As wealthy clients demand more personalization and tax efficiency, direct indexing is emerging as a powerful tool advisors can offer, though many are still learning how to use it.

The strategy, which allows investors to own the individual stocks of an index via a separately managed account instead of buying an index fund or ETF, has grown rapidly alongside rising expectations for portfolio customization in wealth management. For bigger accounts, this also unlocks significant tax advantages.

Emily Gray, managing director at Parametric, an asset manager owned by Morgan Stanley, believes direct indexing is now synonymous with tax management and loss harvesting. She says, “We can do tax-efficient transitions the client can fund with appreciated stocks that they have; we can manage them over time to get closer to the index. And we do daily loss harvesting, so we evaluate portfolios on a daily basis for opportunities to realize a loss − that client can take that loss and use it to offset a capital gain.”

Industry reports show the growth of direct indexing in recent years. Cerulli Associates found that direct indexing strategies closed out 2024 with $864.3 billion in assets − nearly double the level reported in 2021 − and they projected direct indexing to eclipse $1 trillion in assets this year. However, just 18 percent of advisors adopted direct indexing strategies as of 2024, with asset managers like VanEck remaining confident in the market dominance of ETFs and mutual funds.

“I see them working together. When direct indexing came out, everybody was like, oh this is going to eat ETFs alive,” says VanEck’s head of product management, Ed Lopez. “It will be an arrow in the quiver, a tool for advisors to use as needed.”

Direct indexing, as a subset of SMAs, represents 37.6% of manager-traded assets, more than doubling since 2020, per Cerulli’s latest data. Roughly one-quarter (26%) of advisors said they had access to direct indexing but hadn’t used it, while 12% indicated they were unfamiliar with the concept.

“Advisor education is crucial to adoption, as advisors are unlikely to recommend direct indexing strategies … if they do not fully understand them,” Michael Manning, research analyst at Cerulli, said in a statement. “Wealth and asset managers that want advisors to adopt these solutions must make a concerted effort to educate them on potential use cases, the added benefits, and the tax optimization element.”

A report released in January by MSCI found that 98% of high-net-worth portfolios include a customization strategy, and that 62% of wealth firms expect direct indexing usage to increase over the next three years. Direct indexing is viewed as being “essential” for serving high-net-worth clients by 59% of wealth industry professionals surveyed in MSCI’s 2026 Wealth Trends Report.

“Personalization has moved from a differentiator to a baseline expectation in wealth management,” says Alex Kokolis, global head of wealth at MSCI. “Nearly every new high-net-worth portfolio now reflects some level of customization, as clients seek investments aligned with their goals, values, and evolving views on risk. The challenge for advisors is no longer whether to personalize, but how to do so at scale while maintaining efficiency, consistency, and transparency.”

Investment clients who work at a Big Tech company like Apple or Google are an example of a particularly good fit for direct indexing. Given that they likely already own significant shares in these companies as employees, direct indexing can exclude their employer’s stock or avoid further investing in it, preventing outsized exposure in a single company.

“If an advisor has a client that maybe works in Silicon Valley and they’ve got concentrated wealth in that company that they work for, Parametric can partner with the advisor and the client to not only design something that excludes that particular company, but look across the universe of securities and maybe also exclude highly correlated sectors, industries, other companies,” says Gray.

Envestnet has seen 40 percent annualized growth in its direct indexing offerings since they debuted in 2013, the company’s chief investment officer Brandon Thomas tells InvestmentNews.

“Advisors for various reasons like the fact that [with direct indexing] they don’t have to worry about underperformance like with an active manager, so they don’t have to explain underperformance to their clients,” says Thomas. And of course, they like the lower cost of direct index strategies. So I think those two things have really fueled the growth of direct indexing offerings.”

Envestnet’s push into direct indexing traces back more than a decade, shaped by the aftermath of the financial crisis and shifting advisor behavior. In the years that followed, ultra-low interest rates and quantitative easing made it harder for active managers to distinguish themselves.

“We wanted to offer advisors a way to get the best of both worlds, to have a passive, index-like low-cost solution in an SMA format,” Thomas says. “There had been other direct index providers, one or two at the time that were doing SMA business, but nobody had done it in the UMA [Unified Managed Account]. So we decided to offer these direct index portfolios as SMA sleeves in a UMA portfolio offering.”

Thomas says that large-cap ETFs typically charge about four or five basis points, with some at seven or eight bps, while a comparable U.S. large-cap core direct indexing strategy can be as high as 15 bps. However, large direct indexing accounts could see their fee shrink to five or six basis points. “So, for smaller account sizes, there’s a fee advantage for ETFs for sure, but as the account size grows there’s less of a distinction between the two,” adds Thomas.

“It’s the clients that may have not only larger accounts but more income outside of their investment accounts,” Thomas says of the ideal fit for direct indexing. “In their investment portfolio, they may need to generate as many tax losses as possible. For those types of clients − large investment accounts or very high-income investors − they typically will benefit more from a tax management type of situation.”

Even as more platforms and asset managers enter direct indexing, market share remains concentrated. Envestnet ranked ninth in terms of direct indexing assets, according to Cerulli’s report released last April. Roughly 87% of the total market share was controlled by the top five direct indexing providers − Morgan Stanley (via its Parametric business), Goldman Sachs Asset Management, Northern Trust, BlackRock, and Fidelity Investments.

That concentration reflects the structural advantage of separately managed accounts (SMAs), for which large providers have the scale and technology needed to deliver personalization and tax optimization at the individual client level.

“Clearly the incremental advantage of an SMA is both personalization based on what the end client wants if they have preferences or needs, but very importantly, [also] taxes,” said Paul Riccardella, managing director at MSCI. “Because the SMA wrapper allows for sophisticated tax optimization, the generation of tax alpha and taxes are increasingly important to high-net-worth individuals.”

Even as direct indexing gains traction, ETFs remain foundational in portfolio construction, and Riccardella is clear that the rise of SMAs has not displaced ETFs, nor was it ever likely to.

“ETFs, simply put, are just the preferred commingled vehicle for any investment strategy, regardless of whether it’s active or indexed,” Riccardella says. “They have a place in every portfolio. Obviously, there’s been regulatory changes that are going to make them even more accessible.”