Nasdaq index veteran and architect behind QQQs looks back, and ahead.
This is the sixth in a series of interviews with some of the most influential people in the field of indexing and index-based investment. The interviews are also published in the November/December 2014 issue of the Journal of Indexes.
John Jacobs has been with Nasdaq for more than 30 years, and was one of the driving forces behind the 1999 launch of one of the most actively traded and largest ETFs in the world, what is now known as the PowerShares QQQ (QQQ | A-46). At the same time, he launched the exchange's index services business and, more recently, shepherded the Nasdaq OMX through the rollout of its global index family. With his retirement set for January 2015, Jacobs is stepping down from his role as executive vice president of Global Information Services, a business unit that he created and that represents more than one-fifth of Nasdaq's revenue. However, the indexing pioneer will not leave the stage entirely—he's agreed to stay on as a "strategic advisor."
Would you talk a little bit about how the PowerShares QQQ (QQQ | A-46) was developed and what the impetus was to create it?
In 1997, one of my functions at Nasdaq was to lead strategic planning for nontransaction businesses, and one of the challenges we faced as a stock market was we didn't touch retail investors directly, or for that matter, institutional investors. They were clearly the customers of our trading firms such as Goldman Sachs, Morgan Stanley, etc., and they were the shareholders of our listed companies, such as Apple and Intel, etc., but we didn't touch them directly.
And so we challenged ourselves to "figure out a way to interact directly with and touch and influence individual investors and institutional investors to make Nasdaq more tangible to them." So the idea we came up with was, why don't we do a Nasdaq-branded financial product? Our research pointed out to us this fairly new product in the market, the SPDR. It was a couple years old and it was based on the S&P 500. Nobody called them ETFs back then; it was called an index share.
So I started the work to create, for lack of a better word, a SPDR on Nasdaq so that we could in fact touch and influence investors and traders. Each and every day, millions of people say, "How is the market doing?" And the most common and relevant answer around the world is, "The Nasdaq is up and the Dow is down and the S&P is flat." At the time, they could invest in the other two indexes, but not the Nasdaq index. It was that impetus, to actually create a mechanism for investors and traders to participate in Nasdaq and touch Nasdaq every day.
That led very quickly to the creation of an entirely new business unit at Nasdaq, and we continue to lead the wave of indexing that is still prevalent today.
You have been at the helm of Nasdaq's index business, which seems like it has been transformed with the rollout of the global indexes more recently. What have the challenges been in building up the index offerings at Nasdaq?
A couple things. One is that Nasdaq, like most exchanges, had its own indexes that were proprietary to the stocks listed on their market. For us, early on, our indexes reflected exactly that—the Nasdaq-100 or the Nasdaq composite or something along those lines. We very quickly realized though that to be a global indexer, to offer products, you needed to be able to do indexes across all equities in the U.S. That was the first step. And then secondly you needed to start looking at doing other asset classes.
We invested heavily in technology and distribution mechanisms, dissemination mechanisms, and data acquisition and data cleansing and index admin, so a lot of infrastructure. And we did it in a very, very efficient fashion. We had to build it very scalable. We concluded the only way you could really compete today is if you can be a multi-asset indexer across all asset classes, in a very scalable format, and deliver it very inexpensively. Therefore, we invested in the best technology to do that.
It takes quite an investment to be a world-class indexer versus a hobbyist or a niche indexer, and I think you're seeing that the continuing trend toward concentration among the top indexers is prevalent in the ETF space today.
So we followed a couple of different paths to get us to where we are today, with 155 ETFs worth $104 billion and 9,000 other index products. It wasn't a speedy journey, but it was definitely worthwhile.
What do you see as the biggest positive or negative developments in the indexing space in the past 20 years or so?
The big positives are that people are really starting to look past things like just brand or, "I have always done it that way; that's why I'll do it that way again," and are starting to look at the actual construction and cost of indexes. We call it the true cost of utilization. Sometimes people pick an index, they don't realize how that index may have tracking errors, or that it's not transparent, or it doesn't reflect what they want it to, or the downstream data costs are exorbitant, etc. We're finding there is a real discipline now for people to actually understand that objective, transparent, inexpensive indexes and understand that the total cost is really important. It's more important to pick the right index than it is just to pick the same brand I have always picked. That is the No. 1 thing.
The biggest downside as an industry is that we're not great on necessarily labeling everything as clearly as possible. There's confusion over what an index is supposed to represent. You'll see a product and say, "That product, what does that mean? Three times up the Dow. What does that mean? Does that mean if the Dow is up 10 percent that I'm going to get a 30 percent return?" The confusion stems from the lack of a standardized language, standardized naming conventions, etc. If it causes any investor confusion, it can't be good. We can make things easier for investors to understand.
How do you think ETFs have changed the indexing industry?
ETFs are leading the charge for indexing. Indexing has been around only since 1975—that first Wells Fargo fund years ago, but it took ETFs to really make it a retail product. That has been a great thing. We have given investors low-cost, tax-efficient vehicles that highlight even further that most active managers can't beat an index fund. Then you also add in tax advantages and low expense ratios—all features of ETFs, and it's easy to see what spurred this revolution. I think the indexing revolution will continue not just through ETFs, but through index mutual funds that lend themselves better to 401(k)s and through structured products and equity-linked notes and other products. However, ETFs were the big catalyst that got it going.
Do you think ETFs will eventually overshadow or maybe even replace mutual funds?
I don't think they will overshadow or replace mutual funds. What they will do is they will take their rightful place. ETFs will have their role, but so will mutual funds, so will structured products, etc. There is no "one size fits all," but I do think the world is going to tilt much more toward index products of all kinds than in the past.
I do not at all foresee the demise of mutual funds. I just see ETFs kind of taking their rightful place as side by side with them.
What do you think is left for indexing? What's next?
Indexing is very strong in the U.S. and it's strong in Europe. I think Asia is still a big opportunity, as well as India, Africa and Latin America. Equity index products are very comprehensive today, but the other asset classes such as fixed income, commodity, currency, alternatives are still in early stages. There is also ample opportunity in different distribution channels such as defined contribution (401(k)s, etc.). There are still tremendous opportunities to grow geographically, by asset class and by product.
What role does indexing play in your own portfolio?
I have a financial advisor and we actually sit down and look across the asset classes at my asset allocation model and we pick benchmarks that I am going to use to measure the return of each category. I always require my financial advisors to not just tell me what the product returned or what that part of the portfolio returned, they must also tell me how it returned versus a benchmark that is relevant. Indexing is an absolutely critical tool for me.
You're about to retire; what do you see as your biggest accomplishment in your career or the thing you are proudest of?
I have been very lucky and have the benefits of a truly wonderful career at the best company I could have imagined. I have been lucky to work with the smartest and most dedicated and passionate team here at Nasdaq. I have helped build Nasdaq from when I was among the first 80 employees to where we are today and helped us grow into a global company. I will always [be proud of] starting and launching QQQ, and being able to build this world-class index business and brand.