that exposure with individual stocks, creating more opportunities for tax-loss harvesting going forward.
Contributed ETFs may also be sold to manage risk or to keep your portfolio tracking its index. For Long short, they may additionally be sold to meet a margin call. Because contributed ETFs are often highly appreciated, selling them in any of these cases could realize significant capital gains.
Supported ETFs
We currently support most major cash equity ETFs. Specialized asset classes and non-equity funds (including fixed-income, commodity, currency, crypto, mortgage, and leveraged ETFs such as TQQQ) are not supported yet.
You can still fund or contribute using an unsupported ETF. We’ll simply sell it and reinvest the proceeds into your direct index. Since that’s a full sale rather than an in-kind contribution, it can trigger a taxable gain.
Take a look at the current supported ETFs here:
Supported ETFs
Large Cap US
| Ticker | Name | Region |
| SPY | State Street SPDR S&P 500 ETF Trust | United States |
| SPYM | State Street SPDR Portfolio S&P 500 ETF | United States |
| IVV | iShares Core S&P 500 ETF | United States |
| VOO | Vanguard S&P 500 ETF | United States |
| XLG | Invesco S&P 500 Top 50 ETF | United States |
| USMC | Principal US Mega-Cap ETF | United States |
| IWB | iShares Russell 1000 ETF | United States |
| DIA | State Street SPDR Dow Jones Indust Avg ETF Trust | United States |
| GSEW | Goldman Sachs Equal Weight US Large Cap Equity ETF | United States |
| RSP | Invesco S&P 500 Equal Weight ETF | United States |
| QQQ | Invesco QQQ Trust, Series 1 | United States |
| QQQM | Invesco NASDAQ 100 ETF | United States |
| BKLC | BNY Mellon US Large Cap Core Equity ETF | United States |
| SCHX | Schwab US Large-Cap ETF | United States |
| FNDX | Schwab Fundamental US Large Company ETF | United States |
| SFY | SoFi Select 500 ETF | United States |
| VV | Vanguard Morningstar Large Cap ETF | United States |
Small & mid cap US
| IJH | iShares Core S&P Mid-Cap ETF | United States |
| IWR | iShares Russell Mid-Cap ETF | United States |
| SCHM | Schwab US Mid-Cap ETF | United States |
| VO | Vanguard Morningstar Mid Cap ETF | United States |
| DFAS | Dimensional U S Small Cap ETF | United States |
| SCHA | Schwab US Small-Cap ETF | United States |
| VB | Vanguard Morningstar Small Cap ETF | United States |
| SMMD | iShares Russell 2500 ETF | United States |
| FNDA | Schwab Fundamental US Small Company ETF | United States |
| VXF | Vanguard Extended Market Index Fund ETF | United States |
All cap/total market US
| ITOT | iShares Core S&P Total US Stock Market ETF | United States |
| SCHB | Schwab US Broad Market ETF | United States |
| SPTM | State Street SPDR Prft S&P 1500 Comp Stk Mkt ETF | United States |
| VTI | Vanguard Total Stock Market Index Fund ETF | United States |
| AVUS | Avantis US Equity ETF | United States |
Sector or industry
| FTEC | Fidelity MSCI Information Technology Index ETF | United States |
| VGT | Vanguard Information Technology Index Fund ETF | United States |
| XLK | State Street Technology Select Sector SPDR ETF | United States |
| SMH | VanEck Semiconductor ETF | United States |
| XLE | State Street Energy Select Sector SPDR ETF | United States |
| VDE | Vanguard Energy Index Fund ETF | United States |
| VNQ | Vanguard Real Estate Index Fund ETF | United States |
| VPU | Vanguard Utilities Index Fund ETF | United States |
| XAR | State Street SPDR S&P Aerospace & Defense ETF | United States |
| ARKK | ARK Innovation UCITS ETF USD Acc | Global |
| BUZZ | VanEck Social Sentiment ETF | United States |
Global
| VT | Vanguard Total World Stock Index Fund ETF | Global |
Developed & emerging
| IEFA | iShares Core MSCI EAFE ETF | International Developed |
| SPDW | State Street SPDR Portfolio Devt World ex-US ETF | International Developed |
| VEA | Vanguard Tax Managed Fund FTSE Developed Markets ETF | International Developed |
| SCHF | Schwab International Equity ETF | International Developed |
| FEZ | State Street SPDR EURO STOXX 50 ETF | International Developed |
| VXUS | Vanguard Total International Stock Index Fund ETF | Int’l Dev. & EM |
| IEMG | iShares Core MSCI Emerging Markets ETF | Emerging Market |
| VWO | Vanguard Emerging Markets Stock Index Fund ETF | Emerging Market |
| SCHE | Schwab Emerging Markets Equity ETF | Emerging Market |
| SPEM | State Street SPDR Portfolio Emerging Markets ETF | Emerging Market |
| JPEM | JPMorgan Diversified Return Emerging Mkts Eqty ETF | Emerging Market |
