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Direct indexing has long been on the radar, but is gaining serious traction with financial advisors and individual investors. It’s particularly attractive to high-net-worth individuals who are looking to reap the benefits of tax-loss harvesting.
As tools develop and advisors seek more personalized investment opportunities for their clients, here’s what asset managers need to know about direct indexing vs ETFs.
Direct indexing offers investors customized solutions and the ability to invest in individual securities within an index rather than investing in the fund itself. This is an attractive proposition to many investors. In comparison to ETFs, index funds, or mutual funds, it gives investors direct ownership of the individual stocks, creating more flexibility and new opportunities.
Advisors are increasingly turning to direct indexing. Below, we explore some of the reasons driving this shift.
Direct indexing doubles as a tax management strategy. Direct indexing can easily incorporate tax-loss harvesting. If an individual stock drops below the cost basis, investors can use that loss to offset capital gains. This lowers tax bills and helps build wealth over time.
Additionally, because investors own each individual security instead of having everything under one fund, each individual security has its own cost basis.
Investors are increasingly interested in customization and want personalized solutions with more control over their investment decisions. Not only does customized market exposure have the potential to reduce risk, it can also filter companies based on ESG criteria and allow investors to express their philosophical preferences through their investments.
It can even restrict sectors or industries entirely. For example, a pacifist might forgo defense companies altogether.
Direct indexing allows investors the opportunity to invest in securities that align with their personal values, helps them meet their investment objectives, and can offer other benefits such as diversification. Many investors prefer this to accepting the broad market exposure that comes with traditional funds.
Direct indexing strategies are on the rise, yet exchange-traded funds (ETFs) continue to grow in popularity. This creates as many opportunities as it does challenges for asset managers.
Here’s what your firm should consider when acquiring and retaining clients:
Target prospects who meet the minimum investment requirements and can justify costs through tax benefits. Focus on high earners in top tax brackets who hold significant assets in taxable accounts, as they stand to gain the most from tax-loss harvesting strategies.
Investors with concentrated stock positions, frequent portfolio rebalancing needs, or existing relationships with tax professionals are often ideal candidates for direct indexing solutions.
SMAs are not ideal for every type of investor. With minimum investments ranging from $100K-$250K, as well as higher costs and fees, direct indexing currently targets high-net-worth investors. SMAs may also have management fees.
Create ROI calculators showing tax savings and develop differentiated service offerings that can give your firm a competitive edge and increase the value proposition for your clients.
You can attract high-net-worth clients by partnering with tax professionals and estate planning attorneys to provide additional perks and opportunities. These include tax optimization strategies, estate planning coordination, and wealth transfer planning.
Due to low costs, tax efficiency, and broad market exposure, the ETF remains a popular, fast-growing vehicle. ETFs continue to attract billions in new assets each year as investors appreciate their transparency, intraday liquidity, and ability to access diverse markets and strategies with minimal effort. "VettaFi's focus is building custom index solutions for clients, based on the highest quality data, that result in products that serve investors interests," said Peter Dietrich, VettaFi's Global Head of Index Sales. "Our partners choose VettaFi not just on our index capabilities, but also our ability to help educate advisors and investors what the strategy is and how to use it in a portfolio."
You can always transition interested clients into direct indexing as their assets grow. Establishing trust through a successful, well-performing product can keep clients in your ecosystem.
It never hurts to build a diversified portfolio that includes direct indexing, ETFs, mutual funds, and every other tool in the box. ETFs are still ideal for investors who are new to investing and want simplicity. They're also ideal wrappers for investors who prefer to invest passively or wish to invest in specific sectors, countries, industries, or trends.
With client acquisition strategies in mind, asset managers also need to consider how to implement direct indexing. It’s easier to implement direct indexing in a portfolio than you may think, especially since the market for sophisticated tools is only expected to grow.
Technologies that can make direct indexing easier include:
Asset managers should consider adding direct indexing investments to portfolios now. By the end of 2028, direct indexing is expected to exceed the growth of ETFs and mutual funds and double to approximately $1.1 trillion.
When building a direct indexing portfolio, follow these steps:
One other thing to consider is that direct indexing is often centered around the S&P 500 index, which negates some of its diversification possibilities. The S&P 500 represents only the U.S. equity market, leaving out small and midcap companies with growth potential. Direct indexing is an ideal tool to invest in international markets, small and midcap stocks, and alternative U.S. large-cap indexes.
As clients build wealth, it makes sense for them to add direct investing to their portfolio, even if only as a tax savings opportunity.
