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Clients of all stripes love feeling as though their advisors are doing something special on their behalves. Call it bespoke, customization, tailoring or a synonym of those words, whatever it may be, clients like it. One way for advisors to deliver on that is with direct indexing.
Direct indexing is very much what it is implied. Consider the following definition, courtesy of Ryan Poterack: “Direct indexing involves replicating the performance of an index by directly purchasing the individual securities that constitute it, rather than investing in a mutual fund or an ETF that tracks the index. This method allows investors to own the actual stocks within the index, offering a high degree of customization and control.”
In other words, an advisor offering direct indexing on the S&P 500 conceivably can dial back on the more than 19% of that index controlled by Microsoft (NASDAQ: MSFT), Nvidia (NASDAQ: NVDA) and Apple (NASDAQ: AAPL) and direct some of that weight to other members of the gauge.
Many advisors are already offering direct indexing and with good reason: it’s a favorite among ultra-high-net-worth and other affluent clients. Data also indicate there’s momentum for this methodology in the wealth management community.
Direct Indexing Is Catching On
Among advisors, the current state of direct indexing affairs can largely be broken up into three groups: those already using it, those planning to get on board and those that aren’t there yet. Given the following data, those in the last camp are at risk of being beaten by their competitors.
“In a sign that advisors have accepted direct indexing as a product offering with distinct client benefits, the majority plan to use it more over the next 12 months,” according to the London Stock Exchange Group (LSEG). “Of the third (33%) of advisors already using direct indexing, most (67%) intend to increase usage in the next 12 months. Additionally, more than four in 10 (43%) advisors plan to start using it during this time. Just a quarter (24%) of advisors aren’t using direct indexing and don’t plan to. The vast majority (81%) of advisors expect advancements in AI and automation will help drive the growth of direct indexing.”
Currently, direct indexing is most widely deployed among wirehouse advisors with nearly half offering it to clients. In the ready to embrace it camp, 82% are wirehouse advisors compared to just 53% that are independent RIAs. Arguably, those percentages should be closer because it’s a nearly universal view that direct indexing is an effective avenue for better meeting the demands of wealthy clients.
“Most (74%) also agree direct indexing is an essential offering to have available for HNW/UHNW clients and prospects,” adds LSEG. “The majority of advisors view the strongest level of opportunity for direct indexing with wealthier clients, with 86% indicating a ‘moderate’ or ‘strong’ opportunity for ultra-high-net-worth ($10M+) and 85% for high-net-worth ($1M–$9.99M) clients. Fewer than half (49%) of advisors see a moderate or strong opportunity with affluent ($250,000–$999,999) clients and just 20% see opportunity with the mass affluent ($100,000–$250,000) segment.”
Direct Index Is ‘Essential,’ Youthful
As noted by LSEG, just over half of advisors polled describe direct indexing as “becoming an essential offering to remain competitive in wealth management.” Perhaps not surprisingly, there are age considerations when it comes to advisors and direct indexing.
“63% of NextGen advisors, defined as those under age 45, agreed with this statement versus just 47% of advisors over age 55. The disparity was even greater across channels with 69% of wirehouse advisors supporting this view versus 49% of traditional, 53% of independent broker-dealers and 34% of RIA advisors,” notes LSEG.
When considering the struggles of the industry to attract young people to profession and the desire of many advisors to be somewhat hands-on when it comes to investment management, direct indexing could be an advisor recruitment/retention tool.