As financial institutions across the
A Form ADV filed in late January revealed the Boston-based financial service has developed a new digital offering for retail investors called Fidelity Managed FidFolios. Using Fidelity’s existing direct indexing capabilities (the firm has $33 billion invested using the strategy) and the
FidFolios will offer three strategies — U.S. Large Cap Index, International Index and Environment Focus — and will allow clients to customize by removing individual stocks or entire industries from the portfolio. The digital service will automate ongoing rebalancing and tax-loss harvesting, which Fidelity estimates can generate 1.0% to 1.5% of after-tax value.
Not only is the low minimum surprising — even digital advisor Wealthfront required a $100,000 minimum to receive direct indexing — but so is the timing. Fidelity is already beta testing Managed FidFolios internally and is expected to make it publicly available in the coming months. The timeline for other firms working to integrate their new direct indexing acquisitions just got significantly shorter.
Financial Planning spoke with Rich Compson, Fidelity’s head of managed accounts, about the new service as well as the accelerating adoption of direct indexing across the wealth management industry.
This interview has been lightly edited for length and clarity.
FInancial Planning: So what exactly is this new product, and why is Fidelity interested in direct indexing?
Rich Compson: Fidelity Managed FidFolios offers a digital front end to invest in one of three strategies like you would a mutual fund or ETF. Within that, they can personalize the strategy by excluding individual stocks or industries, and tax manage it to their personal tax situation. Compared to stock investing, we like to think of these as auto-everything: ongoing rebalancing, tax management, tax-sensitive withdrawals and proxy voting. We simplify individual stock ownership.
Direct indexing — obviously we think it’s the next wave of indexing solutions for the industry. We currently have $33 billion in direct indexing delivered through the wealth advisory offering at our retail branches. It’s been a great success for us. We’ve seen strong growth. The real value is index-level results with tax management and personalization capabilities on top.
The big thing for us is we continue to look at how we use technology innovation to bring solutions for a broader set of customers. The key capability that allows us to do that is leveraging fractional shares to be able to bring minimums down. It was $100,000 to $200,000 per account. We’re bringing it down to $5,000.
We’re piloting the solution right now with our internal employee base.
FP: Is this technology that Fidelity acquired, or something built in-house?
RC: It is all internally built capabilities. We built our own internal portfolio management capabilities that allows for high-scale portfolio construction and trading, and integrated with our core trading and brokerage platform.
FP: How is this going to coexist alongside Fidelity’s other digital advice products for retail investors? Will this eventually replace offerings like FidelityGo?
RC: When we look at the customers that come to Fidelity, there’s a spectrum of needs. FidelityGo offers a more diversified [managed account], but some customers are more self-directed and want to build a portfolio on their own to complement existing indexes and ETFs. So we see this as additive to our capabilities for more self-directed or self-advised investors.
We include [direct indexing] in our diversified solutions. It’s a core sleeve within those portfolios. We can eventually bring it over to FidelityGo and Portfolio Advisory Services.
FP: Some in the industry say that for accounts with just $5,000, direct indexing doesn’t create enough benefit to outweigh the increased complexity. How did Fidelity decide to make the entry point so low?
RC: Generally, we’re looking at how we can use these capabilities more broadly. At the end of the day, fractional share capabilities allow you to get diversification with low minimums. It will be interesting to see what plays out in terms of average account size [on FidFolios]. For more than 94% of our SMA clients, the tax benefits cover the fees.
FP: Direct indexing has been around since the early 1990s, so why is there so much interest in it now?
RC: I think, more broadly, a couple of things are driving it. More and more of the strategies are being included in broad financial plans. If you start with a plan and understand overall objectives and include things like the client’s tax situation, these strategies help grow wealth and minimize the drag of taxes. I think it naturally fits into the financial planning process and the concerns that investors have.
Technology has helped scale these solutions and bring them to more clients. If you see the industry activity, a lot of what’s happening is buying the technology that allows you to deliver [direct indexing].
