What’s An Index Worth?

October 17, 2012

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Vanguard’s move to ditch MSCI is the latest sign of an indexing industry in transition.


[This article originally appeared on our sister site, IndexUniverse.eu.]


Vanguard’s recent decision to switch benchmark providers on half a trillion dollars of assets has thrown the indexing world into turmoil.

What’s an index worth to its provider? Put another way, how much should an investor expect to pay for the benchmark underlying an index-tracking fund?

Industry participants offer very different answers to this question, revealing tensions that go to the heart of how the asset management business operates.

A radical view of the indexing world, but one that’s apparently gaining traction, suggests that only a few large equity benchmarks have real brand value.

According to Steffen Scheuble of index provider Structured Solutions, maybe 10-20 indices worldwide fall into this category. He didn’t tell me what he thinks they are, but we can probably all come up with the likely names—S&P 500, MSCI World, Dow Jones industrial average, FTSE 100, Euro STOXX 50, Nikkei 225, DAX, CAC 40, plus a few more.

A couple of weeks ago, I’d have added the MSCI Emerging Markets index to the list, but Vanguard’s recent decision to ditch that benchmark for a lower-cost index offered by FTSE suggests the premium brand-name group might be shrinking.

Scheuble’s firm, and others of its type, offers to undercut the prices charged for brand-name indices by providing a slimmed-down service focusing on calculation and index maintenance only. This approach is bringing in a large volume of new business from cost-conscious product issuers, Scheuble says.

According to one index industry veteran, who spoke to me on condition of anonymity, a large indexing firm like BlackRock—and the investors in its funds—could easily save tens of millions of dollars a year in licensing fees by abandoning the majority of branded indices they pay for, internalizing the index design and outsourcing the index’s calculation and maintenance functions to low-cost providers. This basic service can apparently cost as little as a few thousand dollars a year per benchmark.

By contrast, says my industry contact, most index providers currently charge between 6 and 12 percent of an exchange-traded fund’s total expense ratio under the AUM-based licensing model that’s become standard across the industry over the last two decades. It’s that AUM-based fee scale that’s now under open attack.

And there are stand-out licensing fees, too; some falling well outside that 6-12 percent of total expense ratio range.

State Street Global Advisors’ $116 billion SPDR S&P 500 ETF (NYSEArca: SPY), the world’s biggest exchange-traded fund, pays a whopping 33 percent of its annual net expense ratio—3.1 basis points out of 9.45 basis points—to S&P Dow Jones for use of the 500-stock index, something that’s set in stone in the fund prospectus. That’s a cool $36 million a year in fees to the index provider from a single ETF.

So no wonder BlackRock has applied to the SEC to develop the benchmarks for its own funds.



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