The Advisor’s Case for Smart Beta Direct Indexing

Key Points

  • Technological advances are making smart beta direct indexing increasingly accessible to investors, possibly allowing for tax management and strategy customization benefits.
  • By understanding a client’s tax circumstances, ESG beliefs, and professional circumstances relative to a sector or specific company, the advisor can help their client assess and maximize the benefits of a smart beta direct indexing approach.
  • Complementing smart beta ETFs and mutual funds, smart beta direct indexing can be an important part of the advisor’s toolkit.

Advisors often serve as their clients’ educator or coach about how the capital markets function and how best to navigate available investment options, a role that requires them to stay on the leading edge of new developments such as smart beta direct indexing. As direct indexing becomes increasingly available to investors given rapid advances in technology, advisors are uniquely positioned to assess whether this opportunity fits into their clients’ portfolios, and if so, to maximize its potential.

Smart beta direct indexing can be an important part of the advisor’s toolkit. The advisor understands a client’s tax situation and can help determine the tax advantages afforded by smart beta direct indexing. The advisor can also guide clients in aligning their equity portfolio with personal beliefs, strongly held values, and human capital considerations. For clients who adopt smart beta direct indexing, the advisor can maximize its potential in ways that mark the essence of a long-term fiduciary relationship through framing client conversations, establishing philosophical buy-in, and sharing narratives grounded in research.

In his 2001 article “Personal Indexes,” Andrew Lo foresaw that advancements in computing power and artificial intelligence would likely lead to investors having personalized indices purposed for their unique financial picture. Lo admitted that such customized asset management sounded like science fiction, but noted the technology existed and “as with the transformation of all great ideas from theory into practice, it is only a matter of time.”

According to Dave Nadig of, the time for growing mass customization has come. At the 2019 Research Affiliates Advisor Symposium, Nadig’s “Radical Disruption: Post-ETF Investing” presentation advanced the premise that direct indexing1—investing in a portfolio of individual stocks instead of a wrapped product such as an ETF or mutual fund—is emerging as a core building block of equity portfolios. This “unwrapping” allows for the kind of customization Lo described 18 years ago. While we believe ETFs and mutual funds will remain a staple of investment alternatives, smart beta direct indexing may increasingly offer advisors an additional tool for producing better outcomes for some of their clients.