The Squeeze On Index Fees
[This article originally appeared on our sister site, IndexUniverse.eu.]
Competitive pressures in the index-tracking business have been building for some time. BlackRock's application to U.S. regulators to do its own indexing has been in the headlines for months, but in the end it was BlackRock's arch-rival, Vanguard, which dropped a bomb on the index industry by ditching MSCI yesterday as the benchmark provider for some of its biggest tracker funds.
At first glance the dramatic reaction in MSCI's share price—it fell 27 percent in Tuesday trading in New York—looks overdone. MSCI earned over US$900 million in revenues last year and is facing the loss of less than 3 percent of that total as a result of the departing Vanguard business. And yet the index firm suffered a decline yesterday of over US$1 billion in its market capitalization.
(As a side-note, the lost revenue reported yesterday by MSCI—US$24 million—allows us to calculate the average index licensing fee Vanguard was paying the index provider: on the departing US$537 billion of indexed assets, it works out as a mere 0.45 basis points a year*).
But if one considers that Vanguard’s switch is likely to result in other index licensees queuing up for fee cuts—and not just at MSCI—then the market’s savage reaction to yesterday’s news becomes more understandable.
Up to now, the index industry has been regarded as one of the few bright spots in a shrinking financial services sector. MSCI, for example, has more than doubled both revenues and income over the last three financial years. Yesterday that handsome growth rate suddenly looked like a thing of the past, at least for the index provider segment of the passive funds business.
To me, the most interesting aspect of Vanguard’s decision is what it says about how fund management firms are owned and structured.
The fund at the centre of yesterday’s announcement, Vanguard’s $67 billion MSCI Emerging Markets ETF (NYSEArca: VWO), is in fact part of a larger legal vehicle, which also incorporates daily-dealing “admiral” and “investor” shares (ETFs trade continuously). It’s worth noting that the name for the two non-ETF share class categories is the “Vanguard Emerging Markets Stock Index Fund”—with no mention of the index provider.
Vanguard has been grumbling off-the-record about what it sees as unjustified index licensing fees for some time. Now, it’s making a statement that its own brand name means the most to the man in the street, with the identity of the benchmark being of secondary importance.
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