EIU - Beyond the status quo: Searching for value in index products - November 2013
Post on 30-Oct-2014
DESCRIPTIONReport Summary Beyond the status quo: Searching for value in index products is an Economist Intelligence Unit (EIU) report sponsored by Northern Trust Asset Servicing. It is a follow-up briefing paper to our March 2013 executive summary entitled Obtaining value from index products, which drew on a survey of 329 financial industry executives. Why read this report Most respondents say they choose a particular index because it aligns with their key business objectives and meets technical requirements. However, a majority of survey respondents (60%) also say they want a brand name that creates credibility with stakeholders and a licensing policy that allows wide dissemination (57%). Licensing policies are the greatest source of user dissatisfaction. A mere 38% are satisfied with this aspect of index products and only 11% say they are extremely satisfied. Only 30% of index users say they can share data across their organisations without additional fees, and only about one in five can redistribute index data to non-employees. 59% believe that index providers exploit their reliance on them to increase fees for add-on products. Moreover, only 28% of executives say that the index provider they use most is generally willing to negotiate, and only 7% say the provider is willing to adapt product offerings to meet client needs. Executives that assess their organisations as top performers tend to be heavy index users and tend to be extremely satisfied with every aspect of index products. In most cases, they employ in-house index data experts, are strongly focussed on data quality and take a pragmatic view of brand value, meaning they recognise value obtained from well-regarded brands but are willing to look beyond them.
1. A report from the Economist Intelligence Unit Beyond the status quo Searching for value in index products Sponsored by 2. Beyond the status quo Searching for value in index products Contents About the report Introduction 3 1 The search for business value 5 2 Index products: Which one to choose? 6 3 Licensing agreements: To agree or not to agree? 8 4 Increasing ROI: Weighing the options 9 5 Search out new business models 11 6 Get licence management under control 12 7 In-house data cleansing experts 13 8 Overcoming obstacles 15 9 Characteristics of high performers 16 10 Conclusion 17 Appendix: survey results 1 2 18 The Economist Intelligence Unit Limited 2013 3. Beyond the status quo Searching for value in index products About the report Beyond the status quo: Searching for value in index products is an Economist Intelligence Unit (EIU) report sponsored by Northern Trust Asset Servicing. It is a follow-up briefing paper to our March 2013 executive summary entitled Obtaining value from index products, which drew on a survey of 329 financial industry executives. The EIU bears sole responsibility for the content of this report. The findings do not necessarily reflect the views of the sponsor. The paper was written by Kenneth Waldie and edited by Janie Hulse. The report draws on extensive desk research, original survey analysis and interviews with highlevel financial industry experts with experience using index products. We would like to thank the following individuals for sharing their time and insights: Carl Bacon, chairman of StatPro Group and founder of the Freedom Index Company Rolf Agather, managing director of global research and innovation, Russell Indexes Ali Toutounchi, managing director of index funds, Legal & General Investment Management Jeff Molitor, chief investment officerEurope, Vanguard Asset Management Lucas Garland, global head of product management, Thomson Reuters Indices Steve Ellenberg, senior consultant, Market Data Services Limited (MDSL). 2 The Economist Intelligence Unit Limited 2013 Who took the survey? In February 2013, The EIU conducted a survey of 329 financial industry executives personally involved in the selection and/or use of index products for their organisation. Nearly half (46%) are C-level executives or board members, another 31% are other senior executives (SVP, VP, director, head of business unit or department). North America, Western Europe and Asia-Pacific are nearly equally represented in the survey sample with approximately 30% each. Just over half (55%) of respondents are with companies with more than US$500m in annual global revenue, while about 22% are with firms with yearly revenue greater than $10bn. The survey covers 19 different financial subsectors, with the largest representation from asset management (14%) and wealth management (12%); investment banking, retail banking, corporate banking and financial consulting each have 10% representation. 