A report from the Economist Intelligence Unit

Beyond the status quo
Searching for value in
index products

Sponsored by
Beyond the status quo Searching for value in index products

Contents

About the report
Introduction

3

1

The search for...
Beyond the status quo Searching for value in index products

About the
report

Beyond the status quo: Searching for value ...
Beyond the status quo Searching for value in index products

Introduction

Market indexes, with their rising licence fees ...
Beyond the status quo Searching for value in index products

buying are brands; they’re buying a well-known
brand like FTS...
Beyond the status quo Searching for value in index products

1

The search for business value

Depending on the nature of ...
Beyond the status quo Searching for value in index products

2

Index products: Which one to choose?

Financial services c...
Beyond the status quo Searching for value in index products

Q

Client satisfaction with the index industry
(% of responde...
Beyond the status quo Searching for value in index products

3

Licensing agreements:
To agree or not to agree?

Most comp...
Beyond the status quo Searching for value in index products

4

Increasing ROI:
Weighing the options

When asked to name t...
Beyond the status quo Searching for value in index products

Market index licence agreements
Index data are readily availa...
Beyond the status quo Searching for value in index products

5

Search out new business models

The EIU survey demonstrate...
Beyond the status quo Searching for value in index products

6

Get licence management under control

Active asset manager...
Beyond the status quo Searching for value in index products

7

In-house data cleansing experts

Another way to extract gr...
Beyond the status quo Searching for value in index products

data, Mr Toutouchi maintains that they don’t
necessarily need...
Beyond the status quo Searching for value in index products

8

Overcoming obstacles

Financial services executives seekin...
Beyond the status quo Searching for value in index products

9

Characteristics of high performers

Survey respondents wer...
Beyond the status quo Searching for value in index products

10

Conclusion

Users of market indexes are clearly challenge...
Beyond the status quo Searching for value in index products

Appendix:
survey
results

Percentages may not add
to 100% owi...
Beyond the status quo Searching for value in index products

To what extent has your specific business unit changed its us...
Beyond the status quo Searching for value in index products

Considering your organisation’s exposure to these asset types...
Beyond the status quo Searching for value in index products

To what degree are the following criteria factored into your ...
Beyond the status quo Searching for value in index products

Please select the statement below that best characterises the...
Beyond the status quo Searching for value in index products

Over the past five years, has your organisation discontinued ...
Beyond the status quo Searching for value in index products

What are the biggest obstacles to your organisation obtaining...
Beyond the status quo Searching for value in index products

Which sub-sector of the financial services industry is your
o...
Beyond the status quo Searching for value in index products

Whilst every effort has been taken to verify the accuracy of ...
London
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London
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United Kingdom
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EIU - Beyond the status quo: Searching for value in index products - November 2013

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Report 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.

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EIU - Beyond the status quo: Searching for value in index products - November 2013

