Fintech startup Atomic has a plan to blow up the $8 trillion ETF industry

For decades, exchange-traded funds, or ETFs, have trumped mutual funds as the most popular vehicle for investors looking to own baskets of stocks in a tax-efficient manner. Today, fintechs want to bite into the ETF stronghold by bringing direct indexing mainstream.

Direct indexing involves buying shares that make up an index in proportional weights. ETFs provide the same diversified index exposure, but a person’s brokerage stands between them and owning the stocks directly. ETFs have risen to prominence by allowing individuals to diversify with a single trade while avoiding the costs of professionally managed mutual funds. Direct indexing was reserved for wealthy investors who could pay the fees associated with executing the hundreds of transactions required to buy all the component stocks in an index.

The rise of commission-free trading has largely removed the fee barrier to direct indexing, prompting firms like San Francisco fintech Atomic Invest to chase the opportunity to bring the strategy to small investors. The company offers white label brokerage services to banks, fintechs, credit unions and other consumer-oriented financial platforms. “We think ETFs will be dead in the next five years,” says an enthusiastic David Dindi, CEO of Atomic Invest.

In the US, direct index assets under management grew from $100 billion to $350 billion between 2015 and 2020. Over the next five years, the industry is projected to grow 12%, outpacing ETFs and mutual funds. Still, ETFs, at $8 trillion in assets, globally according to ETFGI dwarf direct investment. In the 1990s, some predicted that ETFs would displace open-end mutual funds. But in financial services, where account inertia and salespeople are often stronger forces than, say, tax efficiency or low costs, mutual fund assets continue to grow and now stand at $71 trillion, according to the Investment Company Institute, more than doubling over the past decade.

Atomic isn’t the only company moving to offer direct indexing more broadly. Fidelity, Vanguard, Blackrock and Morgan StanleyMS
all newly launched direct indexing services. The features came after Vanguard acquired Just Invest in August 2021, Morgan Stanley acquired Parametric Portfolio in March 2021 and Blackrock acquired Aperio back in 2020. Fidelity’s service is the most retail-friendly of traditional providers with one of the lowest minimum requirements of $5,000. Atomic has no minimum investment requirements. “A lot of these traditional financial institutions have recognized that the future of investing is direct indexing,” says Dindi. “The time left for ETFs is ticking.”

A key feature of direct index offerings is fractional trading, which allows investors to spread smaller amounts of money by owning parts of a stock. Fractional trading is available through a number of brokerages, including Charles Schwab, Fidelity and Robinhood. Atomic is intent on courting young, novice investors. An Atomic customer used $5 to buy 150 different shares on a fractional basis, says Dindi.

The two main features of direct indexation are adjustment and the possibility of tax losses. With direct indexing, an investor will realize the same gains as an ETF holder, but can sell the losing positions to offset their gains come tax season.

By customization, direct indexing allows individuals to filter out stocks according to their values. An investor might track the S&P 500 but remove all tobacco companies, for example. They can also choose to prioritize investing in environmentally conscious or women-led companies.