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Praise For "Direct Indexing" From An Unlikely Source

We were more than a little surprised to read this piece on the merits of "direct indexing." Not surprised by the merits or because it corroborate our own research and service offering, but because it was written by ETF-expert Dave Nadig and published by ETF.com. For someone who built his career in the ETF industry, even Nadig admits, "...it came as a bit of a shock to some when my keynote at the 2019 Inside ETFs conference was about what comes next—after ETFs. And what comes next is 'direct indexing.'"

For those unfamiliar with "direct indexing," a brief history may provide some helpful context. Institutions and individuals used to buy individual stocks to gain exposure to the stock market. Mutual funds were a positive development for individual investors, as they represented instant market exposure and diversification even for smaller portfolio sizes. Index mutual funds hit the scene in the 1970s, which began to bring investor costs down. Then index ETFs began launching in the 1990s and early 2000s, which provided increased liquidity and tax-efficiency. Intense competition has now driven the cost of holding and trading many ETFs to effectively $0.

But a funny thing happened on the way to today. Trading costs for stocks have also fallen precipitously and a diversified portfolio of individual stocks is no longer cost-prohibitive for individual investors. While direct indexing used to be the exclusive domain of institutions and later available to "smaller" accounts of $10M or so, today's investors can implement a direct indexing strategy with as little as $250k (and sometimes less, depending on the asset class!).

Improving technology and falling transaction costs are making direct indexing increasingly attractive for many investors. This is especially true for investors who want to screen out specific companies and/or industries, integrate favorable environmental/social/governance (ESG) factors, or simply desire increased tax-efficiency. MFA is not a "mutual fund shop" or an "ETF shop;" we use both vehicles, as well as direct indexing in separately managed accounts (SMAs). Mutual funds make more sense in certain situations, while ETFs make more sense in others, and direct indexing is superior in still others. MFA remains agnostic towards investment vehicles and committed to utilizing the tools that make sense for each of our clients.