Demanding new types of indices
The biggest index providers are having to rethink structures, but it is a delicate process of anticipation and collaboration.
Trillions’ worth of assets globally are benchmarked against indices provided by the likes of S&P Indices, FTSE and MSCI, but exactly how much is difficult to pin down precisely, for two reasons.
Firstly, besides the hundreds of thousands of indices produced daily, there is also a flourishing market in bespoke index manufacturing, the details of which are not always public. Secondly the type of indices demanded by clients has been changing, such as away from market capitalisation weighted, to non-market cap weighted.
Some index products are used as benchmarks by active investors such as managers of standard long-only funds, looking to beat a generic S&P 500 or FTSE 100. But the indexing industry has been growing and there is now a lot of money being run on individual indices.
The growth of passive investing has coincided with pressure on the asset management industry to curb costs. This is partly because the hunt for yield has become so expensive relative to possible reward, in a climate of zero or negative real interest rates.
But there are also regulatory pressures for transparency of costs linked to manufacturing and distribution, and demand from both regulators and clients to adopt new practice such as up-front fees for financial advice.
The emergence of passive investing is critical in explaining the trends among index manufacturers, says John Davies, vice-president and head of exchange-traded products at S&P Indices. He says more fund selectors and asset allocators are looking at index based products and how they can be used.
There has always been a stark difference between the level of fees investors pay for active products versus traditional index product. “The ETF market is now so diverse in terms of product offering and exposure you can get, that is adding to the fee debate as well.
Obviously ETFs are a much lower cost product than traditional index funds,” Davies says. “What we are seeing is clients looking for the next new thing. Certain things go in and out of vogue depending on the economic cycle. We have seen a lot more interest in the past year in dividend plays.”
Concerns about yield continue, despite flows into fixed income. There has been a trend back to dividend income strategies, and building indexes around such strategies, but at same time, interest in alternative indices, he said.
Another issue has been the long running debate over whether indices should be market cap weighted, or weighted on other factors.
“For years we were asked: do we believe factor-based indices are a better way to measure a market as opposed to market cap,” says Davies. “Our position historically has always been that market cap is what the market is. You can’t get away from the fact that price times the number of shares determines what happens in the market.”