The Direct Index Arms Race. And You.

What BlackRock’s purchase of Aperio and Morgan Stanley’s purchase of Eaton Vance/Parametric means to you.

BlackRock recently announced that they are purchasing direct-index provider Aperio. Last month, Morgan Stanley bought Eaton Vance, the parent company of direct-index provider Parametric portfolios. (A direct index is like an index ETF, but where the investor directly owns some or all of the securities in the index¹). Why all this activity?²

Well, here’s what BlackRock had to say:

“The wealth manager’s portfolio of the future will be powered by the twin engines of better after-tax performance and hyper-personalization…{We} will bring institutional quality, personalized portfolios to ultra-high net worth advisors and will create one of the most compelling client opportunities in the investment management industry today.” (Link)

And here’s what RIABiz had to say about Morgan Stanley buying Eaton Vance:

“Morgan Stanley's Eaton Vance deal yields a golden nugget — Parametric — and a means to own the direct-indexing super trend…{the} Seattle-based subsidiary Parametric, which has no equal in its category, is the key to the deal.” (Link)

Aperio and Parametric were purchased because demand for direct indexes is growing. Parametric and Aperio have grown at roughly 20% per year for more than a decade. And the reason for the growth is straightforward: direct indexes are more customizable and more tax efficient than ETFs and mutual funds. (See Mutual Funds and ETFs Are Dead, Direct Indexes Are Better Than ETFs, and Why Not Direct Indexes?) 

Direct indexing is pretty clearly here to stay, and firms that don’t offer direct indexes and other separately managed account options will be at a competitive disadvantage. Where does that leave you if you’re not Morgan Stanley or BlackRock?

Actually, in pretty good shape. Managing tax-optimized and customized direct index portfolios used to be a highly specialized skill, one that required expertise in quantitative financial methods. This is no longer true. Ordinary practitioners now have access to technology³ that can automate the management of sophisticated direct indexes. By leveraging more modern infrastructure, newcomers to direct indexing have the potential to not just equal but leapfrog existing providers like Aperio (BlackRock) and Parametric (Morgan Stanley) in terms of scale, price, quality and functionality. 

Let’s break that down. Newcomers to direct indexing have the potential to leverage rebalancing automation to offer direct indexing to a broader market and at lower prices than incumbents. Newcomers can offer more customization options, such as unlimited asset allocation and product choice customization. And, importantly, newcomers can do a better job of holistically managing portfolios that contain direct indexes. 

Your greatest competitive strength is that you know your clients better than anyone else. That’s obviously important for financial planning and choosing appropriate product mixes. But it’s also critical for creating customized portfolios. When the value proposition is centered on customization to meet your client’s needs, you have the advantage. Armed with the right direct indexing technology, no one — not BlackRock, not Morgan Stanely, not Aperio, not Parametric — can serve your clients as well as you.

¹ The term “direct index” is sometimes used to refer more generally to the idea of bundling or “unwrapping” mutual funds and ETFs, regardless of whether the strategy is literally following an index. In this sense, “direct index” basically means the same thing as a separately managed account (SMA), but with less implication of a specific implementation structure typically associated with SMAs.  

² Also, JP Morgan just announced they are purchasing 55IP, which, while not a direct-index provider, does, like Aperio and Parametric, focus on customization.

³ Such as our automated rebalancing workflow platform.