  1. 1. A report from the Economist Intelligence Unit Beyond the status quo Searching for value in index products Sponsored by
  2. 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. 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 officer—Europe, 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. 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 Fund—which tracks Standard & Poor’s 500 Index—surpassed 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 brands—S&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. 5. Beyond the status quo Searching for value in index products buying are brands; they’re buying a well-known brand like FTSE or MSCI and often it’s 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: “We’re 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 you’d rely on an unproven product just because it’s cheaper doesn’t 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. 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 fund’s 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. StatPro’s 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 isn’t index design, that’s 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. 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 constituents—data on individual companies that are “members”’ of an index—are 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 firm’s 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 provider’s 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 provider’s 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. 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 most in the retail segment”, he says, “because that reflects the overall service, the experience and the tracking, which are all driven by the quality of execution and the commitment to providing a good product and competitive pricing.” While experts may debate the importance of 7 © The Economist Intelligence Unit Limited 2013 brand name and licensing policies in purchasing decisions, these factors appear to grow in influence when the focus shifts to obtaining business value from index products. Alignment of the index and its constituents with key business objectives, along with other technical features, are still the dominant factors. The majority of respondents to our survey, however, say that a strong brand that creates credibility with stakeholders and a licensing policy that allows wide dissemination are also important drivers of value. Yet, these are among the areas of greatest user dissatisfaction. Only 38% of users surveyed say they are “extremely” (11%) or “somewhat” (27%) satisfied with the flexibility of their index providers’ data distribution (licensing) policies, while only half are satisfied with the ROI obtained. Moreover, 68% of surveyed executives agree that index providers with the strongest brands tend to charge prices that are high relative to the quality of services rendered, and 59% agree that index providers exploit user reliance on them to increase fees for add-on products.
  9. 9. Beyond the status quo Searching for value in index products 3 Licensing agreements: To agree or not to agree? Most companies don’t focus on licensing issues in their purchasing decisions—they say they have little influence over them. Indeed, many are forced to choose from among a handful of sellers because of their need to use particular indexes either to satisfy clients or to access the most prominent benchmarks. Buyers say that these constraints on competition often lead to vendor inflexibility. Only about one-third of executives surveyed indicate that the index provider they use most is “generally prepared to negotiate” (28%) or is willing to adapt Q product offerings “to ensure that we get what we need at an affordable price” (7%). A nearly equal number say their provider adopts a take-it-orleave-it attitude towards pricing (26%) or considers renewals as business that can command higher prices (9%). That a majority of executives consider these licensing policies reasonable (16% “very reasonable” and 44% “somewhat reasonable”) may simply reflect their powerlessness to negotiate better terms. Licensing restrictions imposed by the provider respondents use most (% respondents) We must pay extra fees to this provider to obtain sector data on index constituents 37 We can share access to data internally across our organisation without limits or additional fees 30 This provider restricts our ability to redistribute index data with non-employees We disagree with this provider’s licensing policies but we have not been able to negotiate more reasonable arrangements 21 12 Source: Economist Intelligence Unit survey, February 2013. 8 © The Economist Intelligence Unit Limited 2013
  10. 10. Beyond the status quo Searching for value in index products 4 Increasing ROI: Weighing the options When asked to name the single biggest problem with the index industry, lack of regulatory oversight and inadequate competition are among financial executives’ most frequent complaints. These factors, however, are beyond the control of individual buyers, leaving dissatisfied companies with four main alternatives: They can switch among incumbent providers; they can seek out providers with alternative business models; they can manage their existing licences more effectively; or they can try to use index data more efficiently. Bite the bullet and switch providers Index users are free to change providers whenever their existing contracts expire, which is commonly once per year, and they can change even sooner if they’re prepared to write off the unused portion of prepaid licences. Of the companies represented in the EIU survey, 29% say they have discontinued using at least one provider over the past five years, and another 17% say they are not satisfied with their provider but cannot find an acceptable alternative. These findings, however, reflect the global index market and not just the major providers. Mr Agather suggests that their churn rate is much lower, especially in the institutional market. “Our retention is in the order of 95%”, he says, “and not many of our clients want to assume the costs of changing indexes, which can be considerable.” Dr Toutounchi points out that switching providers is generally easier for active asset 9 © The