Direct Indexing on Track to Grow Faster Than ETFs | ETF Trends

Direct indexing could grow at a faster rate than ETFs, mutual funds, and separate accounts over the next five years. Analysts expect the technology to reach more than $800 billion in assets by 2026, according to a report from Cerulli Associates.

Direct indexing is an individual account that’s managed to track an index, like a separately managed account. As opposed to a mutual fund or ETF, the investor directly buys and owns an index’s constituent securities to mirror it without using a fund wrapper.

According to the report, assets in direct indexing products reached $462 billion in Q1 2022. However, only 14% of financial advisors are aware of and recommend direct indexing to clients.

This is despite 63% of financial advisors serving clients with more than $500,000 in investable assets, and 14% targeting clients with more than $5 million in assets. In other words, the ideal investor to consider direct indexing.

“As advisors universally adopt fee-based models and financial planning, the line between business models is blurring, making differentiation challenging,” said Cerulli Director Tom O’Shea in a statement announcing the report. “Many wealth managers are looking to the tax management and customization features of direct indexing to create a personalized client experience.”

See more: “How Tech Is Pushing Demand for Direct Indexing

As more investors turn to direct indexing, Cerulli expects that assets will grow at an annualized rate of 12.3% over the next five years. Cerulli also expects direct indexing to make up 33% of the retail separate account market by 2026.

“Given investors’ desire to exercise more control over their portfolios, we believe that direct indexing will continue on its current growth trajectory for years to come,” O’Shea added.

How Tech Has Enabled Direct Indexing

Advancing tech has enabled direct indexing services to regularly screen for tax-loss harvesting opportunities. A service like Vanguard Personalized Indexing can automatically scan portfolios throughout the year for tax-loss harvesting and rebalancing opportunities.

VPI’s software scans the portfolio for harvesting opportunities at a set frequency (daily, quarterly, or monthly). Generally, the more frequent the scans, the higher and more consistent it is. It can also help capitalize on volatile markets without violating the wash-sale rule.

According to Vanguard, the differences in tax-loss harvesting opportunities alpha can range from 20 to more than 100 basis points. When considering a direct indexing strategy for its tax-loss harvesting abilities, those with daily harvesting scans “is critical to achieving the maximum harvest in ‘typical’ (non-high) volatility environments,” Vanguard added.

More information about VPI can be found online.

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