I have been fascinated by the recent discussions of index managers, index strategies, and overall market focus on the growth of indexing, stemming from recent developments such as (a) Massive flows of assets into index funds, often at the expense of traditional active managers. (b) The popularity of ETFs, which have until recently focused nearly exclusively on passive management. (c) The consolidation of the asset management sector, often led by managers focused on index funds and ETFs. (d) The Fed’s endorsement of ETFs & Index funds (e) the saga of TSLA & the S&P 500 index, and (f) the innovations in indexing focused on ESG, impact, and smart beta investing such as factors and themes. Not to mention, the recent acquisitions of Parametric and Aperio have shined a light on an interesting corner of the market, direct indexing.
While I am happy to educate everyone on the details, history, complexities, and evolution of indexing, this is well-trodden ground, and I would be delighted to provide links to articles that are deeply researched, edited, and well-written for those wanted to dive into the topic.
In this article I will highlight the business of Index Providers – these are the companies that calculate and maintain the underlying benchmarks. We can write an entire article on the function of index providers, but in summary, these are the folks who: determine and publish index rules & methodology, provide weightings and rebalancing information of index constituents, and calculate index returns and other statistics, among other important functions. As we found out in 2020, not all index methodologies are transparent, and nearly all benchmark rules have a fine-print “force-majeure” clause, as evidenced by rebalancing suspensions this past spring. While the most well-known use of benchmarks is as performance targets for index-tracking portfolios, benchmarks are also used as guideposts for active funds, hedge funds, allocation strategies, derivative instruments & transactions, SMA accounts, and other important uses.
By focusing on the $5 Trillion U.S. ETF Universe, which is 97% index-tracking funds, we can dissect the market positioning of the major index providers. While the revenue formulas for index licensing is often opaque and inconsistent, I think it’s fair to say that more AUM benchmarked to a provider’s index family correlates to higher revenue. Many index providers are well known in the popular press, such as S&P, MSCI, and FTSE Russell, while others may not be household names, but nonetheless command leadership positions in the industry and reputations for quality, transparency, and consistency.
Index Provider Concentration: The data set for this study, comprised of index-focused U.S. ETF funds¹, includes 74 ETF issuers which are serviced by 104 Index providers. While the concentration among ETF issuers is well documented (83% for the Big Three), there is more breadth among providers of the underlying indices, with the largest three providers accounting for 59% of benchmarked assets:
Asset Class Leaders: It should be no surprise that S&P leads the equity category, given its powerful brand in large-cap growth, but in fact, the fixed income and commodity categories are far more concentrated from an index-provider perspective. Bloomberg dominates the bond space with its ownership of the “AGG” and its respective components, and thus eight of the ten largest bond ETFs, while the LBMA is effectively the “gold standard” for funds tracking the price of gold. Other category leaders include FTSE & MSCI in non-U.S. Equities, MSCI in Real Estate, ICE in Preferred Stocks, and IndexIQ in Alternatives.
Issuer / Provider concentration: It’s illuminating to examine the different strategies that issuers have taken (or fallen into) regarding their index relationships. For example, while iShares manages ETFs tracking nearly 15 different benchmark providers across their 280 funds, Vanguard has just six providers across a suite of 74 funds. Meanwhile, Invesco has over 25 different index vendor relationships, albeit many with just one or two funds. While iShares and Vanguard have relatively balanced relationships (20-30% of AUM) with their top providers, State Street, Invesco, and Schwab have much higher concentrations in their leading benchmark vendors, though this reflects their top-heavy product sets:
2020 Flow Winners: Riding the wave of Fixed Income flows in 2020, Bloomberg came out the big winner in terms of flows into ETFs benchmarked to their index family, with nearly 30% of total flows this year. The performance and flows into growth and technology stocks have helped to solidify S&P at the top of the leaderboard, while also boosting CRSP (Vanguard’s equity provider of choice). Lagging non-U.S. equities kept MSCI and FTSE share of flows in single-digits this year.
ESG and Impact Investing. This is a meaningful new indexing category, with nearly all ETF and mutual fund managers now offering ESG & Impact focused funds. While there are volumes of research and literature rapidly advancing this space, there remains work and education to be done regarding standardization and investor confusion. Thus far, MSCI has taken an early and commanding lead, with nearly 75% of ESG-designated ETF assets referencing an MSCI-managed index. Expect continued dramatic growth and innovation in this category.
Conclusion: Indexing continues to be an exciting growth business, full of compelling research and innovation, as investors have flocked to lower-fee funds, institutions and advisors have embraced ETFs, and the industry has seen a boom of ETF options and offerings. Innovation is thriving in many areas, especially in fixed income, ESG & impact investing, alternatives, and factor / thematic investing, while zero-commissions are opening up avenues for greater efficiency in ETF models, trading, and direct indexing. The benchmark providers outlined in this article play an integral role in the evolution and health of the investment ecosystem, the transparency of investing methodology, and the expansion of investment solutions for institutions, advisors, and investors.
“Let’s be careful out there” – Sgt. Esterhaus, Hill Street Blues.
REFERENCE CHARTS – or – “Why are we discussing indexing so much now?”
Chart A1: Growth of Index Assets at the Expense of Active (source: ICI)
Chart A2: A Decade of ETF Growth: (sources: ICI, etfdb)
Table A3: U.S. ETFs hit $5 Trillion in Q3 2020; Bond Funds Dominate Flows:
Chart A4: 20 Years of Falling Fees: (source: ICI)
¹Data Methodology: I started with a complete set of U.S. ETFs, dated Nov. 24, 2020. This was comprised of 2322 funds total $5,140 B. I removed funds designated as Active, which comprised $143 B, or 2.8% of the universe. I then screened out funds under $75 M in size, to simplify data issues; this covered $24 B, or 0.5% of the universe. My final data set, used in the tables for this article (except A3, which is the complete U.S. ETF universe), thus included 1146 funds and AUM of $4,973 B, representing 97% of the U.S. ETF universe by assets.
Data Sources: ETFlogic.io, etfdb.com, ICI annual factbook; issuer and index provider websites. Any data errors are my own. PDFs of all articles available upon request.
Elya Schwartzman is the founder and president of ESIC LLC, an independent advisory firm specializing in ETFs, indexing, fixed income portfolio management, and investment infrastructure and technology. ESIC also provides independent research on these topics. Over the past 15 years, Mr. Schwartzman has played a key role in the growth of the ETF industry, having managed teams, portfolios, and investment process initiatives for BlackRock and SSGA.
Disclaimers: ESIC seeks to provide paid advisory services to companies in the ETF ecosystem, including but not limited to issuers, index providers, analytics and data vendors, and market makers. Any views expressed are solely of the author and should not be construed as investment advice.