4. Beyond the status quo Searching for value in index products Introduction Market indexes, with their rising licence fees and usage restrictions, have become expensive and burdensome for many financial services firms. Until the 1990s, the provision of indexes was not a particularly lucrative business, but the emergence of index funds changed that. Investment in the Vanguard 500 Index Fundwhich tracks Standard & Poors 500 Indexsurpassed US$100bn in 1999, establishing indexed mutual funds and, later, exchange-traded funds as mainstream investment vehicles. Previously, indexes were employed mainly as post hoc benchmarks for actively managed investments, but their use to establish the composition of passive investment vehicles proved to be a game changer, establishing the groundwork for index providers to claim ownership of intellectual property embedded in the indexes. As a result, fee structures became more restrictive and licensing for specific uses emerged as a more profitable revenue stream than the traditional data subscription fees. Today, the number of mainstream index providers in the market approaches 100. Users literally have access to thousands of indexes that track global equity and fixed-income security prices along with an array of alternative indicators. Yet, many financial services companies feel locked in to using a handful of established brandsS&P, MSCI, FTSE and Russell. A survey of financial services executives conducted in February 2013 by the Economist Intelligence Unit (EIU), sponsored by Northern Trust, examined how companies are 3 The Economist Intelligence Unit Limited 2013 leveraging existing index products. (Although asset management vehicles are often called index products, we will use the term to refer specifically to benchmark index products from index providers.) About three quarters of the survey respondents indicate that their business unit uses index products directly, with the remainder relying on interpretations of index data from specialists in other parts of their organisation. Executives who participated in the survey say they are satisfied with virtually every aspect of index products except two: flexibility of licensing policies and return on investment (ROI). These two factors are closely linked: By limiting applications, distribution and platforms, restrictive licensing policies can undermine strategies for maximising business value. Despite this sub-optimal situation, financial services companies are using index products more than ever before. Indeed, more than half of executives surveyed say they will increase index use over the next three years, regardless of whether they think index products are essential for their work. Increased usage does not necessarily imply that greater business value is being captured. Although this has begun to change, executives say that, in many cases, purchasing decisions continue to be based more on stakeholder perceptions of brands gleaned from the media rather than relying on a cost-benefit analysis. Carl Bacon, chairman of the StatPro Group and founder of the Freedom Index Company, puts it this way: What people are 5. Beyond the status quo Searching for value in index products buying are brands; theyre buying a well-known brand like FTSE or MSCI and often its the owner of capital that is driving the decision about the index and not the people who actually pay for it. Clearly, Bacon believes that financial services companies often stick with well-known brands only to appease their customers. Rolf Agather, managing director of global research and innovation for Russell Indexes, holds the opposite view: Were talking about products that guide the accumulation of wealth, which means pension plans and other savings that people need to support their future quality of life, choosing a branded index provides an assurance of quality and the idea that youd rely on an unproven product just because its cheaper doesnt make sense. These contrasting perspectives are reflected in 4 The Economist Intelligence Unit Limited 2013 the EIU survey results. Nearly one-quarter (22%) of respondents say that excessive reliance on bigname index products is one of the two biggest obstacles to obtaining greater value for money. But a nearly identical percentage (23%) say that a well-known brand name that creates credibility in the minds of internal and external stakeholders is an essential determinant of business value. This report investigates how these companies are coping with the fees and restrictions imposed by licensing policies for index products at a time when firms are increasingly called upon to integrate large amounts of market data from different sources. It also highlights the difficult choices that financial executives face when owners of capital and other stakeholders place undue emphasis on the value of incumbent index brands. 6. Beyond the status quo Searching for value in index products 1 The search for business value Depending on the nature of their business, financial services companies derive business value from index products in several ways. Active asset managers use index products to assess past performance against a broad benchmark, a more objective method than peer-to-peer comparisons. Asset managers can also use the products to interpret index components and to establish an investment philosophy, differentiate themselves from competitors and quantitatively demonstrate how they add value. Users in this category determine benchmark choices in collaboration with clients, generally with the objective of matching the asset class or investment style that the client desires. In contrast, passive investment managers create portfolios that track a designated index, which the provider periodically rebalances to match a particular market segment. Some index funds track their indexes so closely that the tracking error (the performance gap between the fund and the index) is