Indices are all about money, it is the business of translating market performance into recognisable benchmarks, and making money out of doing the translation. While there are many well-known index brands, like Hang Seng Indexes, Nikkei and Wilshire, the global big 3 are FTSE Russell, MSCI and S&P Dow Jones, plus little brother, Deutsche Börse’s Stoxx which possesses a strong European franchise.
They continue to be very successful businesses, for the big 3½ their combined revenues in 2020 totalled US$3,284 Million up an impressive 67% on 2016. Though it should be noted the strength of Sterling and Euro boosted the US$ values. During this period, MSCI Indices averaged a pre-tax margin of 75%.
Even more remarkable is the index business, especially when combined with analytics has consistently outperformed their overall group companies, and if they were standalone businesses based on a percentage of revenue/group market capitalisation their notional valuation would be US$56,272 Billion today compared with US$35,148 Billion asof 13/04/2019, i.e an increase of 60%
As I continue to argue, index creators and definitely key individual indices are now ‘Brands’. A DJIA, S&P500, FTSE 100, Nikkei 225, MSCI Global can be replicated but not replaced. This inherently limits index competition because key indicators have become monopoly products, and financial institutions find it easier to sell products linked to specific brands, not indices the market fails to recognise.
This creates a ‘Virgin Cola’ barrier to entry where even a well
known entrant cannot compete with established Coke and Pepsi.
From 2016 to 2020 the index creators revenue growth has been consistent, Stoxx (142%), MSCI (66%) FTSE Russell (63%), MSCI and S&PDJI (55%).
In 2019 the Big 3 linked Assets Under Management totalling US$40 Trillion equal to 60% of IPE’s researched Top 400 Global Asset Managers AUM of US$66 Trillion.
In 2021 the index creators are not deviating from their 2 prong strategy each being a trident, a business led strategy and an index led strategy.
- Grow the market, especially via AUM driven revenues
- Add value driven analytics
- Ruthless compliance
- Create new indices out of old, i.e. strong focus on ESG
- New instruments i.e. ETFs
- Cover more asset classes
POTENTIAL FOR COMPLACENCY
In 2020 I stated there was little systemic threat to the underlying businesses of the leading index creators. I was thinking in terms of monopolist use of ‘brands’ and high fees passed on to the underlying investor. The SEC fine of US$9 Million passed out to S&P DJI this year could represent a shift in how the regulators view indices. This fine related to how an index functioned which caused losses to Credit Suisse.
- The business is so high margin, the index creators will be able to weather the current storm, and wait until calm returns. Even a significant drop in revenue potentially caused by a collapse in AUM would be mitigated by the high profit margins currently earnt, and although the initial doom and gloom around COVID in 2020 has not appeared, but may yet come to the fore. In 1998 Gordon Brown, proclaimed the ‘End of Boom and Bust’, history has proven him and every other ‘this time its different supporter tragically wrong
- Without major regulatory change, the index creators clients will still be bound closely to their benchmark providers. Changing index providers is hard work on many levels, even when ignoring the limited choice
- Barriers to entry are high.
• The Big 3 have brand awareness and global presence
• The regulatory framework for creating indices for commercial purposes is clear and concise but onerous. It is why the Banks dropped their indices. Unfortunately BMR is only going one way and that is stricter rules and interpretation, this does favour insurgent index creators
• The expertise available to create indices, associated methodologies, then implement as a business is expensive and not readily available
• Establishing competition in the post-IOSCO principles world is time consuming to build critical mass except in niche markets. This favours incumbents
The notion that it is easy to create an Index is fanciful.
As we hopefully look forward to a post-COVID world the 4 immediate challenges the index creators are facing from 2020 have not disappeared, merely postponed. Regulators are currently focusing on Exchange Data services which presages a more activist role in analysing the dynamics of pricing markets, where indices sit right in the centre.
- Clients remain dis-satisfied with the cost of subscriptions, and lack of transparency in how the index creators pricing models function. Quiescence is being replaced by restlessness. Client willingness to pushback is there, but grounded in the reality that changing from one index creator to another does not solve the problem
- Regulators are interested in costs and quality, especially if it has a negative effect on the costs of pensions and funds
- Data sources, primarily exchanges, are now becoming aware of how little they are paid by the index creators to use their data, and how much profit the index creators are able to make from the sources’ data. Some exchanges have considered linking fees to AUMs, though the inherent problems have prevented a trigger being pulled
- Often competition may not seem like a threat because it is small and then suddenly emerges, the big index creators are facing two levels of competition
• Small new index providers which have not adopted the AUM model, such as, INDXX, ScientificBeta, and Solactive
• Self-indexing, which has been embraced by the likes of Blackrock, Charles Schwab, State Street, and Vanguard
• The importance of these 2 levels of competition is the battleground is not in the field of existing benchmarks, but in areas where ‘brands’ have yet to be established, such as ESG and OTC markets
There is trouble ahead and the index creators will have to make compromises, however unwillingly, but their business models are sound, if not liked, and the future for benchmarks looks bright as new markets open up, especially in OTC markets.
Keiren Harris 16/06/2021
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