Cee
Fidelity to Offer Direct-
Indexed Accounts as Small
as $5,000 to Retail Investors
S tillion in assets, filed documents‘with regulators on Wednesday to launch what appears to be the frst direct-indexing,
product for mom-and-pop retail investors.
Fidelity Managed FidFolios, which should
‘be available before March 30, willbe
accessible to individual investors with as
little as $5,000, Fidelity executives say. That
contrasts with the typical direct-indexed.
account, which requires minimums of at
least $100,000 and is generally sold via
financial advisors. Initially, Fidelity will
Drssmstine offer three account strategies US. Large
Cap Index, International Index, and Environmental Focus—with more to come over time.
Direct indexed portfolios are privately managed accounts that seek to mimic a benchmark.
But unlike funds, they can also be customized to suit an individual investor’ particular
goals, often to maximize ater-Lax returns or execute a specialized environmental, social,
and governance strategy.
“Idon't want to be hyperbolic, bt the FidFolios offering] is really provocative, and, I would,
say, groundbreaking,” says Tom O'Shea, who covers managed and direct indexed accounts,
asa research director for Cerulli Associates. “Over the past couple of years, there's been alot
of tlk of direct indexing displacing index ET¥s and mutual funds. And one of the barriers to
that is the account minimums necessary. Typically, to mimie the S&P 500, you would need
to have a $250,000 portfolio, atleast”
But with free stock trades and fractional-share trading, which Fidelity began offering toretail clients in 2020 and advisors in 2021, its now possible to build a portfolio of hundreds
of stocks for much less than t cost inthe past. “The question was how low can you go?” says
(O'Shea. “This is really the ist stake in the ground that Te seen that you ean go down as low
235 $5,000, which opens [direct indexing] up to the mass market. I allows you to compete
dlireetly against products with much lower (minimum investments] like mutual funds and
ETFs?
Italso means i
estors won't need advisors to set up one ofthese accounts. Yet Ram
Subramaniam, Fidelity’ head of wealth management and digital advice, says FidPolios are
nota threat to advisors but rather ‘complementary. t's targeting different customer set
‘who are more digital and want to have more control over their portfolios). This just opens
the market and customerbase” In fact, he says, the accounts “open the door tothe next
generation of [advisor] customers who dont have ether the asst level or the inclination to
‘work with an advisor yet”
Yet just because Fidelity built something doesn't mean investors will come. One of the key
advantages of direct-indexed accounts is their ax efficiency, as holding hundreds of stocks
allows account algorithms to harvest multiple losses from selling individual company
positions to counteract taxable gains in other positions. By contrast, trading a single ETF
only realizes a single gain or loss. But retail investors in lower tax brackets may be less
concerned about taxes than high-net worth ones.
‘The new FidFolis will have an initial expense ratio of 0.40%. By contrast, the iShares Core
S&P $00 ETE (IVV) has a 0.03% expense ratio, That creates a fee hurdle as the iShares ETF is
already highly tax efficient. t hasn't distributed a taxable capital gain since the year 2000,
although it has distributed taxable dividends. To have a performance edge, FidFolios US
Large Cap Index, which will rack.a similar proprietary index, will have to increase its aftertax performance enough to cover the drag of its higher fees, Harvested losses could
counteract gains in investors’ overall portfolios or the taxes on dividends.
For the wealthy, such after tax outperformance for direct indexed accounts has been
possible. Fidelity already manages some $33 billion in high-net-worth direct-indexed
accounts, According to Fidelity’ research on these accounts, 94% have had their advisory
fees covered by tax savings, which have typically delivered 1% to 1.5% annually in after-tax
return,
Still, after tax outperformance is market dependent. The more volatile stocks are, the more
losses there are to harvest to counteract future gains. “I
just going up, up, up, you can only use your [direct-index harvesting] tools to eliminate so
‘many gains,” says Amrita Nandakumar, president of Vident Investment Advisory, wh
‘manages and designs both ETF and direct-indexed portfolio strategies.
going tobe hard to avoid them entirely”
environments where the market is
=-focused
Yet the real draw for retail investors may not be lower taxes but designing an
portfolio customized to their unique values. FidFolios digital interface will allow them to
eliminate individual stocks they don't like or entire industries such as oil drillers while still,
optimizing their portfolios to have as litle tracking error with benchmarks as possible. It
will also allow them to control their accounts’ proxy votes for ESG shareholder resolutions
‘on whole shares owned ~a big deal if one considers that most money managers have poor
records of support for such proposals. (Investors won't be able to vote on fractional shares,
‘though, by themselves without contacting Fidelity for help)
‘Such ESG customization could appeal especially to younger retail investors who are new to
investing, “Our research shows that the interest in ESG skews younger, O'Shea says, “Peopleunder the age of 30 show a high preference for ESG, almost twice as high as that of people in
their 50s, 60s, and 70s?
Namdakumar also says ESG customization is paramount for retail investors: “It's about
investors wanting more ownership over how their money's being invested, feeling,
empowered about how they’re investing, and using direct indexing as a way to express their
values, meaning they put money towards companies whose missions or objectives they
believe in, and withhold money from those that don't”
If that’s the ease, the new FidFolios could prove to bea big hit.
Write to advisoreditors@barrons.com