Some Asset Managers Pay Twice as Much as Peers to Use the Same Index

Brand power in the index market is “enormous,” which may be one reason new entrants have found it hard to compete, says Substantive Research’s Mike Carrodus.

Erhan Demirtas/Bloomberg

Erhan Demirtas/Bloomberg

Traditional asset managers, hedge funds, and wealth managers may be surprised to learn just how much more they are paying to license an index than their competitors.

Some firms are paying more than twice as much as their peers, according to the latest study published Wednesday by Substantive Research. The firm, which provides analytics on the investment research market for asset managers, also found the amount that an index provider charges its clients for a single index differs by an average of 21 percent. Investors budgets for index services range from 0.55 basis points to 1.27 basis points of their assets under management, according to the study.

The cost to use indices can be significant. For example, index providers, such as MSCI and FTSE Russell, charge fees whenever their indices are used as benchmarks by exchange-traded funds or institutional investors. Over one-third of ETF management fees are paid as license fees to index providers, according to a January paper by Yu An from Johns Hopkins University, Matteo Benetton from the University of California at Berkeley, and Yang Song from the University of Washington. ETF providers have already faced downwards pressure on fees. As the three scholars pointed out, the index provider market is so concentrated that the top providers “wield strong market power” and are able to charge large markups.

The new study from Substantive Research revealed an index market that is not transparent. For example, reporting licenses, which are a sub-genre of licenses that asset managers need to pay for if they want to use the indices to report their performance results, has an average dispersion in pricing of 37 percent. Some institutions are paying almost five times more than their peer group. Reporting license fees are just one type that index providers charge their clients. According to the study, 44 percent of what asset managers pay to each provider is spent on license fees, while the remaining 56 percent is spent on accessing the underlying benchmarks themselves. Substantive Research calculated that the average savings per provider could potentially reach $360,000. In 2019, Morningstar found that index providers had been raising fees even when managers had to cut costs.

Mike Carrodus, CEO of Substantive Research, said it makes sense for index providers to charge their clients different prices because managers differ by size, region, and how they want to use the indices. But even after accounting for all these variables, the range of inconsistencies in pricing can still be as high as 10 percent to 50 percent, according to the study.

“The power dynamics of market data are fundamentally different from the research market [in that] the leverage in market data often sits entirely with the provider,” said Carrodus. He told II that the brand power in the index market is “enormous,” which is why new market entrants have found it hard to compete with the established ones.

“It’s one of those markets that has been crying out for greater transparency, and there are loads of challenges with that,” Carrodus said. The fact that every manager is so different in their use case only adds to the complexity of the index market. “This is a situation where there’s a lot of opacity and people feel a lack of control. I think the market on both sides will benefit from a bit more transparency,” he said.