Lucrative index industry might finally be feeling the squeeze

Fee compression may finally be reaching the lucrative indexing industry with global revenues rising less rapidly than fund industry assets last year.

Worldwide revenues for the increasingly influential index providers rose 9.3 per cent to a record $5.8bn last year, according to estimates from Burton Taylor International Consulting, a research and advisory group focused on capital markets.

However, this was comfortably below last year’s 15.5 per cent rise in the assets of open-ended and exchange traded funds (excluding money market funds) globally, according to figures from Morningstar Direct.

The drop in index revenue in relation to fund assets represents a break from recent years, with global index revenues having risen at a five-year compound annual growth rate of 11 per cent, according to Burton Taylor, faster than the 8.5 per cent five-year CAGR of investment assets, based on Morningstar data, even taking into account 2023.

Asset managers have long complained that index providers are taking an ever-larger slice of the revenue pie. While fund management fees have fallen precipitously in recent years, particularly for passive index-tracking ETFs, the sums asset managers in turn pay to index providers have not fallen anywhere near as fast, if at all.

Funds typically pay an annual fee equivalent to about a couple of basis points of assets to an index provider for the right to track or benchmark against a proprietary index. Alternatively their parent companies can pay flat-rate subscription fees for access to a bundle of indices and other services. 

As a result of this mixed payment model, growth in index fees is likely to undershoot growth in assets during years when markets rally strongly. However, Brad Bailey, research director at Burton Taylor, believed index fees were genuinely starting to fall.

“There has been considerable cost pressure. We are seeing competition in the index business in terms of fees. These fees really have to go down,” said Bailey, who believed investment bank and hedge fund groups were emerging as competitors to the stock exchanges and specialised index providers that have traditionally dominated the industry.

“The economics are shifting” with “increasing index revenues bringing newer providers to the table, pressuring fees downwards”, Bailey added.

In particular, smaller index providers offering “more attractive pricing” have prompted asset managers to “rethink their previous aversion to lesser-known providers”, he said.

More broadly, “the index business has just exploded”, Bailey added, with asset managers launching a panoply of thematic and environmental, social and governance-based funds that require ever more specific indices.

Bailey added that the movement of indices to areas such as private equity, real estate and credit were also providing fresh sources of revenue for indexers.

Despite the growth of some smaller providers, just three groups — MSCI, S&P Dow Jones Indices and FTSE Russell — accounted for 70.3 per cent of index fees last year, according to Burton Taylor.

MSCI overtook S&P to claim top spot in 2023, with particularly strong growth in its ESG indices pushing overall revenues 11.4 per cent higher to $1.5bn.

Nasdaq, the fourth-largest player, has seen revenues rise at five-year CAGR of 20.7 per cent, taking its market share to 9.1 per cent last year, aided by growing appetite for many of the stocks listed on its tech-heavy exchange, headed by the so-called Magnificent Seven.

Among smaller players, Morningstar’s five-year CAGR is 34 per cent, taking its market share to 1.1 per cent, helped by its acquisition of ESG specialist Sustainalytics in 2020. Morningstar’s ESG-related revenues surged 133 per cent last year, according to Burton Taylor’s numbers.

Germany’s Solactive, which offers “a disruptive pricing model charging clients a flat fee”, according to Bailey, has chalked up a 20.8 per cent five-year CAGR, with its market share also now 1.1 per cent.

Those that have lost market share over the past five years, while still seeing rises in nominal revenues, include Deutsche Börse’s ISS Stoxx, which operates the Euro Stoxx and Dax families of indices; Alerian, best known for its master limited partnership index; and Bloomberg, which nevertheless remains number one for fixed income indices, narrowly ahead of FTSE Russell for this category.