Fidelity to open direct indexing to the masses

Asset manager Fidelity plans to roll out a direct indexing tool in the US that will require investment of as little as $1 per stock, in a significant move to open up the concept to small investors.

The direct indexing concept, which allows investors to create bespoke portfolios tailored to their personal preferences, is widely seen as a long-term threat to traditional pooled vehicles such as mutual and exchange traded funds.

Once limited to wealthy investors, Fidelity’s move is the latest sign of direct indexing expanding into the mass market, particularly in the US.

The Fidelity Solo FidFolios platform will carry a monthly fee of just $4.99. It will allow investors to create custom indices, either by building one from scratch or selecting one of 13 Fidelity thematic stock models. Investors can then customise the models by adding or removing stocks or adjusting their weights.

The available thematic models are cloud computing, cyber security, 5G “future connectivity”, electric vehicles, clean energy, fintech, digital health, biotechnology and drug discovery, staples, utilities, real estate investment trusts, “quality” income and robotics and artificial intelligence.

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The models contain ordinary stocks, American depositary receipts and preferred securities, according to the Solo FidFolios website. Foreign stocks, options and other non-equity securities such as ETFs and mutual funds, will not initially be available.

The new platform, which Fidelity plans to roll out “over the coming weeks”, will allow users to rebalance, purchase and redeem an entire portfolio of stocks with a single click, Fidelity’s announcement said.

The Boston-based manager said the growing field of direct indexing was the next “game changer” for retail investors.

“The introduction of mutual funds was a game changer for the average investor, allowing them to gain access to financial markets once only the wealthy had access to,” Fidelity said. “Then ETFs came along and helped with diversification and potential tax efficiencies with intraday trading. What’s next? Direct indexing.”

The direct indexing space has seen explosive growth in recent years, as many shops have been eager to scoop up firms with the technology to provide the service.

In January, UBS announced it would buy robo-adviser Wealthfront for $1.4bn. Wealthfront’s tax-loss harvesting and direct indexing technology were key motivators for the acquisition, Kirt Gardner, then UBS’s chief financial officer, told analysts in February.

In December, BNY Mellon’s Pershing announced that it would buy direct indexing provider Optimal Asset Management and fold the tool into the new Pershing X unit, which aims to manage “multiple and disconnected technology tools and data sets”.

In other recent deals Franklin Templeton acquired O’Shaughnessy Asset Management, a $6.4bn quant shop that runs a direct indexing platform; Vanguard scooped up direct indexer Just Invest; and JPMorgan Chase bought custom indexing provider OpenInvest.

During the next five years, direct indexing will expand at a faster pace than mutual funds and ETFs, according to an August report from Cerulli Associates.

Assets are expected to grow at an annualised rate of 12.4 per cent, faster than the projected 11.3 per cent growth rate for ETFs and 3.3 per cent for mutual funds over the same period, according to Cerulli.

In October Seth Bernstein, chief executive of AllianceBernstein, called direct indexing a “real opportunity” that will continue to grow.

Fidelity’s new service is available as an “enhancement” to its existing brokerage accounts. There are no account fees or trade commissions.

In April it rolled out Fidelity Managed FidFolios, a direct indexing platform that requires an investment minimum of $5,000, carries a management fee of 40 basis points and utilises professionally managed portfolios.

Managed FidFolios aimed to “open the door to the next generation of customers who don’t have either the asset level or the inclination to work with an adviser yet”, Ram Subramaniam, Fidelity’s head of wealth management and digital advice, told Barron’s.

Fidelity’s services are cheaper than most of the competition and require a lower asset threshold. Charles Schwab, for example, recently launched Schwab Personalized Indexing, which requires a $100,000 account minimum and also has a 40bp fee. Schwab’s service requires less than half the minimum of Vanguard Personalized Indexing and Goldman Sachs’ Tax-Advantaged Strategies, both of which require a $250,000 minimum investment.

Fidelity said its existing direct indexing offering had more than $33bn in assets. They are held within separately managed accounts, which carry “high minimums to invest”, it said.

Solo FidFolios users can start investing with $1 per stock and select up to 50 securities in each portfolio, including fractional shares.

Fidelity’s move is likely to be an “asset-gathering play” as it attempts to become a major player in the low-cost direct indexing space, said Scott Smith, director of advice relationships at Cerulli. Offering customised portfolios that align with investor goals is “the way the industry is going”, he added.

About 58 per cent of retail investors are interested in consolidating all their investable assets into a single institution, according to a recent Cerulli report.

“The FidFolios could certainly be a differentiator nudging Fidelity to the top of some investors’ list of consolidation providers,” Smith said.