Direct Indexing Offers Greater Personalization Around the Client Experience
Tuesday, September 26, 2023
September 2023
Direct Indexing Offers Greater Personalization Around the Client Experience

How the next evolution in passive investing gives investors more control over their investments

By Anthony Marcozzi

Key Points

  • Assets in direct indexing (also known as custom or personalized indexing) are projected to nearly double from about $458 billion in 2022 to more than $800 billion by the end of 2026, surpassing those held in exchange traded funds (ETFs), mutual funds, and other separate accounts. 
  • Despite the surge in direct indexing, only 44 percent of advisers say they are currently familiar with direct indexing while just 16 percent say they are using it in their client accounts. 
  • Unlike other managed assets such as ETFs and index funds, direct indexing allows clients to mirror the performance of stock indexes while letting them self-select and hold individual securities within an SMA. 
  • Direct indexing can deliver many benefits to clients, including building personalized portfolios based on their values, potentially reducing tax liabilities, and feeling more control over their unique investor journey. 

Direct indexing (also known as custom or personalized indexing) is the next step in the evolution of managed assets. In the second half of 2022, assets in direct indexing stood at about $458 billion, but growth in direct index separately managed accounts (SMAs) is projected to nearly double to more than $800 billion by the end of 2026, surpassing assets in exchange traded funds (ETFs), mutual funds, and other separate accounts. 

Why the surge in direct indexing? One word: Control. While ETFs and index funds have changed the investing landscape by driving down costs while increasing access to more segments of the market, investors have little to no control over the holdings within these funds. Direct indexing, however, closely mirrors the performance of stock indexes such as the S&P 500 or the Russell 3000 while allowing investors to self-select and directly hold individual securities in a taxable SMA

Ethic uses direct indexing to help wealth advisers create personalized portfolios that are aligned with their clients’ unique values. Therefore, we find it troubling that a recent survey found that only 44 percent of advisers said they were familiar with the solution while just 16 percent said they were using it in their client accounts. 

Why aren’t more advisers offering direct indexing to their clients? We believe a simple explanation is because the approach’s value proposition hasn’t been clearly articulated for many advisers, making it impossible for them to convey the benefits to their clients. In this article, we’ll break down four key benefits of using direct indexing.

Benefit 1: Building More Personalized and Sustainable Portfolios

Investors want to invest in the world they want to see. Therefore, it should come as no big surprise that one of the biggest factors driving client interest in direct indexing is a desire to invest more sustainably. And because investing is personal, then it should also come as no surprise that different clients will be driven by different sustainability factors that reflect their environmental stance, religious beliefs, or other important values.

Direct indexed portfolios can more easily emphasize sustainability factors than some other managed asset solutions because they can remove securities that don’t align with a clients’ values. Have a client who doesn’t want to invest in companies that aren’t transparent about their business practices or offer inflated compensation to executives? Or maybe you have a client who wants to ensure their investments aren’t hurting the ocean? No problem. 

Direct indexing lets clients remove securities that negatively impact the things they most care about — and it makes it easier to reallocate their investments to securities more aligned with their personal values. 

Benefit 2: Even More Control By Accessing Potential Tax Savings 

Helping clients align their portfolios with their values can help them make more informed investment decisions, but it doesn’t necessarily address concerns of what might happen during an economic downturn or if specific securities underperform. But there are potential tax advantages to direct indexing that investors can tap into, especially when there is high volatility in the market. 

Unlike mutual funds or ETFs, which are required to distribute capital gains to investors, direct indexing allows wealth advisers to control when and how their clients realize capital gains throughout the year at the individual stock level. This means that tax liabilities can potentially be reduced by harvesting losses. 

This tax management capability, called tax-loss harvesting, involves the selling individual positions or tax lots when there’s an unrealized tax loss. The proceeds can then be used to buy similar securities to stay invested in the market or mitigate the risk of the portfolio. 

Is tax-loss harvesting worth it? The answer is often a resounding yes. For example, in the high-volatility market of 2022, research showed that investors who automated their tax-loss harvesting had an average benefit of 0.95 percent — nearly a percentage point of return. 

