Keeping track of users' demands
The world of benchmark indices and index providers has changed significantly over the past few years as investors have required new products and more competitive services. The traditional business of providing pure benchmark indices for asset managers to use as a performance measurement tool has typically ceased to be a value added product. The real challenge for index providers is to establish themselves with credible products for the benchmarking of performance across asset classes ranging from equities, bonds, currencies and most recently hedge funds. At the moment index providers can be broadly split between those that are successful providers of pure benchmark data – MSCI and FTSE, and those that thrive on the use of traded products such as S&P and STOXX / Dow Jones.
One of the fundamental problems within the index business over the past three to four years has been the broad convergence of products in terms of equity indices. The shift to free float created a landscape of index families that whilst retaining individual characteristics, are broadly similar in terms of providing products that represent exposure to equities as an asset class. The table shows how close the main index providers are in terms of delivering comparable products, although in this respect the S&P Global 1200 is the least representative and also involves emerging market exposure. The recent acquisition of the Citigroup indices by S&P, may help in terms of expanding their product coverage and depth. However it simultaneously creates further problems by bringing in an index family that is inconsistent with the existing range of S&P products.
There has been an element of product development within the equity index business that has allowed providers to differentiate themselves. Investors are becoming more demanding with respect to specialised and dedicated areas within asset classes. One of the best examples of this was the shift by FTSE to a broader index family with greater depth as represented by the shift to the FTSE Global Equity Index Series. This is an index family that covers large, mid and small cap stocks across both developing and emerging markets in a comprehensive and consistent fashion.
In the European market the pace of change has been driven by STOXX with the aggressive marketing of their pan-European index family. This approach had a significant impact in terms of the business model that traditional index providers could follow. This had typically centred around the delivery of data and provision of licenses to track indices. The STOXX business model was centred around free data, readily available from its website, together with a push in the direction of tradeable indices with the likely benefits being from derivatives and fund-based licensing revenue. This new paradigm altered the scope for existing index providers to capture the burgeoning equity environment that typified the equity markets of the late 1990s and early 2000. It became clear that revenue growth in Europe was unlikely to come from the traditional model.
It is probably fair to say that STOXX, due to the strong presence afforded to it by its founding partners that included three of Europe’s main exchanges, has had an unprecedented impact on the index landscape. This linked relationship with exchanges was crucial in the promotion of futures and options on the narrow blue chip indices. Latterly this has extended to the emerging ETF market in Europe where again the combination of the brand name recognition in the retail market, together with aggressive ETF issuance has made STOXX the leading provider of indices related to listed derivative products in Europe. In Europe, STOXX-based ETFs account for close to 40% of the assets under management and this equates to around E7bn. In the US market, S&P have the dominant products accounting for over 48% of the ETF market in terms of assets under management and this amounts to over $75bn (E58.8bn). In the US market, MSCI products, whilst a small proportion at only 9% of the market, represent close to $15bn of assets. Index providers clearly see that the potential for this market, especially in Europe as representing a key growth opportunity.
FTSE has also been proactive in building relationships and products with local exchanges, not just on a European, but on global basis. The most recent example of this in Europe has been the creation of the FTSEurofirst Indices that are the basis of two futures products listed on Euronext LIFFE. However, the new FTSEuroFirst products have yet to gain significant usage. With liquidity remaining concentrated in the EURO STOXX 50 it is difficult to see how this product will break the STOXX stranglehold of the derivatives markets in Europe.
Given that the derivatives market and related indices in Europe is relatively stable, with no real success for FTSE, MSCI (Pan Euro, Euro futures contracts) or S&P (with the S&P 350) the main challenge lies elsewhere. One of the key trends amongst European equity investors is the undeniable desire to diversify their European equity exposure by owning a broader base of global equities. Cross-regional flows represent an important part of investors’ focus. This trend has been driven by the undeniable and highly observable shift in correlation between the regional portions of global sectors. Towards the end of last year, 61% of European sectors by market capitalisation had a correlation higher than 70% to the equivalent North American counterparts. European investors continue to put great emphasis on sector investing opportunities and the requirement to have useful listed and OTC products that offer easy implementation. This type of trend is clearly beneficial to index providers that have been willing to provide data for free. This aspect of the use of the data has allowed a broad range of users to understand the products that they want to construct and has hampered traditional benchmark providers. The joint use of the GICs structure by both MSCI and S&P has not helped them capture sector-related flows, with the US market in sector ETFs being dominated by the Holders product.
One area that remains a challenge is the global benchmarking business and it is possible that this will follow the trends set within Europe. This is perhaps even more likely now that Dow Jones have created a Global 1800 benchmark that is a credible alternative to the global benchmarks offered by both MSCI and FTSE. It does not have the long run depth of index history that is available from MSCI, nor does it have quite the exact ability to break it down into component parts at all possible levels that is a key characteristic of FTSE’s Global Equity Index Series. However, it provides data that is free at a constituent, corporate action and index level, as well as having available all the relevant regions and sector level calculations. This focus on costs is perhaps especially important in an environment where funds are looking to minimise their overall costs. It is unlikely that long-term global equity investors will switch, but there are clear attractions for other investors looking for a global index product.
Index providers have to develop relevant products both within their existing business lines and more importantly across new asset classes. If there is a key growth area it is the benchmarking of performance within the hedge fund industry. As this area increasingly becomes part of institutional asset allocation mandates so appropriate and relevant benchmark data is also required. Additionally there has been strong growth in the demand for index providers to deliver a tradable form of their hedge fund indices. S&P have clearly been the most successful at this with a well established product that covers the main strategy classes within the hedge fund universe. This area is at a relatively early stage of development, with MSCI having recently added a form or tradable product to its hedge fund benchmark indices. FTSE are soon to follow with their own family of indices in April of this year. The focus will be the ability to create indices that reliably represent the breadth of performance within the hedge fund industry.
Overall the challenge for index providers rests on many fronts and different product areas, especially as the core benchmark business is both low growth and under pressure from new entrants with different pricing models. The real growth opportunities lie with tradeable products, ranging from ETFs, futures and options, to new asset classes such as hedge funds. It is not clear that investors will require a single provider of data for all asset classes as ultimately the quality of data will differentiate the products. What is clear is that the market continues to evolve and index providers need to remain flexible enough to face the challenges presented by the change in product usage.
Nizam Hamid is director of global portfolio and index research at Deutsche Bank in London