Direct Indexing’s Not Exactly an ‘ETF Killer’ 

It turns out the “ETF killer” thing might have been a stretch.

Direct indexing, an investment strategy that buys and holds stocks for clients directly in separately managed accounts, was expected to go toe-to-toe with the exchange-traded fund industry and even undercut much of the value of indexed products. By owning the underlying securities directly, the strategy gives clients the increased benefits of creating their own customized indexes and tailoring tax strategies. The threat was real enough for top assets managers, like Morgan Stanley, BlackRock and Vanguard, to spend billions snapping up direct-indexing firms of their own. 

But new research from Cerulli Associates is suggesting those fears may have been overblown. Just 18% of advisors used direct indexing last year, and 12% don’t even know what it is … awkward.

Get Rich Quick 

Sure, the strategy has opened up new personalized indexes to investors, but it’s also a niche service that benefits super-wealthy investors the most. While direct-indexing assets closed 2024 at $864.3 billion, that’s still tiny compared with $9.4 trillion in ETFs, according to Cerulli. The reason could be that the benefits of direct indexing, like tax-loss harvesting, are more significant for the wealthiest clients that have the most tax liabilities. Without benefiting a broad range of investors, the popularity and growth of direct indexing may be muted, according to the report.

While asset managers have long feared the fast-growing direct-indexing marketplace, those fears may be fizzling out. “The gains one can realize on a small portfolio are by definition more limited,” said William Trout, director of securities and investments at Datos Insights. “While there are many advantages to direct indexing, and adoption by advisors and clients will grow over time, it’s not a silver bullet.”

In other bad news, advisory firms in the US are converting assets held in separately managed accounts into ETFs. According to a separate Cerulli report from this week: 

• Assets held in all SMAs topped $2.7 trillion with more than half, or $1.6 trillion, in wirehouses and another $484 billion within the registered investment advisory channel. 
• Yet just 45% of advisors report using separate accounts, compared with 90% using the ETF structure.

Educate Me. Advisors who have worked in SMAs before are far more comfortable articulating the benefits of direct indexing to clients, Trout said. Explaining concepts like tax-loss harvesting and capital gains deferral is no easy feat, especially if clients could potentially get hit with a tax bill by transitioning a client from a legacy portfolio. But advisors will slowly come on board, he said.

“The bottleneck here is really the financial advisor,” Trout told ETF Upside. “Education on the benefits of direct indexing is definitely needed for advisors to be able to sell it effectively.”