Benefit 3: Greater Automation and Better Reporting

Being a better-informed investor is important to most clients. Therefore, helping them make more informed decisions should be of paramount importance to the wealth advisers who serve them. 

Automation is key to delivering this information. Direct indexing requires far more granular levels of data than traditional managed assets accounts, as it requires, among other factors, knowing underlying security prices, position management at the stock level rather than at the ETF level, corporate action management, and potential tax management at the security level. And because firms need to track the individual tax lots of each security held within an SMA, they require automated portfolio management tools for tax optimization, tracking error management, rebalancing, and reporting — and they also need to look at all of the research and data available about companies to make informed decisions about removing securities from a portfolio that aren’t aligned with a client’s values. 

It’s important to choose a direct indexing provider that can provide superior data management and tax management. Ethic’s proprietary investment platform manages all of these things — what’s more, our data-driven Sustainability Model supports customized portfolio construction by evaluating companies’ impacts on sustainability issues. 

Benefit 4: Feeling Engaged And Delighted During the Entire Investment Journey

Direct indexing can open the door to more meaningful conversations with clients and prospects than ETFs or mutual funds are able to by offering more opportunities to align clients’ values with their investments. And this higher level of values alignment doesn’t need to be traded for performance, as clients may also take advantage of tax loss harvesting at the individual stock level while getting a holistic view of their investments with more data and automated reporting.

Clients who have more control over their unique investor journey may feel more satisfaction and delight, and be more likely to see the value of working with their adviser.

When weighing whether direct indexing may be an approach to offer to clients, wealth managers may want to pose the following questions: 

  • Is investing in a customized approach that gives you more control over your investments important to you?
  • Are you interested in unlocking potential tax advantages?
  • Would you like to have a better understanding of your investments and receive automated reports that keep you abreast of timely changes?
  • Would you like to explore building a more sustainable portfolio that is aligned with your personal values? 

If the answer to any of these questions is “yes,” then you may want to consider offering direct indexing as a part of your clients’ investment strategy.   

Contact your relationship manager to learn more about how Ethic can help you and your clients build a direct indexing portfolio.

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Sources and footnotes

Ethic Inc. is a Registered Investment Adviser located in New York, NY. Registration of an investment adviser does not imply any level of skill or training. Information pertaining to Ethic Inc’s registration or to obtain a copy of Ethic Inc.’s current written disclosure statement discussing Ethic Inc.’s business operations, services and fees is available on the SEC’s Investment Adviser Public Information website – or from Ethic Inc. upon written request at Information provided herein is for informational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Any subsequent, direct communication by Ethic Inc. with a prospective client shall be conducted by a representative of Ethic Inc. that is either registered or qualifies for an exemption or exclusion from registration in the state where a prospective client resides. Information contained herein may be carefully compiled from third-party sources that Ethic Inc. believes to be reliable, but Ethic Inc. cannot guarantee the accuracy of any third-party information.

Ethic Inc. does not render any legal, accounting, or tax advice. Ethic Inc. recommends all investors seek the services of competent professionals in any of the aforementioned areas. Ethic Inc. cannot provide any assurances that any investment strategies, simulations, etc. will perform as described in our materials. ALL INVESTMENTS INVOLVE RISK, ARE NOT GUARANTEED, AND MAY LOSE VALUE. BE SURE TO FIRST CONSULT WITH A QUALIFIED FINANCIAL ADVISER AND/OR TAX PROFESSIONAL BEFORE IMPLEMENTING ANY STRATEGY.


Anthony Marcozzi is a proud born and raised New Jerseyan. Previously Anthony worked at UBS in the Global Wealth Management Division and most recently worked on the sustainable investing solutions team with a focus on growing the ESG product set and educating financial advisors. He holds the Chartered Sustainable, Responsible and Impact Investing Counselor (CSRIC™) designation and graduated from Bucknell University with a B.S. in Managing for Sustainability.

Melissa Banigan is a content strategist with over 15 years of communications experience working with global companies and nonprofits. Also a journalist and author, her work appears in The Washington Post, CNN, the BBC, NPR, and the Independent, among other publications, and she's written three books for youth.