Direct indexing has been around for more than 30 years, yet many people still don’t know what it is or how it continues to grow and evolve. We dive into the history, and more importantly the future, of direct indexing and how Parametric pioneered this space.
Building portfolios quantitatively was once a brand-new idea—one that Parametric’s founders made the foundation of a whole company. Parametric has since taken the principles of market efficiency, transparency, attention to taxes and risk and made it into a strategy that’s thrived for more than 30 years: direct indexing. But how did it start, and what’s the future of this established strategy?
How did direct indexing begin?
When Parametric’s founders brought the new idea to the firm where they all worked, the firm didn’t think it fit its brand. It was the inspiration Mark England-Markun, Bill Cornelius and Randy Lert needed to begin something new: an industry leader in custom solutions.
At the time, they were using technology to look at the risk-return attributes of stocks. Then a large family office came to them with a question: Can we have a portfolio that behaves like an index but is thoughtful about taxes? That’s when the first custom portfolio designed around a client-chosen benchmark began. Little did they know that’s how the seed of direct indexing was planted. That family office is still a client today.
What is the future of direct indexing?
Client demand for personalized investment strategies continues to increase, and direct indexing has become one of the fastest growing segments in the managed account space. According to a 2021 Cerulli Associates report, direct indexing is the leading category for manager-traded SMAs, with direct indexing assets expected to top $800 billion by 2026.
We believe that for direct indexing to keep moving forward, scalability and customization must go hand in hand. Like we often say, we make passive investing personal. We focus on adapting our skills to each investor’s challenges and being completely transparent with our methods. We also aim to balance the needs of scale and personalization to make our onboarding and support systems seamless.
We think we’ll continue to see increased adoption as more investors seek tax-efficient solutions and customization options and the use cases continue to expand. It’s also possible that it can work for more complex solutions, including multi-asset portfolios where direct indexing can be used as a core for more tax efficiency across the client’s overall portfolio.
How is Parametric innovating in the direct indexing space?
In the late 1980s and early 1990s, the technology that Mark, Bill and Randy built would take a full 11 hours to calculate trades. We’ve focused on consistently developing that technology since its inception. Those early machines took overnight to do what we can now produce in moments—and a much more robust report at that. Our technology and methods seek to provide systematic, client-focused solutions with repeatable outcomes.
Interest accelerated in direct indexing in 2020 and 2021, with several big-name companies acquiring firms that provide direct indexing services. Other major wealth management platforms started offering this service in response. We hope this will continue to raise awareness of the potential benefits of direct indexing.
We keep our focus on continually enhancing our processes and capabilities, working to increase tax efficiency, better manage risk and enhance and expand capabilities. Our most recent optimization enhancements have focused on refining our loss harvesting process, as well as enhancing how we trade volatile securities. Our update on how we trade volatile securities is an example of how we look to refine our techniques as market conditions change.
Our research and strategy team is tasked with continuing to develop and evolve our strategies, and they spend a lot of time thinking about tradeoffs. Though we’re big proponents of tax-loss harvesting all year round, not all tax losses are created equal. We want to make sure that losses don’t come at the expense of pre-tax returns. We’ve fine tuned our approach through many market environments so that it aims to deliver the most efficient balance of realized losses per unit of single-stock risk.
Investors are also growing increasingly comfortable using passive exposures to fulfill the high-quality fixed income portions of their portfolios, and the trend is only accelerating. Compared with actively managed bond allocations, laddered portfolios allow for more predictable return outcomes in changing interest rate environments. Investors can incorporate active tax management into their bond ladders, with customizations based on maturity range, credit quality, geography and responsible investing guidelines. We’re pleased to say that the ability to connect fixed income and direct indexing to advisors and investors won Parametric a WealthManagement.com 2024 Industry Award.1
Personalize tax-managed portfolios around client needs
The bottom line
The ideas that made Parametric what it was in 1987 still hold today: efficiency, transparency, attention to taxes and risk and, above all, listening to client needs. We stay innovative by listening to investor challenges and daring ourselves to meet them. Direct indexing continues to grow in popularity, and its range of use cases expands in turn. It can be a powerful tool to help investors take control of their portfolios in a world where customization is increasingly desirable.
1The Wealthmanagement.com Industry Awards are independently granted in recognition of business initiatives introduced or enhanced in the previous 18 months that enhance financial advisor success and help advisors create better outcomes for their clients. Submissions are reviewed and ranked by a panel of independent judges with required industry expertise, looking at the submission’s innovation, scope and impact. No financial compensation is paid for consideration in the award process.
The views expressed in these posts are those of the authors and are current only through the date stated. These views are subject to change at any time based upon market or other conditions, and Parametric and its affiliates disclaim any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for Parametric are based on many factors, may not be relied upon as an indication of trading intent on behalf of any Parametric strategy. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. Past performance is no guarantee of future results. All investments are subject to the risk of loss. Prospective investors should consult with a tax or legal advisor before making any investment decision. Please refer to the Disclosure page on our website for important information about investments and risks.
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