How control of indexing can impact investors

20200506 – How control of indexing can impact investors.mp3

Dan Barnes Welcome to ETF TV, I’m Dan Barnes. Joining me today. Rick Redding, CEO of the Index Industry Association, and Deborah Fuhr, also of ETF TV. We’re going to be discussing the current challenges around indexing, self indexing, and regulation of the indexing business. Rick, could you tell us a bit about the Index Industry Association?

Rick Redding The IAA is a not for profit organization that is comprised of independent index providers. And we’re seeing independent, we define that as; they neither trade the underlying component securities, nor do they create product directly for investors. So if you think about a simplified model of the indexing world, you have three components. You have people that trade that make prices, you have people that create and administer indexes, and then you have people that create investable products for investors. So where we sit in the value chain is right there in the middle of it, but our members cannot do either of the other two pieces of the chain.

Deborah Fuhr We are seeing an interest as there is fee compression. Many people see that there’s fees for licensing indices. Does it save money to move to self indexing, so can you tell us, in your mind what is self indexing and how is it being used?

Rick Redding Self indexing, and just to kind of give you a definition is; when the asset manager or the bank is creating the index and then creating the product, they also may be trading the underlying securities. If you go back to that kind of simplified model I used earlier. So they don’t have distinctive pieces of the value chain. They’re in fact in every one. What does give the regulators and others pause is that’s effectively the model that IBOR was under, and so that’s part of the reason for the regulation in the EU. To answer your question of why people self index, there’s a couple of reasons. One is, as you mentioned, trying to save on fees. That’s a question of what safeguards are you giving up to get those couple of basis points or half a basis point difference. What the IBOR situation brought up is, now that there are potential conflicts of interest, I think investors should figure out why the person is self indexing. Even within the self index model, we’re starting to see the asset manager fx, creating the index, creating the product, but now saying, wait a minute, the investors want us to outsource the administration to make sure that they’re following their procedures and what’s in their rulebook. The second part of self indexing that I think gets a lot of press are the asset managers that are doing it. A lot of it gets talked about for fee issues, but I see many more of them are all about, ‘this is our IP on how we invest, we don’t want to give that to others.’ So, I see many more of them going down that route than it is just for fee compression issues.

Deborah Fuhr And have you noticed a growth in stealth indexing?

Rick Redding In some parts of the market, it’s dramatically gone down. In other parts it’s gone up because most people don’t think about the European banks. The European banks were very much into the index business kind of pre-2008. And when the IBOR crisis happened, a lot of those businesses actually got sold to a lot of our members. So a lot of that business now, even though they may still have a bank name on it, is being independently administered and is also available for licensing by others.

Dan Barnes I’d like to thank Rick and Deborah for their expertize on self indexing in this show. To catch up on Trader TV or ETF TV, go to TRADERTV.NET or ETFTV.NET.

Published on May 6, 2020