Historically, direct indexing has been used by institutional investors or ultra-wealthy individuals who could afford to meet high investment minimums. But today, a fast-growing pool of RIAs is seeking to deploy direct indexing in new ways to customize client exposures much further down the wealth spectrum.
Their motivations for doing so are clear, says Manju Boraiah, Allspring’s head of systematic fixed income and co-head of custom separately managed accounts. Both mass affluent and high-net-worth clients are demanding more tax-savvy advice.
They also want portfolios tailored to their long-term investment goals — including retirement and legacy planning — that use traditional and alternative asset classes to right-size risks and return profiles.
“Direct indexing is a powerful means of capturing tax alpha opportunities, reducing concentrated positions or efficiently tilting the portfolio toward a specific sector or values preference,” Boraiah says. “We’ve made great strides in recent years moving our capabilities from the fixed income side of things to the equity and alternatives markets, as well. The opportunity set for RIAs is significant.”
Deploying direct indexing at scale is far from simple, Boraiah warned, and many RIAs are finding the process to be more difficult than they expected. That was the feedback Boraiah received at the Future Proof Festival in Huntington Beach, California, where he was in attendance with Allspring’s recently formed RIA-focused distribution team.
“Future Proof was a really special event that gave us the opportunity to speak directly in a very open setting with a lot of clients and prospects in the RIA space,” Boraiah recounted. “As you know, the wirehouse space continues to be our bread and butter — we’re working with all four, currently — but we see a lot of opportunity in supporting the RIA industry as it seeks to improve its tax-aware investment capabilities.”
With RIAs poised to add more tax-aware investment and income strategies, Boraiah said, adopting and integrating the tools required to do this will be a major challenge that requires collaboration among technology providers, asset managers and advisors.
Where RIAs Fall Short
The advisors who came to Allspring’s booth at Future Proof to learn about SMAs, unified managed accounts and direct indexing were split into two primary camps, Boraiah said.
“The first one is the group of people who have been using off-the-shelf model portfolios, who now realize that they need to add more tax awareness to their models and overall investment process,” he said. “They’ve been either using ETF-only models or mutual fund and ETF models, and now they want to evolve their platform to include custom SMAs and alternatives. That’s where they struggle.”
This approach doesn’t require the unified managed account platform approach to work “well enough," he added, without the needed collaboration.
The second category is RIA aggregators.
“The challenge there is that each team you acquire, they’re all basically in a silo until you do the hard work of actually integrating their investment and client service processes. Against this backdrop, Allspring is speaking with a lot of CIOs at these organizations about how they can advance their scalable portfolio-building capabilities.”
Generally, these chief investment officers will have a model portfolio approach that they want their advisors to use.
“But what they lack is a coherent platform through which to propagate the home office’s approach across all these different teams,” Boraiah observed. “The other problem is that they don’t have an efficient means of transitioning portfolios from the existing state to the new state in a tax-aware fashion.”
Boraiah said he expects the RIA aggregators to make progress in this area as their focus shifts to integration and technological advancement.
“A lot of the big aggregators have been focused almost exclusively on growing their advisors and revenue,” he said. “They haven’t really been focused on integration, but I think we’re reaching a stage where that is quickly changing.”
Big Vision
Some of these RIAs and aggregators are thinking of “leapfrogging forward” to use a platform approach, Boraiah said, where they can deploy alternatives (and traditional asset classes) via separately managed accounts from a custom model framework.
“So they definitely want to go to an open architecture, multi-manager model framework where they can add SMAs across both fixed income, equities and alternatives — including fairly simple alternatives like interval funds,” Boraiah said. “And the vision is to be able to manage that in a more realistic fashion and to be able to efficiently customize those models.”
One ongoing question, Boraiah said, is how CIOs can manage the customization of those models across big and growing teams.
“Overall, I think it’s exciting and challenging at the same time for RIAs, because they know what they want to do, but they don’t necessarily fully understand the ecosystem of technology providers and asset managers. “They don’t necessarily know how to evaluate all these potential platform partners, either. That’s where I think we, as trusted asset managers, can play a big role.”
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