Direct Indexing Presents New Opportunities for Customization of Separately Managed Accounts

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Direct Indexing Presents New Opportunities for Customization of Separately Managed Accounts

Fintech solutions and new industry developments are key to enabling mass customization

October 2020, BOSTON—Direct index separately managed accounts (SMAs) present opportunities for tax optimization at scale and fintech solutions that permit mass customization may provide the silver bullet, according to the latest Cerulli Edge—U.S. Managed Accounts Edition.

Firms distributing managed accounts have long promoted the ability of these products to be customized for individual client attributes such as taxes. But so far, only half (53%) of managed accounts receive tax treatment, with only 16% subject to ongoing systematic tax optimization. Nearly half (47%) receive no tax treatment at all, and only 24% benefit from tax location strategies. “At a time when overlay management of taxes is readily available, this low proportion represents a failure to realize the long-articulated benefits of managed accounts,” according to Tom O’Shea, director.

Recent industry developments—the disappearance of brokerage commissions, use of fractional shares, and ever-increasing sophistication of algorithmic portfolio construction techniques—have increased the opportunity to expand tax optimization to a broader set of clients, allowing the industry to deliver on the promise of tax customization. “The absence of trade commissions and increased sophistication of technology has made it possible for managed accounts to customize portfolios at a lower price point to more wealth tiers,” adds O’Shea. According to the research, 67% of asset management firms believe direct indexing presents the most immediate opportunity to manage for both tax and environmental, social, and governance (ESG) factors.

Due to the high-touch interaction required to facilitate direct index SMAs, evaluating and deploying technology will become increasingly important. “Advisors need to work with clients to assess trade-offs,” states O’Shea. “The options advisors present to investors when evaluating whether to generate tax alpha or observe ESG rules against the deviation from the index will require technology.” The research suggests the need for asset managers to build a console that allows the advisor to construct portfolios in consultation with their clients and communicate this information to the portfolio manager. “To do this, the industry has to move to tech-enabled solutions,” adds O’Shea.

Managed accounts have long been touted for their ability to be customized for the unique circumstances of each investor, particularly their tax situation. Yet decades after the emergence of this product, the industry could do more to create a personalized investment experience through managed accounts. “The growing availability of fintech solutions that can support mass customization may help the financial services industry better deliver these benefits,” concludes O’Shea.

 

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NOTES TO EDITORS

These findings and more are from The Cerulli Edge—U.S. Managed Accounts Edition, 3Q 2020 Issue.

 

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