According to Parametric’s Jeremy Milleson: “Direct indexing isn’t a whole new asset class, it’s an investment technique designed to fit comfortably with an investor’s existing allocation.” In other words, asset managers can help advisors serve their clients by combining direct indexing with ETFs.
Because of changes in the investment landscape and the development of tools like direct indexing, asset managers should prepare for the inevitable impacts on revenue.
Noteworthy impacts include:
The margins on traditional fund management are tight. However, while direct indexing requires an investment in tools and capabilities, it can be a significant value add for asset managers.
The ability to offer tax-loss harvesting, customization, and personalized solutions can justify higher fees and create stronger client relationships that go beyond simple product sales.
Even with the rise of direct indexing, ETFs and mutual funds have their place. However, asset managers should strive to personalize and adapt their business models using the following methods:
Move beyond traditional AUM-based fees to value-based pricing models. It could also be worth considering transaction-based or performance-based fee components for tax alpha generation. Asset managers can justify higher fees through demonstrable tax savings and the additional value gained for customization.
Adding tax management expertise and capabilities to investment management creates more value for clients. Developing ESG screening tools or values-based investing competencies can bring in more investors. Asset managers need to look beyond basic portfolio construction and create comprehensive wealth management solutions.
Differentiate from low-cost robo-advisors through personalized service and sophisticated tax advice. Look at fintech companies that combine tech with human expertise, and carve out a place as a premium service provider for the high-net-worth segment rather than a mass market competitor.
Asset managers could find success pivoting away from simply being focused on product sales and into ongoing advisory relationships that focus on long-term wealth outcomes over the short-term performance of a particular fund. Deepen client engagement through customization and tax optimization.
While the benefits of direct indexing are incredible, ETFs still serve valuable functions in investor portfolios. Asset managers must understand when to recommend each approach.
ETFs remain ideal for:
Direct indexing works best for:
Sometimes, a hybrid approach is best. ETFs can serve as client acquisition tools and provide broad market exposure, while direct indexing can be layered in as clients’ assets grow and their needs become more sophisticated.
VettaFi helps asset managers innovate and evolve to better meet the needs of their clients. Our firm is uniquely positioned to help asset managers develop and distribute the products and services that will be transformative for years to come.
Direct indexing has long been on the radar, but is gaining serious traction with financial advisors and individual investors. It’s particularly attractive to high-net-worth individuals who are looking to reap the benefits of tax-loss harvesting.
As tools develop and advisors seek more personalized investment opportunities for their clients, here’s what asset managers need to know about direct indexing vs ETFs.
Direct indexing offers investors customized solutions and the ability to invest in individual securities within an index rather than investing in the fund itself. This is an attractive proposition to many investors. In comparison to ETFs, index funds, or mutual funds, it gives investors direct ownership of the individual stocks, creating more flexibility and new opportunities.
Advisors are increasingly turning to direct indexing. Below, we explore some of the reasons driving this shift.
Direct indexing doubles as a tax management strategy. Direct indexing can easily incorporate tax-loss harvesting. If an individual stock drops below the cost basis, investors can use that loss to offset capital gains. This lowers tax bills and helps build wealth over time.
Additionally, because investors own each individual security instead of having everything under one fund, each individual security has its own cost basis.
Investors are increasingly interested in customization and want personalized solutions with more control over their investment decisions. Not only does customized market exposure have the potential to reduce risk, it can also filter companies based on ESG criteria and allow investors to express their philosophical preferences through their investments.
It can even restrict sectors or industries entirely. For example, a pacifist might forgo defense companies altogether.
Direct indexing allows investors the opportunity to invest in securities that align with their personal values, helps them meet their investment objectives, and can offer other benefits such as diversification. Many investors prefer this to accepting the broad market exposure that comes with traditional funds.
Direct indexing strategies are on the rise, yet exchange-traded funds (ETFs) continue to grow in popularity. This creates as many opportunities as it does challenges for asset managers.
Here’s what your firm should consider when acquiring and retaining clients:
Target prospects who meet the minimum investment requirements and can justify costs through tax benefits. Focus on high earners in top tax brackets who hold significant assets in taxable accounts, as they stand to gain the most from tax-loss harvesting strategies.
Investors with concentrated stock positions, frequent portfolio rebalancing needs, or existing relationships with tax professionals are often ideal candidates for direct indexing solutions.
SMAs are not ideal for every type of investor. With minimum investments ranging from $100K-$250K, as well as higher costs and fees, direct indexing currently targets high-net-worth investors. SMAs may also have management fees.