| PDN | Invesco RAFI Developed Mkts ex-US SM ETF | International Developed |
| FNDF | Schwab Fundamental Intl Equity ETF | International Developed |
| INTF | iShares International Equity Factor ETF | International Developed |
| IVLU | iShares MSCI Intl Value Factor ETF | International Developed |
| DIVI | Franklin International Core Dividend Tilt Idx ETF | International Developed |
Factor & dividend based
| DGRO | iShares Core Dividend Growth ETF | United States |
| HDV | iShares Core High Dividend ETF | United States |
| VIG | Vanguard Dividend Appreciation Index Fund ETF | United States |
| VYM | Vanguard High Dividend Yield Index Fund ETF | United States |
| SCHD | Schwab US Dividend Equity ETF | United States |
| USMV | iShares MSCI USA Min Vol Factor ETF | United States |
| SPLG | Invesco S&P 500 Low Volatility UCITS ETF Acc | United States |
| IVW | iShares S&P 500 Growth ETF | United States |
| SCHG | Schwab US Large-Cap Growth ETF | United States |
| SPYG | State Street SPDR Portfolio S&P 500 Growth ETF | United States |
| VUG | Vanguard Morningstar Growth ETF | United States |
| VONG | Vanguard Russell 1000 Growth Index Fund ETF | United States |
| VOOG | Vanguard S&P 500 Growth Index Fund ETF | United States |
| IVE | iShares S&P 500 Value ETF | United States |
| SCHV | Schwab US Large-Cap Value ETF | United States |
| SPYV | State Street SPDR Portfolio S&P 500 Value ETF | United States |
| VTV | Vanguard Morningstar Value ETF | United States |
| IWN | iShares Russell 2000 Value ETF | United States |
| AVUV | Avantis US Small Cap Value ETF | United States |
| VBR | Vanguard Morningstar Small Cap Value ETF | United States |
| IWS | iShares Russell Mid-Cap Value ETF | United States |
| VOE | Vanguard Mid-Cap Value Index Fund ETF | United States |
| MDYV | State Street SPDR S&P 400 Mid Cap Value ETF | United States |
Values based
| ESGD | iShares ESG Aware MSCI EAFE ETF | International Developed |
| ESGE | iShares ESG Aware MSCI EM ETF | Emerging Market |
| ESML | iShares ESG Aware MSCI USA Small-Cap ETF | United States |
| DSI | iShares ESG MSCI KLD 400 ETF | United States |
| ESGV | Vanguard ESG US Stock ETF | United States |
Impact on Long short direct indexing
When you fund a Frec Long short direct index partially with ETFs, your cash buys the core long positions at a fresh cost basis. Meanwhile, any portion of your contributed ETF that’s retained becomes collateral for your long and short extensions, which are actively traded based on your factor tilt exposure and to harvest tax losses.
The ETF position itself can still generate a harvestable loss if it happens to be trading below its cost basis. Since most contributed ETFs may have been held for a while and appreciated in value (often the reason you’re contributing rather than selling in the first place), there tends to be fewer of those opportunities on the ETF position itself compared to the actively-traded extensions.
If you already have a funded Long short direct index, contributing additional ETFs can be a strategic way to increase your total funded portfolio value, in turn increasing long and short extensions and potentially generating more tax losses over time.
As illustrated above, contributing existing ETFs to a cash-funded Long short direct index boosts tax-loss harvesting returns at every leverage tier, allowing you to maximize tax savings using assets you already own rather than deploying new cash.
Contributing ETFs can also help you move up to a higher leverage tier, for example from a 140/40 tier ($100,000 minimum) to a 200/100 tier ($500,000 minimum), without raising it all in cash. A higher tier means larger extensions relative to your account value, increasing both your gross exposure and tax-loss harvesting opportunity.1 In Frec’s backtesting of strategies benchmarked to the Russell 1000, annual harvested losses rose from about 8.5% of the portfolio at 140/40 to 15.6% at 200/100 and roughly 19% at 250/150. See the full Long short direct indexing white paper for details.
Impact on Classic direct indexing
When you fund a Frec Classic direct index partially with ETFs, your cash buys the remaining index constituents at a fresh cost basis while the retained ETF becomes part of the portfolio. This can be useful if you’ve built up positions in several legacy or sector ETFs over time, say a handful of sector funds, and want to consolidate them into a broader benchmark like the S&P 500 without selling first. Frec holds the overlapping exposure and fills the rest with cash.
