Direct index investing, known primarily for low-cost tax optimization, has risen dramatically over the past five years as a tailored investment strategy, hitting $864.3 billion in assets by the end of 2024. However, according to the latest research from Cerulli Associates, registered investment advisors still use it in limited quantities.
According to the Boston-based consultancy, only 18% of advisors reported using direct index strategies, up somewhat from 2023’s 16%. And the hill looks steep for more advisors to start implementing them, with 26% of advisors choosing not to use direct indexing with clients despite having access to it and 12% not even knowing what it is.
“Adoption of these financial solutions among financial advisors has yet to match the apparent popularity across the industry,” the consultancy wrote.
Direct indexing has become a much-discussed strategy for customizing an index investment for a client for tax strategy purposes, to meet investor preferences, or to better track a rules-based investment strategy. Wealth management platform providers such as Envestnet and Orion offer advisors access to direct indexing, as do the wirehouses and independent broker/dealers.
At the moment, it is being used mostly by wirehouse advisors who are using separately managed accounts, the vehicles used to administer them, according to Cerulli.
“I would tend to agree that advisors in the independent broker/dealer channel are more inclined to adopt direct indexing,” said Cerulli research analyst Michael Manning. “Research from Cerulli’s advisor survey suggests that (broker/dealers) across all channels currently adopt SMAs at a higher rate than RIAs. Advisors were also asked about their expected product use through 2026, and this trend is expected to remain consistent.”
In an interview with WealthManagement.com earlier this year, Brandon Thomas, co-founder and co-chief investment officer at Envestnet, noted that direct indexing is the fastest-growing product on the Envestnet platform.
He attributed its popularity to its low cost, transparency in terms of objective, strategy and outcome compared to actively managed investments, tax management benefits, and ease of customization that aren’t available in ETFs, index mutual funds and active separately managed accounts.
According to Cerulli, those traits may not be reaching many of the advisors who would consider implementing them, partly because they get mixed up with the vehicle that can be used to administer them—separately managed accounts.
“Many financial advisors either do not understand direct indexing or do not understand it to the degree necessary to discuss it with clients and implement it into their portfolios,” the firm wrote.
The demand for SMAs that offer direct indexing strategies appears to be there if providers can communicate the message, according to Cerulli.
According to a survey of distribution executives, 53% said model-delivered SMAs were in high demand from wirehouses and broker/dealers, and 44% said manager-traded SMAs were in high demand.
SMAs were less in demand among advisors but still showed decent interest at 34% for manager-traded SMAs and 27% for model-delivered.
Cerulli cited one executive at a turnkey asset management program provider, who said: “[We still see] significant direct indexing growth. About five to 10 years ago, [demand] was more institutional, but, increasingly, wealth platforms are enabling movement and access downmarket to advisors.”
The top direct indexing providers are seeing growth. According to Cerulli, in both 2021 and 2024, the compound annual growth rate for firms that reported assets over the three-year period was 22.4%.
The beneficiaries are concentrated among the top five early movers, who account for 86.9% of total assets. They are Morgan Stanley (via its Parametric direct indexing business), Goldman Sachs Asset Management, Northern Trust, BlackRock and Fidelity Investments.
“Despite the current concentration, there is room for disruption,” Cerulli wrote, noting “asset managers with existing wholesaler teams, financial advisor relationships, and pipelines into key platforms (e.g., broker/dealers (B/Ds), turnkey asset management programs (TAMPs), enterprise registered investment advisors. (RIAs))”
Envestnet, for its part, appears at No. 9 in terms of direct indexing assets, LPL Financial at No. 11, Robert W. Baird at No. 12, Ameriprise Financial at No. 13, and Orion Advisor Solutions at No. 19.
Cerulli wrote that broker/dealer firms have the potential to build their own direct indexing option or acquire a provider.
One broker/dealer executive told the researchers: “We don’t have the scale of use to require it [right now], although if demand increases for direct indexing solutions, we may consider building [internally].”
Independent RIAs, meanwhile, will likely be hearing from direct index providers they can use as vendors.
Cerulli also floated the idea of leveraging index-based ETFs to get RIAs to consider direct indexing, as they are more popular among that set than SMAs.
“While a steep challenge, asset managers could look to this channel as a potentially fruitful opportunity,” the researchers wrote.
Cerulli noted that the direct indexing strategy may not be for all advisors, writing that “certain client segments cannot meet the high minimums to invest in an SMA. Even with decreasing minimums due to increased adoption of fractional shares, the cost of the product may not be worth the tax optimization elements for many investors, or investors may not see a benefit from the portfolio customization potential.”
The consultancy also put the more than $864.3 billion in direct indexing advisor adoption in context: exchange-traded funds accounted for $9.4 trillion at the end of 2024, and mutual funds held $6.6 trillion.