The role of index providers in the capital markets has evolved dramatically over the years. At first indices were used to help sell financial newspapers, but by the 1970s, they became the basis of index funds. It was the first step towards the commercialization of data and intellectual property that gave rise to today’s crowded index industry.
The breadth of business and the increasing understanding of the workings of index providers, coupled with the constant shift of assets from active to passive, has led to a major increase in index based product offerings. Index providers have adapted their business models to reflect this tremendous growth; And with the potential to increase the licensing of index intellectual property to product issuers, profitability and revenue increased significantly as capital markets dominated the industry.
With the increase in demand, index providers became more innovative in their design. It is no longer an index measuring just a broad market or market segment. Today, an index is more likely to be the basis of an investment subject, slicing and cutting the market into almost endless types of market risk and consequences. In fact, almost any quantitative strategy can be modeled as a rule-based index. With the rise in index-based investing, there has been a tremendous increase in the number of index providers. Index providers are now competing not only on the calculation and publication of an index but also on their ability to provide a new and differentiated index product.
Although it is easier than ever to develop a new index, this access does not automatically translate into a successful index provider. The cost of licensing an index has dropped significantly, and the cost of running an index business has increased. Pricing is more competitive, and even the larger index providers are now more price sensitive. The focus of most index providers today is satisfying a seemingly insatiable appetite for new and innovative exposure. Whether it is themes, factors, ESGs or other new concepts, there are a myriad of indices and providers to choose from. Providing the index still provides attractive revenue growth and margin improvement, but the costs of data, technology and qualified staff are also rising, providing significant benefits to firms with the ability to scale up their operations.
The perceived dominance of large established players as well as the increase in the number of new index providers raise some interesting questions. What is the value proposition of an index provider and how much should one be prepared to pay for their intellectual property? There are also inevitable, and justifiable, concerns about increased regulation, which we touch on in Part 2 of this series.
The new Battlefield Index is in terms of innovation in design and market momentum to capture first mover advantages. Index providers need to adapt and become even more customer centric in addition to providing an index methodology that is sound, transparent and managed without conflicts of interest. In addition, index providers must provide research and analysis to help investors understand what they are investing in. This transparency is the key to the success of the product. It is important to understand what the end-investor or financial advisor wants. Index providers should step up their efforts to help their direct customers, product issuers, succeed in amassing assets.
Choosing the right index provider partner can be critical to a successful product. There are several factors that differentiate a good index provider from the rest. One of the most important considerations is the governance structure used to oversee its indices. Adhering to best practices or IOSCO principals is now table stake, and index providers need to ensure that their process is free from conflicts of interest. It is possible to close an index provider within a larger organization, working with an independent provider that is unrelated to the entity issuing the investment products, reducing any risk of conflict and sending a message of true independence to the market. Is.
While product issuers may feel that they no longer need a brand-name and may design their own indices or work with a low-cost provider, the question should be whether it is worth it. ? The unit cost of an index license has decreased dramatically, and this trend can be expected to continue due to the scale nature of the industry. Rather than focusing on minimal cost, product issuers should work with index providers who can aid their efforts by providing support such as marketing and business development. Index providers, and their well-known and respected brands, can be a big difference in a highly saturated market.
The future of index providers will continue to evolve. They will develop more specialized and complex indices because that is what the market demands. In an effort to scale, these indices will be offered in many different types of product wrappers. There will also be the potential for increased regulation, which will have the effect of making large providers even bigger and putting many smaller providers out of business. Large providers will have scale across all asset classes and can support clients in all geographies.
Alex Maturi is the retired CEO of the S&P Dow Jones Index and is currently an advisor to Index Standard and a member of the Board of Directors of CBOE Global Markets.