While it’s still a niche offering, the report says direct indexing will grow at an annualized rate of more than 12% over the next five years. This compares with 3.3% for mutual funds, 11.3% for ETFs and 9.6% for separate accounts.
Direct indexing has an advantage over mutual funds or ETFs, Cerulli said, because it gives individual portfolios finer control for generating gains and losses at the individual security level without falling outside the risk and tracking error bands. While a pure direct indexing solution is best used against passive exposure initially, actively managed and highly individually managed accounts have made their way into retail channels as well.
“The value proposition of Separately Managed Retail Accounts (SMAs) is similar to direct indexing – by owning the underlying securities in an index-like solution, customers can invest more tax efficiently than mutual funds, which they may lose. embedded capital gains, ”the report says. “Retail SMAs have the potential for automated tax losses, but only 16% of consultants take advantage of it.”
In addition to the potential for tax optimization, direct indexing can also enable beta exposure to stocks based on other strategic priorities such as ESG or responsible investing, factor tilts and thematic investing. Leading consultants can also further differentiate their services through customizations to allow for flexible onboarding and tax-optimized charitable donations, O’Shea said.
The momentum of direct indexing is increasing across the industry as the market for the product expands, noted Cerulli. In addition to applying direct indexing to novel asset classes, asset managers are expected to acquire direct indexing providers and bring proprietary solutions to market.