equal to the funds own administration fees. Some indexes are exclusively objective and rules-based, but others include a subjective element governed by an index committee. This raises the question of whether the index provider is selling raw data or providing pre-formulated 5 The Economist Intelligence Unit Limited 2013 investment strategies. The question is central to the debate about licences for intellectual property rights. StatPros Carl Bacon believes that the investment strategy component is becoming more important: The debate has moved from investment management to index design where you are designing the index to deliver good returns and then [the asset manager] delivers performance as close to that index as possible. So that isnt index design, thats asset management in my book. Asset servicers are another broad category of financial services firm that uses index products intensively. Custodians, for example, manage the technical aspects of holding securities on behalf of clients that shape their own portfolios. Asset servicers carry out performance and risk assessments on behalf of both active and passive asset managers and may provide consolidated services for portfolios involving multiple asset managers and brokers. They face extremely complex licensing issues because clients collectively demand a very broad range of specific index products spanning the whole spectrum of license terms. For example, an asset servicer may need constituent and weightings data to support attribution reporting, but it will face limits on the amount index data that can be disclosed in these reports. 7. Beyond the status quo Searching for value in index products 2 Index products: Which one to choose? Financial services companies purchase a wide variety of index products that track changes in security prices and, to a lesser extent, other indicators relating to companies included in investment portfolios. Price and total return data are the most widely used by financial services firms to support both proprietary and client accounts. Price data are purchased by 61% of executives in our survey, while 49% buy total return data. Index constituentsdata on individual companies that are members of an indexare used by more than 41% of companies represented in our survey. Executives surveyed say that relevance to the business is the most important consideration in selecting the type of index to purchase. Index products, therefore, must be aligned with the firms underlying investment strategy. When choosing the provider of a particular type of index, however, other factors come into play. Accuracy is the top consideration, with 78% of respondents Q saying that this very strongly (45%) or strongly (33%) influences their selection. The providers independence and integrity along with analytical quality, product adaptability and delivery platforms are also important considerations. Brand names play a complex role in users selection of index products; experts who were interviewed for this report offer differing interpretations. Brand value ranks fourth among factors strongly influencing purchase decisions according to survey respondents, well behind accuracy and quality of analytics. But the providers independence and integrity rank second, which implies a more subtle role for branding when it comes to extracting business value. Also, institutional and retail users interpret brand value differently. Brand, in my view, is more important for retail than for institutional clients, says Ali Toutounchi, managing director of index funds at Legal & General Investment Management (LGIM) in Factors very strongly influencing index selection (% respondents) Accuracy of data products 45 Perceived independence and integrity of provider 35 Quality of analytics provided 32 Brand value of the products 22 Pricing model 20 Ability of provider to adapt products 17 Ability of provider to deliver single-window service Familiarity of stakeholders with the brand 6 The Economist Intelligence Unit Limited 2013 16 14 Source: Economist Intelligence Unit survey, February 2013. 8. Beyond the status quo Searching for value in index products Q Client satisfaction with the index industry (% of respondents who are satisfied) Data accuracy 67 Analytical tools 63 Timeliness of data 60 Customer support 58 Ability to use across different platforms 55 Return on investment (ROI) 50 Technical support Flexibility of data licensing policies 49 38 Source: Economist Intelligence Unit survey, February 2013. London. Dr Toutounchi goes on to explain that, for institutional clients, the main connection is that a strong brand may have helped an index to become the recognised benchmark. He says that brands like MSCI, FTSE and S&P have established themselves as the benchmark for certain investment strategies. Companies like LGIM buy them for that reason and because their clients are measuring their own investment performance against those benchmarks. Jeff Molitor, chief investment officer, Europe, for Vanguard Asset Management, agrees that institutional investors prefer certain benchmarks because they are familiar with them through their own risk evaluations and infrastructure. But he challenges the notion that the retail segment is more focused on index brands. Our experience is that the brand of the investment organisation is what matters m...