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What’s Next in ETFs? The Great Unwrapping

The age of ETF domination is over, said Matt Hougan and Dave Nadig at Inside ETFs. Direct indexing is the next big disruption.

Inside ETFs Chairman Matt Hougan and CEO Dave Nadig took the stage Monday morning at the Inside ETFs conference in Hollywood, Fla., and reiterated their prediction that ETF assets would eventually surpass mutual fund assets in the coming years. But the age of ETF domination is over, Hougan declared. And with any technology, it’s never the end of history; something will disrupt the space. 

The next big thing in investing will be direct indexing, Hougan told attendees, a kind of separately managed account for the masses.

“Dave and I want to welcome you to the next phase of the asset management industry, what we’re calling ‘the great unwrapping,’ where your process of getting from wanting securities to owning securities doesn’t have anything in between—doesn’t have a fund structure,” Hougan said. “We think this is a major new development out there.”

The idea behind direct indexing is, instead of owning a wrapper with 500 stocks, an investor can own a personal index that owns however many stocks they want, optimized to track that index within a certain band of tolerance. An investor can customize a portfolio to fit their beliefs, customize it to their personal employment situation (to avoid concentration) and tax loss harvest.

“Most people in taxable accounts are leaving 1 to 2 percent per year in harvested losses on the ground because they’re not doing tax-loss harvesting,” Hougan said.

Direct indexing has been around; firms such as Parametric, owned by Eaton Vance, and Aperio Group, already offer direct-indexing strategies.

And the market is huge, Hougan argued. Parametric’s custom core direct-indexing solution topped $100 billion in assets last year. It pulled in $10.8 billion in assets last year, while the rest of Eaton Vance pulled in $6.2 billion. In the past two years, Aperio’s custom-indexing solution doubled in size to $22 billion in assets.

“If Parametric were an ETF issuer, it would be the sixth-largest ETF issuer today and the fourth-largest growing. Aperio Group would be the 10th-largest ETF issuer; it’d be the sixth-largest growing. This is not pointy-headed stuff. It’s here today.”

In fact, the quiet growth of this space reminds Hougan a lot of the ETF industry in 2003.

“In 2003, there were a bunch of us running around saying, ‘These ETFs are great. Look at the growth rates.’ And the mutual fund industry was like, ‘Talk to me when you have $1 trillion in assets.’”

Advisors stand to be big winners in the move toward direct indexing, Hougan said.

“When I think about you building portfolios and you out there competing, and you’re competing with Wealthfront and Vanguard and Schwab,” Hougan said. “I just see a bunch of sadness. But when I think about designing portfolios that you get to know your clients and you build Bob’s portfolio and you build Janet’s portfolio and you build specific portfolios that you’re delivering with tax-loss harvesting, in a mixture of direct indexing and ETFs, I think I see the next $1 billion, $10 billion, $100 billion financial advisor opportunity.”


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