Create ROI calculators showing tax savings and develop differentiated service offerings that can give your firm a competitive edge and increase the value proposition for your clients.
You can attract high-net-worth clients by partnering with tax professionals and estate planning attorneys to provide additional perks and opportunities. These include tax optimization strategies, estate planning coordination, and wealth transfer planning.
Due to low costs, tax efficiency, and broad market exposure, the ETF remains a popular, fast-growing vehicle. ETFs continue to attract billions in new assets each year as investors appreciate their transparency, intraday liquidity, and ability to access diverse markets and strategies with minimal effort. "VettaFi's focus is building custom index solutions for clients, based on the highest quality data, that result in products that serve investors interests," said Peter Dietrich, VettaFi's Global Head of Index Sales. "Our partners choose VettaFi not just on our index capabilities, but also our ability to help educate advisors and investors what the strategy is and how to use it in a portfolio."
You can always transition interested clients into direct indexing as their assets grow. Establishing trust through a successful, well-performing product can keep clients in your ecosystem.
It never hurts to build a diversified portfolio that includes direct indexing, ETFs, mutual funds, and every other tool in the box. ETFs are still ideal for investors who are new to investing and want simplicity. They're also ideal wrappers for investors who prefer to invest passively or wish to invest in specific sectors, countries, industries, or trends.
With client acquisition strategies in mind, asset managers also need to consider how to implement direct indexing. It’s easier to implement direct indexing in a portfolio than you may think, especially since the market for sophisticated tools is only expected to grow.
Technologies that can make direct indexing easier include:
Asset managers should consider adding direct indexing investments to portfolios now. By the end of 2028, direct indexing is expected to exceed the growth of ETFs and mutual funds and double to approximately $1.1 trillion.
When building a direct indexing portfolio, follow these steps:
One other thing to consider is that direct indexing is often centered around the S&P 500 index, which negates some of its diversification possibilities. The S&P 500 represents only the U.S. equity market, leaving out small and midcap companies with growth potential. Direct indexing is an ideal tool to invest in international markets, small and midcap stocks, and alternative U.S. large-cap indexes.
As clients build wealth, it makes sense for them to add direct investing to their portfolio, even if only as a tax savings opportunity.
According to Parametric’s Jeremy Milleson: “Direct indexing isn’t a whole new asset class, it’s an investment technique designed to fit comfortably with an investor’s existing allocation.” In other words, asset managers can help advisors serve their clients by combining direct indexing with ETFs.
Because of changes in the investment landscape and the development of tools like direct indexing, asset managers should prepare for the inevitable impacts on revenue.
Noteworthy impacts include:
The margins on traditional fund management are tight. However, while direct indexing requires an investment in tools and capabilities, it can be a significant value add for asset managers.
The ability to offer tax-loss harvesting, customization, and personalized solutions can justify higher fees and create stronger client relationships that go beyond simple product sales.
Even with the rise of direct indexing, ETFs and mutual funds have their place. However, asset managers should strive to personalize and adapt their business models using the following methods:
Move beyond traditional AUM-based fees to value-based pricing models. It could also be worth considering transaction-based or performance-based fee components for tax alpha generation. Asset managers can justify higher fees through demonstrable tax savings and the additional value gained for customization.
Adding tax management expertise and capabilities to investment management creates more value for clients. Developing ESG screening tools or values-based investing competencies can bring in more investors. Asset managers need to look beyond basic portfolio construction and create comprehensive wealth management solutions.
Differentiate from low-cost robo-advisors through personalized service and sophisticated tax advice. Look at fintech companies that combine tech with human expertise, and carve out a place as a premium service provider for the high-net-worth segment rather than a mass market competitor.
Asset managers could find success pivoting away from simply being focused on product sales and into ongoing advisory relationships that focus on long-term wealth outcomes over the short-term performance of a particular fund. Deepen client engagement through customization and tax optimization.
While the benefits of direct indexing are incredible, ETFs still serve valuable functions in investor portfolios. Asset managers must understand when to recommend each approach.
ETFs remain ideal for:
Direct indexing works best for:
Sometimes, a hybrid approach is best. ETFs can serve as client acquisition tools and provide broad market exposure, while direct indexing can be layered in as clients’ assets grow and their needs become more sophisticated.
VettaFi helps asset managers innovate and evolve to better meet the needs of their clients. Our firm is uniquely positioned to help asset managers develop and distribute the products and services that will be transformative for years to come.
