Rob Flatley, chief executive officer at New York-based financial markets data firm CoreOne Technologies, was watching with great interest after Vanguard said early in October that it would drop indexes from MSCI on 22 funds and replace them with benchmarks from FTSE and CRSP.
Looking ahead in the aftermath of that announcement, Flatley told IndexUniverse Correspondent Cinthia Murphy in a recent interview that Vanguard’s plans signal a more competitive future for index providers that now face threats from rivals with lower barriers of entry.
Murphy: As Vanguard gets ready to move a lot of money from point A to point B, transitioning 22 ETF portfolios to match their new indexes, how careful does it have to be to avoid front-running? And will Vanguard be able to do a lot of this internally and avoid going to the open market for securities?
Flatley: You can do different things, but I think the first thing you do is internalize that flow and cross that flow internally if you can. In the case of the switch to FTSE, how many brokers can trade in 50 countries in a transition trade in one snap? Not many, maybe eight or nine.
So, if you are Vanguard, you typically don’t want to load up these orders into some algorithm and start sending it all over the planet. They’ll go to brokers and have them bid on a programmed trade. The broker will internalize that before they go to market so that they minimize market impact.
These are the so-called implicit costs of trading—they don’t want to drive up the price of the stocks they need. Vanguard will try to cost it internally; they’ll look for a risk bid. Brokers will make a bid and ultimately everything comes out as an agency trade in the market. So I don’t see a big impact on the markets from this transition.
Murphy: What do you see as the biggest impact of Vanguard’s decision to ditch MSCI on all those funds?
Flatley: I think the major impact of Vanguard’s move is not related to the transition. If you look at it, the MSCI stature in the marketplace—the brand—is really valuable. People trust the brand. But when it comes to a market-cap-weighted index, it doesn’t take a lot of proprietary logic to build it. It’s a formula you can pretty much pull out of a textbook, so there are very low barriers to entry to getting into the index business from a technical and intellectual property perspective. The real barrier to entry is the presence of the brands already established.
The big issue here is that once someone who has $500 billion in assets decides they are going to ditch someone like MSCI for the University of Chicago Booth School of Business, that’s an important signal. When someone like Vanguard can do that, what’s to say that others won’t follow suit? The disproportionate drop in MSCI’s value that day is also a signal that that’s the real issue. If there’s no big barrier to entry in this business, what are MSCI and others like it really worth?
Murphy: The days of giant index providers are numbered?
Flatley: This is kind of analogous to the mutual fund vs. ETF story—the idea of trying to get the same thing a mutual fund provides out of the ETF structure for less money. Vanguard was a leader in that space, and it has now taken that philosophy and applied it to indexes.
It’s really been about brand, but when you look at the industry today, anyone can come in and be a player, so it becomes a race to zero on commissions and costs. Is this a race to zero on index calculations and index provision? It looks like the market thinks it is.