BNY Mellon Pershing announced Thursday that it plans to acquire Optimal Asset Management, a step into the world of direct indexing that signals the firm’s intentions with its new technology business arm.
Optimal uses software to create personalized investment portfolios using direct indexing, a formerly esoteric strategy that has recently vaulted into the mainstream. The market for direct indexing — where an investor buys the individual equities that make up an index rather than an ETF — is expected to grow from $350 billion in AUM in 2020 to $1.5 trillion in 2025, according to data from Morgan Stanley and Oliver Wyman.
The transaction is expected to close by the end of the month, and terms of the deal were not disclosed.
Jersey City-based Pershing plans to make Optimal’s software part of Pershing X, a unit launched in October to accelerate the development of a highly integrated, all-in-one technology suite for RIAs, independent broker-dealers and trust companies.
“What we see missing in the market are tools that work beautifully together. Advisors have to go buy or use a whole range of tools, but nothing is interoperable, nothing connects and nothing is seamless,” said Ainslie Simmonds, president of Pershing X. So while Pershing has the tech needed for core custody and clearing services, Pershing X is “looking to add the rest of their advisory needs: [investment] models, direct indexing, financial planning, the things that they need to do their job.”
While whatever product Pershing X ultimately produces will integrate with other third party technology, the idea is to create a proprietary platform that goes much further, Simmonds said. The goal is that it will eventually be multi-custodial as well.
Simmonds did not rule out the possibility of future acquisitions for Pershing X.
“It’s absolutely a build, buy [or] partner decision for each capability. They are all on the table,” she said.
Pershing joins a crowded race of financial institutions diving into direct indexing. In 2021, Vanguard, Franklin Templeton, BlackRock, Morgan Stanley and JPMorgan Chase have all the technology, which promises greater portfolio customization and tax-loss harvesting advantages to buying an ETF.
“With investors now expecting more customized advice, wealth managers must offer a range of flexible, cost-effective investment solutions that advisors can tailor to individual clients,” said Scott Reddel, lead of North American wealth management at consultancy firm Accenture. “Custodians and platform providers will continue to expand their product offerings and use tuck-in acquisition to accelerate their roadmaps.”
Competing custodian Fidelity recently made fractional share trading — which brings down the minimum asset requirements for direct indexing by eliminating the need to own entire shares of expensive companies — available to advisors, but hasn’t announced any specific plans for direct indexing yet. Charles Schwab filed a disclosure for Schwab Personalized Indexing, a separately managed account with an array of strategies built with direct indexing, and plans to launch introduce the service in 2022, a spokesperson said.
Pershing has some existing support for fractional shares, but Pershing X will look to expand on this capability, Simmonds said. And with a background in software development and a Ph.D. in finance, Optimal founder and CEO, Vijay Vaidyanathan built software that will help Pershing X’s eventual offering stand out from the crowd, she added. Vaidyanathan and his team of engineers are joining Pershing X.
“There’s a lot of great tools on the market. People are building a lot of great things, but our assessment is this technology had everything we needed and more,” Simmonds said.
With direct indexing technology going mainstream across the wealth management industry, Brad Roth, the founder and chief information officer of wealthtech company THOR Financial Technologies, wonders how the technology will start to evolve. The current process is centered around the tax benefits of harvesting a loss and then buying the harvested security 31 days later, Roth said.
“It’s our opinion that the next iteration will include analytics as to when the most optimal time to harvest and when to optimally buy back the security given the current market environment,” Roth said. “It doesn’t make sense to us why you would want to re-purchase a security just because 31 days have passed. Introducing analytics could potentially improve the performance and tax benefits overtime.”