Time to disrupt the lucrative index-licensing businesses?

Both active and passive asset managers affected by continually rising fees, argues Morningstar

Time to disrupt the lucrative index-licensing businesses?

The generally steady gains from stock-market investing over the past few years has provided a strong tailwind for index-based investment, creating strong demand for generic equity benchmarks. That has supported a highly lucrative business for index providers — and it may be high time to disrupt that market.

A new paper from fund research firm Morningstar observes that index licensing fees are on the rise as asset managers face continuing pressure to cut costs from squeezed margins and declining fee income, reported Institutional Investor.

A pressing need to access popular benchmarks leaves asset managers with little choice but to pay the index providers. This is an issue for passive funds as well as active managers, who need to formally compare their own performance to indexes in legal documents as well as provide consultants with such comparisons.

“Industries dominated by just a few players that benefit from high switching costs tend to exert pricing power,” the Morningstar paper said. “Anecdotally, [index licensing fees] have risen past the rate of inflation — by some accounts doubling or tripling over a five-year period.”

There’s no ready source of industry information on licensing fees, but the research firm claimed that benchmarking data is among the top five data expenses faced by some asset managers. Institutional Investor also cited a claim from an unnamed research executive at a large asset manager, saying that index licensing fees have been rising every year and only large managers are capable absorbing the costs of self-indexing, or developing in-house benchmarks.

While it’s typical for asset managers to reserve the right to replace a fund’s benchmark index, switching is not that easy. Part of the problem is the fact that the industry has become more concentrated, according to Morningstar.

“Thanks to mergers and acquisitions, a few providers control the bulk of market share,” the paper’s author’s said. The largest players in the index-licensing space include S&P Dow Jones Indices, MSCI, FTSE, Russell, and Bloomberg.

Dan Lefkovitz, a member of Morningstar’s index team, said in an interview with Institutional Investor that he expected a 2012 move by Vanguard Group to be followed by more asset managers. At the time, the index fund giant lowered costs by switching the benchmarks used by 22 of its index funds.

“We were expecting it would set off a bunch of switching, or at least price comparison,” he said. “Costs are coming down across the board. You have zero cost funds, no trading fees. This is one area where they are going up.”


Follow WP on Facebook, LinkedIn and Twitter