BLOG. 4 min read
Direct indexation and environmental, social and governance (ESG) investing aren’t as popular with financial advisors as industry news coverage would suggest—just two in five advisors have incorporated ESG into a client’s portfolio and only three in 10 advisors have used direct or custom indexing strategies with clients, according to our advisor research conducted in association with Horsesmouth.
Furthermore, there is significant advisor resistance to both direct indexation and ESG. For each, one-third of advisors don’t use the products now and have no plans to use them in the future.
Source: SS&C RAC, Personalization Survey, in association with Horsesmouth, 2022
Why? Our research shows that ESG and direct indexation have a complexity problem that prevents advisors from embracing these strategies. The forces driving that complexity will be a challenge for firms selling these products through advisors but in very different ways.
Advisors certainly need more education about direct indexation, as shown by the 26% of advisors who said they don’t know enough about these products to even have an opinion about them yet. But, unfamiliarity with ESG products is compounded by the use of ESG-specific jargon, a lack of standards for this type of investing—every firm means something different by “ESG”—and the need to discuss the related complicated and often politically charged issues with clients. In fact, 30.4% of advisors said they don’t sell ESG investments because they don’t understand the issues these strategies aim to address enough to discuss them with clients. The bottom line, it will take far more than a basic product education program to get past the multiple layers of complexity and make advisors confident in their understanding of ESG investments.
For direct indexation, the obstacles are more systemic, as these products make the advisors’ workflow and even practice strategy more complex.
Source: SS&C RAC, Personalization Survey, in association with Horsesmouth, 2022
Among the one in three advisors who don’t use direct indexing and don’t plan to use it, more than half said it’s because they prefer professionally constructed investment models. Advisors have flocked to investment models in recent years to help create a more efficient, planning-focused practice. Models create a consistency that simplifies the more mundane aspects of monitoring and servicing client accounts as well. So, personalizing investments through tools like direct indexation can feel like a step back in the other, less efficient, direction.
Nearly a quarter of advisors specifically cited concerns about compliance, which models can help alleviate. Knowing that home offices and asset managers have conducted rigorous analysis and vetting on their investment models likely makes them seem safer, compliance-wise, to advisors who don’t take pride in individually choosing investments.
But, model adoption also prompted a change in overall practice strategy for many advisors, which we see reflected in other key objections to direct indexation. After all, many forces advocating for models proclaimed that investment management has become commoditized—and that advisors’ real value lies in financial planning and building relationships with clients and prospects.
So, it’s no surprise that nearly half of these advisors aren’t interested in direct indexation because they believe personalizing the advice they offer is more important than personalizing the investments. One in three of these advisors also said their clients simply don’t need that degree of customization.
Although complexity is a common thread underlying the previous objections, advisors specifically cited the inability to effectively scale their practice when managing and supporting customized portfolios and the challenge of the technology and process to implement these strategies as well. The good news is direct indexation providers can address these objections by improving the user interface and functionality of the direct indexation platforms and products.
The bigger challenge for direct indexation will be reconciling a renewed focus on personalizing investments down to the individual holding level, with an environment of advisors moving away from investment selection as a key value proposition. Highlighting compelling use cases that justify the return to personalized investing, at least for some clients, will be key.
The bottom line is, complexity is an obstacle to the widespread adoption of both ESG and direct indexation strategies. For both products, some issues of complexity will be simpler for firms to address than others. However, direct indexation providers seem to have a clearer bridge to reach advisors than managers of ESG strategies. For both topics, it is critical to understand advisors’ behaviors, preferences and investment approaches. Learn more about how SS&C can help.
