I was fortunate enough to attend PMAR North America recently. It was a very good conference with interesting presentations from interesting people. There was one session in particular which left an impression on me. It was a panel session called “The Rising Cost of Benchmark Data”. The discussion was interesting and thought-provoking, but I was left with the feeling that I had been taken for a stroll down memory lane. I heard little in the discussion that hadn’t been an issue for me 15 years ago when I was an Operations Director at an investment manager. So why, I wondered afterwards, has this become such a hot issue now?
Indices are a long, long way from being a new concept; they have been a central component of the asset management industry for over 100 years. The first stock market index is generally regarded as the Dow Jones Industrial Average which was first calculated in 1896. Some of the most widely used indices today were first calculated over 45 years ago: e.g. MSCI World (1968) and S&P 500 (1957). Why has an industry issue that appears to be so serious today, remained unresolved for so long? What has changed over the past 15 years? Will the issue go away and, if not, how do we resolve it?
Getting to the heart of the matter
The essential issue here is that index data owners, the organisations that calculate and publish index data, require a fee to be paid by anyone who uses or distributes the published data. There is nothing unique here, this is perfectly reasonable and is a form of copyright protection which gives exclusive rights to the creators of original work to use and distribute their work.
The organisations that have to pay these fees are principally investment managers because they are the main users of index data, but other types of organisations use and distribute index data including custodians, fund administrators, pension schemes, and independent financial advisors.
None of this is new. Index data users have always been required to pay fees to the data owners; data owners have not suddenly started charging for something that used to be provided free. Nonetheless, there is a very strong perception within asset management organisations that they are paying a lot more for index data than they used to, and that these costs are escalating to unsustainable levels. Whether or not you agree with this perception, it shouldn’t be ignored. Issues that create the strength of feeling that this one has, don’t usually go away by themselves.
Pointing the finger
What isn’t clear to me is where we should be pointing fingers.
The index data owners have been demonised by some; presented as “greedy”, “exploitative” and “aggressive”. On the surface, it is easy to sympathise with that view if a high fee is demanded just for quoting an index return in a quarterly report sent to investors.
But look at this another way. If a manager is using an investment strategy based on under-weighting or over-weighting components within an index, then the index is acting as a kind of model portfolio. So, it seems fair for the creator of that model portfolio to be remunerated appropriately for their contribution to the investment strategy.
Don’t get me wrong, I am not an apologist for index data owners. But I do think we need to recognise that index data owners have a valid case when they ask to be paid for the use and distribution of data that they have created. Their actions and approach may not have endeared them to the users of their data, but they are not the only industry participants at whom fingers could be pointed. As Louis Nizer, an American lawyer and author, once said, “When a man points a finger at someone else, he should remember that three of his fingers are pointing at himself.”
But why now?
And there is still the question of why this has become such a hot topic now. I think there are three main reasons for this.
First, the asset management industry has become more sophisticated. Investment strategies have become more complex and so too have the indices against which they are measured. There are more indices and more complex indices than there were 15 years ago. And the performance analytics that are carried out are more detailed and more complex. So, asset management organisations are processing a lot more index data that they used to. And if you use more of a service, you generally pay more for it.
Second, index data has become Big Business. Most indices started out as subsidiary businesses within organisations whose primary revenues came from other activities. But this has changed. Index data owners, probably motivated to some extent by the growth in passive management and ETFs, have realised that there are significant revenues to be made from their data. And they have become more determined to maximise their revenues by collecting all fees to which they believe they are entitled. Which is how most businesses would behave, wouldn’t they?
Third, since the Global Financial Crisis of 2008, the asset management industry has been experiencing a sustained squeeze on profits. Significant costs have been incurred on regulatory projects and on improving transparency at the same time as downward pressure on fee levels have intensified.
The combination of these factors has created something of a perfect storm: at a time when they are trying to contain operating costs asset management organisations are using much more of a service, for which providers are demanding higher levels of remuneration. Margin pressure may ease over time, but I don’t think there will be much change in the other two elements of this perfect storm.
Industry-wide issues require industry-wide solutions
What we have here is an industry-wide issue. It isn’t one sector of the industry that is challenged, it isn’t one type of asset management organisation that is challenged. Which brings me back to the discussion at PMAR.
I was left a little troubled by the discussion. I was left with the impression that different industry participants are lining up on different sides of the argument, with the index data owners on one side of the divide and pretty much everyone else on the other. I chose that word ‘divide’ carefully, because that’s what worries me most about this issue. One of the things I’ve learnt is that conflict is never resolved by further dividing the groups on the two sides of the conflict. If this issue is as serious as asset management organisations believe it to be, then what is required is a working party that represents the interests of the industry as a whole. And that means that the index data owners have to be part of the solution, not just part of the problem.
What do you think? Join the discussion by posting your comment below.
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