The future of equity investing is personalization
Monday, June 24, 2019
June 2019
A more in depth exploration of key sustainability topics
The future of equity investing is personalization

The future of equity investing is changing and will soon be driven by personalization. Discouraged by the lack of personalization in many ETFs and mutual funds, clients will move towards direct indexing and customized separately managed accounts (SMAs).

Indeed, the demand for personalization has already shaped the future of many consumer industries.

Imagine yourself in line at the salad chain Sweetgreen. While the long counter of mix-in ingredients looks enticing, your eyes drift to the menu-board above, tastebuds lighting up as you weigh the merits of the “Guacamole Greens” and the “Kale Caesar.” Or consider yourself slumped on your favorite chair, settling in for Friday-night Netflix. Instead of searching for specific shows from the company’s vast library, you rely on Netflix to mine your viewing history and the preferences of others with similar tastes to suggest five options that all look interesting.

The same process happens when shopping for wine at a specialty store, when you’re given a small group of suggestions based on your favorite regions, styles and price point.

Whether you’re picking out a salad, choosing a movie, selecting a wine, or shopping for almost anything, you’re experiencing a fundamental shift in how we consume goods and services. We’re bombarded by endless options and information, so we take comfort in concisely curated menus.

Sweetgreen, Netflix, Amazon and countless other companies are built on providing variety to customers. But they have realized that while an abundance of choice is good, it weakens our ability to choose and to know what we’re choosing. Their solution? Understand the customer and the market, and find a way to best marry the two by delivering a guided experience.

This phenomenon, in which consumers are provided with specialized recommendations based on preferences and behavior, is known as personalization. While it’s permeated many consumer industries, it’s still fairly nascent within financial services.

But that’s about to change. Advisors need to be on the right side of it.

Consider how the demands of today’s clients are nudging the advisor playbook in this direction. Fueled in part by increased information access and a damaging loss of trust from the 2008 financial crisis, clients are seeking greater transparency and values-alignment with their underlying holdings. That means that, much as advisors had to adopt financial planning – including tax advice – after ETFs and mutual funds democratized market access, they must adapt again to face rising demand for environmental, social and governance concerns.

Growing interest in this space is clear: Sustainable investing open-end funds and ETFs sealed their third straight year of record net inflows in 2018, despite poor inflows into the overall U.S. fund universe, according to a report from Morningstar. At a time when advisors face fee compression and a constant need to justify the cost of their advice, the ability to identify and integrate client values into portfolios is a key differentiator.

But off-the-shelf investment solutions for passive equity portfolios make personalization difficult. ETFs and mutual funds, while excellent at providing cost-effective and broad market exposure, offer limited ability to tailor client preferences such as tax, risk and sustainability concerns. They’re a one-size-fits-all approach to a customer base with unique values and needs, requiring a solution personal to them. Complete customization, on the other hand, offers highly tailored choices at each step of the process. This works wonderfully for the financial advisors who distinguish themselves by building client portfolios from scratch, but for those with clients unfamiliar or uninterested in the daily details of their portfolio, customization can be a choice overload and a headache. Such accounts are difficult to scale across a client base because advisors need to know the specifications of each and every individual.

There’s a middle ground that offers a guided experience, but at scale: personalization – direct investing through an SMA. In those structures, clients directly own the underlying securities via an account managed to their preferences. Clients can customize around the edges, but advisors can create the general strategy, allowing them to market such vehicles at scale. It’s like choosing Sweetgreen’s Harvest Bowl, but having the individual flexibility to leave out the goat cheese and add in a double dose of apples.

SMAs give advisors the tools they need in today’s competitive environment. Gone are the days of being measured on just financial returns and planning expertise. Clients want help translating their values into action. Being able to provide personalized portfolios that account for financial and tax preferences as well as ESG criteria not only deepens conversations with clients and strengthens those relationships, but distinguishes advisors among prospects.

Surely the trillions of dollars in off-the-shelf ETFs and mutual funds, as well as custom accounts, aren’t going anywhere overnight. That said, as clients look for personalized equity portfolios and advisors find ways to match that demand at scale, direct investing is poised for significant growth. “This is the next $100 billion advisor opportunity,” Inside ETFs Chairman Matt Hougan said of direct indexing earlier this year.

As we look ahead for financial advisors, one thing is clear: Amid growing choice, expert and personalized advice will become all the more important. Advisors with this skill set with be in greater demand. Are you ready?

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Sources and footnotes

Alex Laipple is originally from Pittsburgh, PA, now living in New Jersey with wife Meghan and his  four daughters Charlotte, Ruthie, Quinn, and Ellie. Alex has over 15 years’ experience in Business Development and Growth roles within start-ups and asset management firms.

Melissa Mittelman creates content at Ethic and is an alumna of Bloomberg News, where she covered private equity & deals. Melissa previously worked at Deutsche Bank, providing institutional, cross-asset sales coverage for ultra-high-net-worth investors.