In the US pension arena, index management has been a major factor since the early seventies and, following a typical product life cycle, has reached maturity: 1) fees have come down to a few basis points, 2) competition has been crowded out to a handful of players sharing more than three quarters of the assets (Barclays Global Investors, formerly Wells-Nikko, State Street Global Advisors, Bankers Trust and Mellon Capital) and 3) the art of index tracking has reached a level of quasi perfection, especially against the S&P 500 index.
In other words, indexing has be-come boring” to vendors and customers alike. Consequently, the growth of indexing started to tail off at the beginning of this decade. Index managers have been scrambling to move up the risk spectrum towards enhanced and active management, in their attempt to break away from commodity-like fee levels, while plan sponsors, having filled their “core” with indexed money, have been ap-pointing active “satellite” managers.
In continental Europe, the situation is quite different as index management is still widely viewed as a “high tech novelty”, rather than a commodity product. In its life cycle, indexing is just growing out of infancy and index managers may view growth and revenue perspectives with optimism.
What then makes European (ex UK) pension markets so different from their Anglo-Saxon counterparts and what triggered this tardy discovery of index management?
Unlike ERISA, which created a level playing field for US pension funds, the absence of pan-European legislation leaves continental Europe a fragmented market; this makes it difficult to generate the economies of scale which are vital to index management. Index managers thus have an opportunity to overcome their “boredom”, by applying creativity in the search for cost-and-tax effective vehicles to pool assets.
The low profile of consultants, compared to the US and UK markets, where every managers is “pidgeon-holed” gives index managers on the continent more flexibility in peddling their wares.
The absence of domestic players (indexing is clearly an Anglo-Saxon game) gives global players an opportunity to compete, as European institutions look for efficient ways to further their diversification into global equities.
Universal banking, meaning banking, brokerage, underwriting, investments and custody, all under one roof, led to unease among the more progressive plan sponsors with regard to transparency of processes and fees. These sponsors embrace index management as a “clean” and transparent investment concept, regardless of performance considerations.
European pension funds, especially in smaller countries, such as Switzerland, the Netherlands or Belgium, rarely seek index managers for their domestic equity markets. Indeed, many of them beat the local stock index, comprised of a mere 20 names (and insider trading legislation is a recent phenomenon!) So, they appoint index managers for the more complicated, foreign portion of their assets, including emerging markets and small caps. They also demand flexible implementation, regionally, against tailored benchmarks, without forfeiting treaty withholding rates on dividends, sometimes even including an “ethical” filter. This flexibility and sophistication naturally commands a fee premium over, say a plain vanilla S&P 500 fund.
Finally, some pensions trustees, experiencing disappointing returns with local managers who had over extended themselves beyond their sphere of competence, embraced indexing as an unemotional cure to their performance solution.
To conclude, index managers may expect more sunny days promoting the many merits of indexing, which European plan sponsors will gradually discover and learn to like.
Jean-Francois Schock is a principal at State Street Global Advisors in Brussels.
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