A deal by large money manager Franklin Templeton to acquire O’Shaughnessy Asset Management, a trailblazer of personalized stock portfolios, further nudges financial advisors to embrace a retail investing trend that’s sweeping Wall Street.
San Mateo, California-based Franklin
Called “
The benefit of custom indexing consists of having a portfolio that’s all about you and your beliefs. Meanwhile, the advantage of direct investing comes from tax benefits. Investors use direct indexing to reduce their tax bills through so-called tax-loss harvesting, in which losing investments are sold in order to offset taxable gains on other stocks that are sold at a profit.
Both methods involve an advisor actively picking and trading stocks, which makes them relatively expensive. Fees are “in many cases a multiple of what you would pay for a broad-based portfolio of low-cost active funds, ETFs or mutual funds,”
With higher costs and steep minimums, the two indexing methods have been a service mainly for affluent and ultra high net worth investors, and for firms whose advisors focus on that demographic.
That could be on the cusp of changing.
Franklin President and CEO Jenny Johnson said in a
Going mainstream?
Advisors typically require minimums of $100,000 to $1 million for indexing. Bing Waldert, a managing director at Cerulli Associates, said Thursday in an interview that the methods were currently “a high-end solution” for “high-end wealth managers” with affluent to very wealthy clients. But what are now niche, upscale strategies would become more mainstream.
“Almost every major financial services company would not invest in this if it were just for rich people,” Waldert said.
Over the past 15 months,
O’Shaughnessy
“Custom indexing represents a significant area of growth in asset management today,” the Franklin statement said Thursday. Patrick O’Shaughnessy, the acquired firm’s CEO, called custom indexing in the statement “the next progression of investing.”
Cerulli Associates
“Eat and absorb your future competition before it eats you?”
Pros and cons
The two indexing techniques reflect the increasingly personalized thrust of “holistic” financial planning, in which an advisor focuses on a client’s complete financial life and individual goals.
“There is a quantifiable way to show a client how much extra value comes from the tax management,” said Jim Dowling, a managing partner at Altium WealthManagement, an advisory firm based in Purchase, New York, which has embraced direct indexing.
Far from all financial planners are sold on the methods. Some smaller independent advisors worry that because custom and direct indexing involve active management of stocks, not passive mirroring of them, trading costs will rise and customer statements will become unwieldy.
Others see it as a fad. Last December, Cerulli
What's more, direct indexing “introduces unique trading difficulties for advisors who may start trading large quantities of individual stocks at the click of a button, after years of being mutual fund & ETF focused,” Kitces
James Dilworth, a co-founder and managing partner at Veriti Management, a registered investment advisor in Boston, countered that an investor’s savings from tax-loss harvesting help pay for the advisor’s higher fee. He added that the shift to low- and zero-cost trading commissions and the emergence of fractional shares, in which investors can buy a portion of a stock, could keep costs down.
The two indexing trends are something smaller independent advisors need to be aware of, Waldert said. “Maybe it’s on your radar screen, but for a smaller advisor with mass market clients, the solutions aren’t built for that today.”
Still, he added, Wall Street “is thinking, how do I take something custom and make it scalable? How do we bring it down market for less affluent clients?”
