Investment managers have long used separately managed accounts, or SMAs, to pick and choose stocks to boost returns, lower taxes, or customize an investment portfolio to a client’s liking. But the elimination of trading commissions, growing use of fractional shares, and increasing interest in customized portfolios, made SMA platforms a hot commodity in 2020 and that trend gained momentum this week.
Ethic, an asset management platform financial advisors use to build custom portfolios for clients, said Tuesday that it raised a $29 million Series B round of funding, bringing its total to more than $48 million and valuing the company at $139 million, according to PitchBook. Ethic and its investors do not comment on the valuation of the company, a spokesperson told RIA Intel.
The latest round of funding was led by Oak HC/FT, a Greenwich, Conn.-based venture capital firm that focuses on early growth stage financial technology and healthcare startups. Other previous investors also participated in the latest round, including Fidelity Investments, Nyca Partners, Sound Ventures, ThirdStream Partners, Urban Innovation Fund, and Kapor Capital.
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In 2019, Ethic raised a $13 million Series A round of funding and since then its assets under management have grown tenfold to more than $760 million. The platform has been able to do that without having to hire as many people as other SMA platforms have to grow. Ethic’s scalability is partly why Dan Petrozzo, a partner at Oak HC/FT, said he wanted to invest in the company.
The venture capital firm was in contact with Ethic before it raised its Series A and kept in touch. It was eager to invest later last year knowing Ethic’s growth trajectory. “The company has grown quite a bit even since we put out the term sheet, honestly. Like, a lot. It’s going great,” Petrozzo told RIA Intel.
Along with Ethic’s growth, advisors are impressed with its technology and user experience, its “distribution was working,” and it stands to benefit from broader trends emerging in wealth management, Petrozzo said.
Historically, direct indexing has only been available to ultra-high-net-worth investors, family offices, and institutions that can meet the investment minimums and justify the costs. But less wealthy clients want the same benefits of SMAs, too, and Ethic and others are delivering those.
“The growing adoption of fractional share trading, the elimination of commissions, the greater acceptance of algorithmic portfolio construction, and the widespread investor demand for beta exposure have combined to make it possible for these products to move downmarket, into the affluent and mass-affluent investor tiers,” according to a March report on direct indexing by Cerulli Associates, a Boston-based research and consulting firm.
However, having the technology that enables the level of customization in demand is only part of the recipe for success. “As firms bring direct indexing to less wealthy investors, they must create products that offer elements of customization, such as ESG and other factor tilts that go beyond tax optimization,” Cerulli says.
Ethic is one example of a company doing that effectively, which is why it has grown at the rate it has and attracted investors, Matt Goulet, senior vice president of Portfolio Solutions at Fidelity Investments, told RIA Intel.
Goulet could not speak directly about Fidelity’s investment in Ethic, but his group consults RIAs that custody assets with Fidelity on their portfolio management, including software they use. His group has recommended Ethic to RIAs. Many use the platform and they tend to be larger. More than a third of Ethic’s assets under management stem from RIAs that custody with Fidelity, Goulet said.
Once a cottage industry, many independent wealth managers have grown tremendously, particularly over the past decade. Some manage tens of billions of dollars and winning enterprise business relationships with them can be lucrative. But service providers also have a growing number of various size RIAs they can market to. The industry is in a goldilocks phase ideal for starting and growing technology companies and there is a “real opportunity for technical disruption,” according to Petrozzo. Ethic, he thinks, is as well positioned as any to take advantage of that.
“We feel like we’ve bet on the right horse here,” he said about Ethic.
Other companies are finding slightly different ways to cater to the same market. In February, Just Invest partnered with QMA, the $120 billion quantitative unit of PGIM, on a new service called PGIM Quant Select that the companies say will “democratize” SMAs and actively shape the bespoke portfolios.
Vise, a Sequoia Capital-backed startup using artificial intelligence to build and manage custom portfolios for RIAs, hired a standout computer scientist in January to lead its investment strategy and free up time for advisors to work with more households.
Last fall, Morgan Stanley acquired the asset manager Eaton Vance for $7 billion, a deal that included the SMA builder Parametric, and BlackRock acquired Aperio Group, a firm that helps build custom portfolios, for $1.05 billion.
How threatened any asset managers really are remains to be seen. In a Cerulli survey last year, some asset management executives said few companies have the wherewithal to actually do direct indexing and some suggested it’s just an “overhyped” fad.
Michael Thrasher (@Mike_Thrasher) is a reporter at RIA Intel based in New York City.
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