Because that ETF portion is held rather than actively rebalanced, it doesn’t participate in the ordinary tax-loss harvesting that happens across the rest of your portfolio in quite the same way, unless it happens to be trading below its cost basis or gets trimmed for a mismatch as covered above, both of which we monitor for automatically, so you don’t have to track it yourself.
Evaluating if ETF funding fits your strategy
Whether ETF funding is the right approach depends on the role you want those assets to play within your broader strategy. When an ETF is contributed, its underlying expense ratio remains, while Frec’s management fee also applies to that portion of the portfolio. The key consideration is whether the benefit of bringing existing assets into the strategy outweighs that cost.
If your goal is to scale up a Long short strategy you’re already running, contributing ETFs can be an effective way to put more of the assets you already own to work, potentially creating more opportunities to harvest tax losses over time.
If you have limited cash on hand to meet strategy minimums, or you’re looking to consolidate outside holdings like existing ETF positions into one strategy, contributing ETFs lets you get started with assets you already own rather than waiting to raise cash.
If your goal is to maximize tax-loss harvesting in a Classic strategy, cash will generally offer greater efficiency. ETF positions retained for overlapping market exposure do not participate in day-to-day tax-loss harvesting in the same way as the individual stocks do.
Moving ETFs out of a direct index
Funding with ETFs isn’t a permanent choice you’re locked into. If you later decide you’d rather have that portion of your strategy funded with cash, you can replace the ETF with cash as your liquidity or goals change. You can also remove an ETF from the strategy without replacing it with cash. In that case, particularly if the ETF represents a concentrated position, removing it may trigger a rebalance across the rest of the portfolio and could result in realized gains.
In a Classic direct index, moving your contributed ETF into a self-managed account can be done at any time within the platform and keeps the ETF position intact.
In a Long short direct index, you can also remove contributed ETFs, but the amount you can remove without replacing them depends on your current leverage tier. Because removing assets reduces the funded value of your portfolio while your long and short extensions remain in place, your leverage increases. If you’re at 140/40 or 200/100, you may have room to remove some ETFs while remaining within the 250/150 maximum. If you’re already at 250/150, you’ll need to either replace the ETF with cash or other eligible assets, or deleverage the strategy before removing it.
To remove ETFs from your Long short strategy, please fill out our contact form and our support team will assist you.
Other ways to bring ETFs onto Frec
If you aren’t ready to contribute ETFs to a direct index, you can still transfer existing holdings into a Frec self-managed account to consolidate your assets into one complete view with no added fees and your cost basis intact. Plus, we’ll cover the transfer fee (up to $100) if you transfer in $20,000 or more. Terms apply.
Getting started
If your ETFs aren’t already on Frec, the first step is to transfer them into a Frec self-managed account. Your whole shares and cost basis transfer over unchanged, typically within 4–6 business days. Once the ETFs are on Frec, you can use them to fund a new direct index or contribute them to an existing one, with the option to select specific tax lots.
To start a new direct index, go to the Invest page and choose a Classic or Long short strategy. Select the ETFs you’d like to fund with, along with any cash or stocks needed to meet the portfolio minimum.
To add ETFs to an existing direct index, select the index from the Overview page, click Transfer, select Move stocks from the dropdown menu, then choose the ETFs you’d like to contribute.
Before you confirm, we’ll show you how the ETF would be incorporated into the direct index and review any estimated taxable gains from shares that may need to be sold.
1 Higher tiers also increase leverage, financing costs, tracking error and the risk of loss and margin calls. In Frec’s backtests, tracking error rose from 1.58% at 140/40 to 4.13% at 250/150, and annual fees rise from 0.50% to 1.30% plus financing costs. Learn more.
Product images are for illustrative purposes only.
All results mentioned in this handbook are hypothetical, do not reflect actual investment results, and are not a guarantee of future results.
The above bar chart shows hypothetical first-year tax losses harvested by a long/short strategy (Russell 1000 benchmark, quality factor tilt) at 140/40, 200/100, and 250/150 leverage, funded with cash only or cash plus low-cost-basis shares of a closely overlapping ETF (e.g., IWB). Cash-only results average 41 simulated 10-year runs of a one-time $1M deposit, with start dates from 04/04/2005 to 03/16/2015 each running for 10 years, covering history from 04/01/2005 to 03/12/2025. Additional losses from ETF funding are estimates based on simulations and heuristics: simulated first-year losses of a long-only strategy were subtracted from those of the long/short strategy over the same dates, then adjusted for leverage.
