Continued pressure to lower ETF fund fees has forced issuers to look at where to make cuts and index providers could be the latest casualty.
It comes amid the rise of self-indexing and an increasingly agnostic attitude from ETF providers towards index brands.
Talk of going it alone has increased in recent weeks after the FT reported ETF providers were floating the idea of setting up their own market indices.
Competition in the index sector has been fierce - there has been consolidation among the large players of late, the most recent of which was last week which saw the London Stock Exchange acquire Citigroup’s bond indexing business for $685m.
In 2015 FTSE and Russell announced a merger, while S&P and Dow Jones joined forces in 2011.
However despite this activity, the cost of index licences remains unclear.
Firms maintain that the independent brand, global reach, research unit and support service index users get are what is being paid for.
The FT reported in its article that last year revenues for the three main providers increased.
S&P Dow Jones Indices’ revenues rose 7% to $639m, MSCI’s index revenues climbed 9.8% to $613.6m and FTSE Russell’s revenues increased 17% to £409m.
According to a source, who wished to remain anonymous, one index provider makes a 71% margin on its fees. This index cost is invariably passed on to the end user.
Steffen Scheuble, CEO of index provider Solactive, said: ‘Not many people are happy anymore about the fees from the large index providers. With high index fees it’s very difficult for the ETF providers to make the ETF fee any lower.’
More try DIY
Self-indexing, helps to keep costs lower. It is not a new concept and it has been happening in the US and the smart beta space. In Europe firms like Wisdom Tree offer the service.
Allan Lane, CEO at Twenty20 Investments explained that there is a lot of merit to self-indexing and it's when you get to niche indices that self-indexing comes into its own.
This rise of self-indexing has also created an increasingly agnostic attitude to index brand.
Scheuble said: ‘The index brand just isn’t as important anymore. You can argue that the top 20 indices are here to stay, but beyond that there is no brand value.’
Lane said: ‘Brand name of the ETF provider plays a big part, investors want a safe brand. Brand name of an index, if it isn’t one of the main benchmarks, is largely irrelevant so long as the index does what it intends.’
ETF providers also argue that the index methodology is what investors are focusing on now.
Chanchal Samadder, Head of UK & Ireland Institutional ETF Sales at Lyxor, added: ‘Investors focus more on the robustness of the index methodology, and whether it delivers the exposure they are looking for. In the case of market cap weighted indices- most indices which are focused on the same geography and segment are highly correlated, delivering almost identical returns.’
A major precedent
However, index fees do vary depending on the index provider. In 2012 Vanguard switched the index provider on 22 of its funds from MSCI to FTSE in order to cut costs.
SPDJI also said it only charges an ETF issuer a percentage of its fees. John Davies, managing director and global head of ETPs at SPDJI, explained: ‘Our interests are aligned with the ETF issuers. It means that as assets grow we benefit but as they decrease our fees reduce.’
There are also limitations with self-indexing. Lane explained that while it is reasonably simple to do in the equity space, once you enter the fixed income world it becomes much harder and only select firms will be able to do it.
Conflicts of interest remain
Peter Sleep, senior portfolio manager at 7IM added that he would be particularly careful of non-equity indexes where the pricing sources are not transparent.
‘We have seen examples of financial institutions failing to manage conflicts of interest in the LIBOR scandal and the gold fixing – both indexes of a sort. Is it appropriate for a bond market maker or a bond portfolio manager to also produce indexes? Surely there is a potential conflict of interest here,’ he said.
Self-indexing also isn’t allowed in all markets. Regulators in some Latin American countries have taken a dim view of self-indexing.
'There are reasons things haven’t changed yet and that is the size and power that the big index providers have. Certain asset owners, such as pension funds, are often linked to the well- established indices and the pressure isn’t coming from them, it’s from the ones buying the product,’ said Scheuble.