5 direct indexing developments large wealth management firms should watch

5 key direct indexing developments to watch

April 21, 2022 1:29 PM

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For the major part of its 30-year history, direct indexing has been a relatively obscure investment strategy primarily for ultrahigh net worth individuals.

But the tide has turned, with the approach making an impact in the market so much in the last two years that large wealth management firms have shown increasingly greater interest.

Here are five recent stories from Financial Planning about key developments in the direct indexing space.

The rise of direct indexing

In 2020, investments in direct indexing reached $362 billion, almost 20% of the total assets in separate retail accounts, according to a report by research firm Cerulli Associates and Seattle-based boutique asset manager Parametric.

But not so long ago in 1992, the concept was just the brain child of a then-portfolio manager at Parametric, Brian Langstraat, who was looking to solve a client investment challenge — to build a portfolio that acted like an index, but with an awareness of and managing for post-tax performance.

Thirty years on, major firms including Charles Schwab, Goldman Sachs and Prudential are getting in on the act as direct indexing goes from exclusive high net worth investment vehicle to mainstream wealth management.

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The rise of direct indexing

5 questions on Fidelity’s new retail direct indexing product

With direct indexing assets projected to hit $1 trillion by 2025, major players in wealth management have quickly bought into the business. Morgan Stanley acquired Eaton Vance in October 2020, BlackRock purchased Aperio one month later and Fidelity has moved ahead with its own direct indexing product for retail investors called Fidelity Managed FidFolios.

Building on the firm’s existing direct indexing and fractional shares capabilities, Fidelity’s new product will allow clients to get access to a managed portfolio of hundreds of individual stocks for an investment of only $5,000. The firm’s head of managed accounts, Rich Compson, recently spoke about the new service and the growth of direct indexing in the industry.

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5 questions on Fidelity’s new retail direct indexing product

12 acquisitions that pushed direct indexing into the mainstream

From an obscure investment vehicle created 30 years ago by a boutique asset manager looking to solve an investor’s desire to avoid the unpredictability of asset management, direct indexing has grown into a mainstream product that has grabbed the attention of all the large wealth management firms.

In the last two years, several major financial institutions have made a stake in the business by acquiring direct indexing capabilities, putting the former millionaire’s product in the hands of the mass investor.

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12 acquisitions that pushed direct indexing into the mainstream

Pershing’s step into direct indexing reveals more about the custodian’s technology vision

Pershing’s acquisition of Optimal Asset Management in December 2021 was an indication of the company’s need to keep pace with its large wealth management peers in the burgeoning direct indexing market, where assets under management totaled $350 billion in 2020.

However, the move also highlighted Pershing’s intention to add technological firepower to its RIAs, independent broker-dealers and trust companies with a highly integrated suite of tech tools.

“What we see missing in the market are tools that work beautifully together,” said Ainslie Simmonds, president of Pershing X. The firm has tech tools for custody and clearing, but wants to add tech for “the rest of their advisory needs: [investment] models, direct indexing, financial planning, the things they need to do their job.”

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Pershing’s step into direct indexing reveals more about the custodian’s technology vision

Why financial institutions are gobbling up direct indexing technology

It must have taken something special for Vanguard to make the first acquisition in its 47-year history. But that’s what the company sees in direct indexing that prompted it to buy Just Invest, a tech company in Oakland, California, that uses data analytics, algorithms and risk modeling to power direct indexing.

“Technology-driven solutions such as direct indexing continue to reshape our industry, driving better investment outcomes and lowering costs for clients,” Vanguard CEO Tim Buckley said in a statement.

Direct indexing replicates the performance of an index fund by purchasing the underlying securities of an ETF or mutual fund rather than the fund itself, making wealthtech companies with the technology to facilitate this investment strategy highly desirable for large asset management firms like Vanguard.

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Why financial institutions are gobbling up direct indexing technology