Wealth Management
Every year, there are countless innovations in wealth management but only a few prove to have staying power and become a disruptive force. It’s increasingly clear that direct indexing is here to stay given its massive growth over the last couple of years.
It also serves a unique niche, because it offers the benefits of index investing with more customization and tax savings. According to a report from Cerulli Associates, direct indexing is expected to continue growing at a similar pace over the next decade due to these reasons. And, it’s especially useful for investors who want to prioritize tax loss harvesting and ESG.
The report also shows that there’s considerable room for growth given that only 14% of advisors are aware of it and recommending it to their clients. However, the firm is confident in its growth especially as fee-based models continue to take market share. It forecasts 12.3% growth over the next 5 years.
Given its usefulness and newness, direct indexing is one way that advisors can differentiate themselves. It can also help create a more personalized experience for clients which can lead to more loyalty and retention.
FinSum: Direct indexing is expected to continue rapidly growing over the next decade, and it’s particularly beneficial for tax loss savings and ESG investing.
2023 has been quite different compared to 2022 especially from a financial markets perspective. Due to raging inflation and a hawkish Fed, 2022 saw weakness in both stocks and bonds. In contrast, both asset classes have delivered positive returns in 2023 YTD despite significant and continued headwinds.
This is particularly the case for active fixed income. In an article for the Financial Times, Madison Darbyshire and Harriet Agnew highlight how large asset managers have been increasing allocations to the category as they look to lock in higher rates with the Fed in the final innings of its rate hikes. Analysts are noting demand from institutional and retail investors, across the active fixed income spectrum.
In 2022, $332 billion moved out of the category, but 2023 has already seen inflows of $100 billion in the first third of the year. This trend is expected to only strengthen with active fixed income ETFs expected to continue taking a larger share of the fixed income and ETF universes. According to State Street CEO Yie-Hsin Hung, "It feels like the beginning stages of what happened in equities.”
Finsum: After a poor 2022, inflows into active fixed income are sharply higher as they look to lock in higher rates given the end of the Fed’s tightening and increasing odds of a recession.
According to an article by Katherine Greifeld and Emily Graffeo, Blackrock is launching its own ETF for income investors. This marks new fixed income CIO Rick Reider’s first ETF launch.
The actively managed BlackRock Flexible Income ETF will invest in more higher-yielding parts of the fixed income spectrum like high-yield bonds, emerging market debt, and securitized assets. It will have an annual expense ratio of 50 basis points and will be managed by Rieder, Jacob Caplan, and Samir Lakhani.
Fixed income ETFs are experiencing rapid growth in terms of inflows and new issues due to high rates and an uncertain economic outlook. Many analysts anticipate ETF flows to become a dominant factor within the fixed income market like ETFs have for equities. Within the category, Blackrock is the leader with $600 billion in assets out of a total of $1.4 trillion in fixed income ETFs.
According to Blackrock, these ETFs are serving investors while also leading to more liquidity in fixed income markets. BINC carries an annual expense ratio of 50 basis points and is actively managed by a team including Rieder, Jacob Caplain and Samir Lakhani.
FinSum: Blackrock is the leading issuer and manager of fixed income ETFs. Recently, it launched the Blackrock Flexible Income ETF which invests in higher-yielding debt.
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With interest rates at their highest level in decades and an increasingly cloudy economic outlook, it makes sense that interest in annuities has increased. Used properly, annuities can create a steady income and reduce overall portfolio volatility.
However, Allan Roth in a Barron’s article shares some risks that investors need to consider before investing in an annuity. In terms of simple annuities, there are two main kinds - single premium immediate annuities and multi year guaranteed annuities.
He says that a single premium immediate annuity is similar to a pension. Typically, these are bought through an insurance company, and it pays a defined amount every year. The benefits are that it provides cash for the rest of a clients’ life. But, the risk is that the value of this income can be diluted by inflation. This becomes more germane the longer the annuity is relied upon.
The other option is a multiyear guaranteed annuity which provides income for a certain period of time, typically between 5 to 10 years. This functions similarly to a certificate of deposit. Yields are slightly higher than a CD especially with longer durations. However, the higher yield does come with higher risk as CDs are backed by the FDIC while these annuities are backed by insurance companies which come with higher levels of risk.
Finsum: Annuities are seeing higher levels of demand due to increasing recession risk and high rates. Yet, there are some risk factors that investors need to consider.
While model portfolios are gaining in popularity, there are some notable detractors such as Lifeworks Advisors CEO Ron Bullis who criticized model portfolios for not providing enough customization for clients. His comments at the WealthStack Conference were covered by Patrick Donachie for WealthManagement.
Specifically, he believes that the risk scores used by model portfolios are not effective indicators of the actual risk faced by clients which can vary by large amounts. He believes that the industry is falling short on meeting the needs of clients especially in a world of increasingly personalized services that are immediately available.
Due to the ubiquitousness of smartphones and finance apps, the cost and inconvenience of switching advisors has dramatically declined. This is a major change from the previous decade. And, we saw a taste of this during the collapse of Silicon Valley Bank with $42 billion in customer deposits exiting the bank in days as rumors of a collapse spread.
Advisors need to start thinking about this new reality as competition for clients could also increase. They need to clarify and understand what is unique about the services they are providing to their clients and need to proactively take steps to grow the relationship with clients.
Finsum: With technology comes inevitable change, financial advisors need to prepare for a world where clients are much more proactive in switching firms due to digitalization.
Regulation Best Interest (Reg BI) was passed by the SEC in 2019 and implemented in 2020. It essentially requires brokers to only recommend products to customers that are in their best interest. It also requires that brokers must inform clients of any potential conflicts of interest and financial benefits they may accrue.
Until recently, enforcement of Reg BI has been lacking, but this is clearly now changing as authorities are stepping up. The most recent incident is FINRA fining five broker-dealers for failing to comply with regulations including Reg BI and Form CRS.
These firms were cited for a lack of guardrails and protocols that would lead their registered brokers to adhere to Reg BI. Relatedly, these firms were also penalized for missing deadlines related to Form CRS and/or providing incomplete information. Form CRS is an overview of a broker’s services, fees, conflicts of interest, prior disciplinary action, and other information to increase transparency and minimize fraud risk.
The five firms did not admit or contest FINRA’s decision. Like previous Reg BI enforcement, the penalties and citations were minor. In contrast, the SEC has only filed one major Reg BI case, but it pursued much harsher penalties.
Finsum: Reg BI is a new regulation which mandates that broker-dealers must inform clients of any conflicts of interest and recommend products that are in their best interest. Recently, regulatory authorities are stepping up enforcement.