Direct indexing continues to gain steam as an important offering to high-net-worth clients even if individual advisory practices have been slow to jump on board—the early adopters have been rewarded and at least one low-cost giant is already setting its sights on being a disrupter on fees.
But the window for using this level of personalization as a meaningful differentiator among advisors won’t be open forever, according to Cerulli Associates, the Boston-based research firm that included direct indexing data in its fourth-quarter publication for U.S. advisors.
In a few years, the researcher said, direct indexing will simply be table stakes.
While just 14% of financial advisors currently are using direct indexing for their clients, 50% of asset managers say they want to add or enhance this capability this year, Cerulli said. Meanwhile, 75% of broker-dealers see value in direct indexing and are prioritizing adding or enhancing this feature.
Getting into the game while it still means something, Charles Schwab & Co. said at this month’s Impact 2022 that the level of personalization offered by direct indexing—for tax loss harvesting and aligning investments with values—will reshape the industry, thanks to efficiency available through technology.
The question is how to do that at a lower cost than competitors, said Walter Bettinger, CEO, as he announced finding that path is now a priority for Schwab. Considering direct indexing is expected to be a $1.5 trillion strategy by 2025, according to a 2021 report by Morgan Stanley and consulting firm Oliver Wyman, even small fees will add up to something substantial.
“We have to get that cost down closer to where a regular ETF or an indexed mutual fund might be,” Bettinger said to some 5,000 attendees. “I can assure you that some of the digital investments that we’re making as measured in hundreds of millions of dollars, when some of those come to fruition over the coming months, you’re going to see us drive that cost for personalized indexing, direct indexing customization down to that kind of level. We’re going to disrupt that industry, and it’s going to help you serve more clients.”
According to Cerulli, asset managers with direct indexing capabilities have said that on an annual basis they can comfortably harvest tens of thousands of dollars in losses per million dollars in the portfolio, leading the researcher to say it believes that “taxes will remain the best and most widely used application of direct indexing strategies going forward.”
One asset manager that took this to heart is Valley Forge, Pa.-based Vanguard. In the fall of 2021, Vanguard Financial bought Just Invest, a fintech company with about $1 billion in assets under management.
This was the first corporate acquisition in Vanguard’s history, and it followed on a jointly run pilot program between the two companies in 2020 that tested the waters by offering the service to selected registered investment advisor clients of Vanguard Financial Advisor Services.
Following the October 2021 acquisition, the company’s name was changed to Vanguard Personalized Indexing Management, and by the time it filed its Form ADV in April 2022, its assets under management had doubled to $2 billion, primarily from the clients of some 40 advisors, the ADV stated.