Direct indexing, via separately managed accounts, is rapidly gaining traction as an investment strategy in the United States, particularly beneficial for those with significant holdings in company stocks, and is already proving to be major movement among prominent investment firms in 2024.

This approach allows investors to replicate index performance while retaining control over individual securities, utilizing automated programs for systematic trading. Once limited to the ultra-wealthy, recent technological advancements have made direct indexing accessible to investors of varying levels, with assets projected to reach $2 trillion by 2024.

Direct indexing offers customization, diversification, and risk mitigation, enabling investors to tailor portfolios to their preferences and goals while reducing reliance on specific stocks. With its tax efficiency and customization benefits, it’s easy to see why it’s so appealing in an SMA format and companies like Goldman Sachs are already making huge strides in this subsector. 

Finsum: The hybridization of products has been one of the defining features of the 2020’s and integrating vehicles like SMAs with direct indexing will continue the rest of the decade. 

Cerulli Associates' recent report predicts substantial growth for structured notes, debt securities linked to underlying assets, in the upcoming year, prompting advisors to take heed of this emerging trend. 

Despite their reputation for being illiquid, inaccessible, and costly, structured notes are gaining traction, with only about 22 percent of advisors currently incorporating them into their strategies, but the landscape is changing, with roughly 8 percent of advisors planning to adopt structured notes within the next year matching industry standards with the likes of hedge funds and private debt. 

While alternative investments pose challenges for many clients, Cerulli's findings reveal advisors' concerns about the lack of liquidity and product complexity associated with structured notes, alongside hurdles related to expenses and subscription/redemption processes. Nonetheless, asset managers are adapting by targeting retail investors and partnering with advisory firms to introduce structured notes capabilities. Advisors could be missing out on a key alternative to improve the performance of clients portfolios. 

Finsum: Liquidity concerns should come down as the interest rate schedule becomes more certain and advisors should consider assets that are traditionally less liquid such as structured notes.

With private credit booming, private equity firms are upping their forecasts for their lending businesses. Apollo Global sees loan origination exceeding $200 billion annually in the next couple of years, up from its previous forecast of $150 billion. It’s seeing increased loan demand due to faster economic growth and public and private spending on infrastructure.

What’s new is that many of these private equity giants are now looking at lower-risk lending to investment-grade companies to fuel growth. This would put them in even more direct competition with banks. Apollo’s co-President Jim Zelter sees many investment-grade domestic companies pursuing capital expenditure projects and believes that private credit can compete with fixed income and equity as funding sources.

Already, banks are feeling some impact. In Q1, JPMorgan reported $699 billion in non-consumer loans outstanding, which was a $3 billion decline from last year. CEO Jamie Dimon has warned that the entry of new lenders brings ‘an area of unexpected risk in the markets.’ 

Previously, he noted that these lenders have less transparency and regulations than banks, which ‘often gives them a significant advantage.’ He specifically cited startup banks, fintech companies, and private equity firms as examples of companies that function effectively as banks but are outside of the regulatory system. 

Finsum: Private credit is taking market share away from banks. Now, private equity firms are looking to target investment-grade companies. Many banks are warning that this brings risks to the financial system.

Energy has been one of the best-performing sectors YTD with a 10% gain. Energy prices have moved higher due to increased geopolitical uncertainty and strong economic data. Looking ahead, LPL remains bullish on energy and recommends overweighting the sector.

It notes that valuations are quite attractive, especially with producers focusing on cash flow in recent years. In the post-pandemic period, free cash flow yields have averaged 8%, while this figure averaged 4% in the preceding decade. And producers have been using this cash to buy back shares, raise dividends, and pay off debt. 

From a technical perspective, LPL notes the relative strength as the sector has been making new, all-time highs for much of this year. Additionally, there has been strong breadth, indicating broad-based buying pressure. 

Another looming catalyst is that there has been some rotation out of the ‘Magnificent 7’ stocks into cheaper parts of the market, such as energy, financials, and small-caps. Growth stocks have led the market higher for most of the past year, but with valuations extended, there is an increased risk of a pullback or correction.

Finally, investing in energy provides some protection against inflation continuing to linger above the Fed’s desired level and rates remaining elevated as a consequence. Energy also tends to rally when long-term bonds weaken, providing a hedge for portfolios.

Finsum: Energy has outperformed to start the year. LPL remains bullish on the sector due to its attractive valuation, positive correlation with inflation, and relative strength.

Last year, assets in passive mutual funds and ETFs overtook assets in active mutual funds and ETFs. This is remarkable considering that passive funds accounted for 31% of total assets in 2015. The trend has been gaining steam since 2008 due to the strong performance of market-cap, weighted indices, and a greater preference for lower fees. 

In 2023, only 47% of active managers outperformed their passive benchmarks. Over the last decade, only 12% of active managers have survived and outperformed their benchmarks. Due to this, it’s not surprising to see that passive strategies are being adopted in separately managed and unified accounts. Currently, it accounts for 32% of assets in these accounts and is forecast to grow at a 12% rate over the next 4 years, faster than growth in ETFs and mutual funds. 

Direct indexing is a customizable, passive investing strategy. It’s designed to track a benchmark but allows for customization for tax purposes or to align investments with a client’s values. According to research, direct indexing can add between 85 and 110 basis points to a portfolio’s after-tax returns. 

Direct indexing also allows advisors to offer clients more personalization while retaining the benefits of passive investing. Already, asset managers and custodians are responding by offering direct indexing solutions at scale to advisors. 

Finsum: Passive strategies have overtaken actively managed strategies in terms of their share of assets. Direct indexing is one factor, as it is a way for advisors to retain the benefits of investing in an index with greater customization and tax efficiency