Registered investment advisors are more hesitant to use direct indexing than their wirehouse peers for reasons including the challenge of incorporating it into their systems, according to FTSE Russell’s second annual direct indexing survey.
In a survey of over 400 financial advisors released Monday, the index and benchmarking firm found that 63% of wirehouse advisors are confident about using direct indexing with upper-high-net-worth clients compared to 45% of RIAs.
The channel difference among advisors was even more stark when asked if they think direct indexing is “becoming an essential offering to remain competitive in wealth management.” In total, 52% said yes. However, 69% of wirehouse advisors agreed with the sentiment compared to just 34% of RIAs.
Ryan Sullivan, head of buy-side Americas at FTSE Russell, said the firm sees long-term growth promise among RIAs, but noted challenges including a lack of education and ease of access.
Regarding know-how, the firm found that 8 out of 10 advisors are uncomfortable “explaining the solution to their clients.”
“It seems like their understanding of the benefits, concerns about implementation and the use of direct indexing as an asset allocation tool might not be there just yet,” Sullivan said.
Even if advisors want to use direct indexing, integrating and managing it within their technology stacks can be challenging.
“Some of this is just that advisors need clients to push for these solutions before they might undertake full-blown due diligence of various tools that they could access today and how quickly and cost-effective implementation could be,” Sullivan said.
When the rubber hits the road on implementing the investment option, only 33% of those advisors report using direct indexing. But, in what FTSE Russell sees as a positive sign, 43% plan to use it in the next 12 months, with just 23% of advisors with no plans to implement.
Mark Stancato, founder and lead advisor with VIP Wealth Advisors based in Decatur, Ga., is one of those RIAs that uses direct indexing.
“For the right client, it is one of the most effective tax optimization tools available,” Stancato said via email. “When paired with thoughtful tax-loss harvesting, direct indexing can materially improve after-tax returns over time.”
Stancato also said he likes the control direct indexing provides him compared to an ETF or mutual fund, as it gives him flexibility to harvest losses in specific positions.
“Those losses can then be used to offset capital gains elsewhere or reduce taxable income, creating compounding tax value year after year,” he said.
The top reason advisors would offer direct indexing is tax-loss harvesting, which 57% of those surveyed said they would do. This was followed by tax-efficient transitions, 32%, reducing concentration risk, 23%, and reducing investment costs, 19%.
Another factor may be the push toward personalizing investment options. Seventy-nine percent of advisors agree that direct indexing offers personalization that ETFs and mutual funds can’t match.
The opportunity for direct indexing appears to be most useful for higher-net-worth clients. Eighty-six percent of advisors see “moderate” or “strong” use cases for people with $10 million or more in assets, and 85% see good use for clients with $1 million to $9.99 million. However, only 49% of advisors see it as applicable for clients with $250,000 to $999,999 in assets, and just 20% would use it for those with $100,000 to $250,000.
For some RIAs, holdups to using direct indexing come from a combination of factors. One is a lack of client demand, which 45% of advisors cited as a barrier to using the investment option. Other issues were “complexity makes educating clients difficult” (34%) and a lack of understanding and knowledge (27%).
Alvin Carlos, a financial planner and managing partner with District Capital Management in Washington, D.C., said his firm does not offer direct indexing in part because it has a younger client base.
“For most of our clients, who are mostly professionals in their 30s and 40s, direct indexing is not cost-effective compared to broadly diversified ETFs, especially at lower account sizes,” he said. “The main benefit of direct indexing is the ability to customize portfolios and harvest tax losses, but the complexity and higher minimums often outweigh the benefits for our client base.”
Carlos said clients don’t mention direct indexing, and at the moment, the firm doesn’t see a strong use case for it.
“For now, we find that ETFs provide strong diversification and tax efficiency with less complexity,” he said.
Even if they’re using direct indexing, most advisors anticipate “some level of friction” when implementing it for a client, with only 13% saying it is “very easy.”
Advisor Stancato agreed that direct indexing can be complex and is not a set-it-and-forget-it strategy. He noted that it can involve trading dozens and sometimes hundreds of underlying positions and requires an automated component to work well.
“The technology makes the strategy scalable, but expert oversight remains critical to ensure it aligns with each client’s broader financial plan,” he said.
In the end, the younger generation of advisors may be the ones to advance direct indexing. About four in 10 (44%) of advisors under 45 use direct indexing, compared to only 26% of those aged 55 and over. FTSE Russell’s Sullivan called this interest among younger advisors a “green shoot.”
“More targeted education to advisors and end clients regarding the use case and best practices in implementation will help improve the perception of direct indexing,” he said. “As more investors become familiar with the applications and availability, we’ll see more RIA adoption.”
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