Vanguard tackles democratizing direct indexing with its first acquisition

The news: The global asset manager acquired Just Invest, an asset management technology provider that lets industry players offer direct indexing, per PR Newswire. This is Vanguard’s first ever acquisition.

What is direct indexing? Traditional index investing involves asset managers like Vanguard giving investors access to mutual funds or ETFs that replicate the performance of a specific index, like the S&P 500 or FTSE 100.

But with direct indexing, investors own the individual stocks in the index outright rather than holding a fund’s shares. As a result, investors can pick and choose stocks within the indices to more closely match their investment goals.

Why is it difficult to offer direct indexing? Direct indexing has traditionally only been available to the wealthy because they can afford direct, broad stock exposure and the increased fees associated with more customization.

But tech advancements like Just Invest’s large-scale data analysis and quantitative algorithms automate this level of customization without increasing operational costs. This, in combination with fractional shares, makes it cheaper and easier to offer direct indexing to a wider pool of investors.

Why acquire direct indexing capabilities? Investors are increasingly seeking out more customizable offerings like direct indexing, creating user acquisition opportunities for incumbents.

Index investing has been a successful product for incumbents—Vanguard, BlackRock, and State Street control up to 90% of the US indexing market. These players are now acquiring the tech to roll out direct indexing in hopes of cornering that market too, which is expected to become widespread—BlackRock bought direct indexing pioneer Aperio for $1.05 billion in November.

The big takeaway: Moving into direct indexing enhances their value propositions in two key ways:

• Greater personalization. Using direct indexing, an investor could, for example, pick exposure to the S&P 500 but exclude any stocks within the index that go against their goals or ethics, such as corporations with large carbon footprints. This can help mitigate greenwashing seen with index investing, where investors leave it to asset managers’ arbitrary views on what constitutes green stocks.
• Tax optimization. Investors can offset capital gains taxes from winning stocks by selling the individual losing stocks, also known as “tax-loss harvesting.”