Economist Intelligence Unit Limited 2013 managers, who use indexes mainly for performance assessment or analytics. “To a large extent, this applies to conventional asset managers,” he says, “but the index is just a yardstick.” He goes on to say that the picture is different for a passive fund manager: “Those who manage index tracking funds can and do switch, as we have done in the past,” he says, “but this is not a light consideration and a lot of important factors must be taken into consideration, and while licensing costs are important, that’s only one factor.” In addition to technical complexity, a large passive user faces significant transaction costs when restructuring a portfolio to track a different index. This suggests that reductions in licensing fees have to be relatively large for the change to be feasible. Recently, intensified competition in the ETF industry has put pressure on management fees, and, with index licence fees accounting for about one-third of those costs, competition is now spilling over into the index business. This seems to have been the case with Vanguard’s decision, announced in October 2012, to switch 22 of its largest mutual and ETF funds from MSCI to alternative indexes. This involved moving six funds with $170bn in assets to FTSE benchmarks and another 16 funds worth $367bn to indexes published by the Center for Research in Security Prices (CRSP) at the University of Chicago. In both cases, reduced licensing fees are locked in under long-term agreements. The same pressures are pushing other large index fund managers to cut
  11. 11. Beyond the status quo Searching for value in index products Market index licence agreements Index data are readily available but severely restricted in their use. The typical base-level Terms and Conditions of Use posted on index provider websites limit the data to personal use—even commercial subscriptions are usually restricted to employees of the subscribing companies. The subscriber may use the index data for its own purposes but may not embed index-based content in any of its products without additional use-specific licences. The terms of these licences are proprietary, making the whole pricing process opaque. Licensing restrictions are generally more complex in the active asset management and asset servicing segments. Providers require separate licences for different uses of the same index, depending on whether they are needed in real time or delayed, whether the licensees want to use constituents or need to customise the data. Moreover licensing arrangements typically permit the index provider to conduct audits and monitor the user’s use of the data. This is partly to identify data uses that may not be covered by existing agreements, which can then engender new licence requirements. The complexity of these schemes can make it difficult for larger buyers to track their own use and ensure that they’re getting the most out of their total index licensing spend. In the passive asset management segment, the trend has been towards blanket flat-fee licences that allow a specific index to be used for the sole purpose of designing a particular structured investment product, with fees based on assets under management. These fees are not usually disclosed, but the January 2013 prospectus for State Street Global Markets’ SPDR S&P 500 ETF Trust reveals that annual licence fees to S&P are 0.0306% of average net assets, for a total of about $30m for the year ended September 2012. This represents nearly one-third of total net expenses for the fund. costs to maintain market position. Three weeks after the Vanguard announcement, Blackrock, another large tracking fund manager, announced lower management fees on certain newly issued funds based on reduced licensing fees from MSCI. Mr Molitor downplays the idea that Vanguard dumped some index products because of dissatisfaction with the providers. “We still use a whole range of providers,” he says, “every one of these organisations does things a little bit differently, but they all follow a set of best Q practices that has improved in several ways over the years.” He goes on to observe that selecting an index for a particular fund often comes down to costs, which must be passed on to investors. And, while the transaction costs to restructure a fund may seem daunting, he points out that “when you have teams of really capable traders you can execute transitions when they make sense. The change very much favoured our investors and it was a long-term decision.” Use of selected index products (% respondents) Proprietary accounts Price and total return data series 49 Index constituent fundamental data 44 © The Economist Intelligence Unit Limited 2013 49 41 42 Index constituent corporate actions data 10 61 46 45 Index constituents, changes and weights Other products Client accounts 7 9 Source: Economist Intelligence Unit survey, February 2013.
  12. 12. Beyond the status quo Searching for value in index products 5 Search out new business models The EIU survey demonstrates high levels of dissatisfaction with the licensing policies of incumbent providers. But many index buyers, especially active asset managers that are less intensive users, lack the clout to successfully negotiate with established index providers, especially if their spending is spread over multiple providers. Increased demand for alternatives from these and other clients has drawn a few established market data distributors into the index licensing business with single-window business models. Bloomberg Indexes LP recently expanded its index licensing business, claiming to bring a “fresh perspective to the traditional world of indexing”. The company hopes to further leverage its substantial data distribution network and its familiar brand. When Bloomberg initially launched this venture in 2001, Kevin Swann, then manager of Bloomberg Index License, was quoted in the Journal of Indexes as saying: “I think branding is very overlooked here … while everything institutional in the United States is [based on] MSCI [indexes], seven out of ten retail investors never heard of MSCI. But they have heard of Bloomberg.” Thomson Reuters, a leading market data provider, has also consolidated its index licensing business. “We have provided index calculation services and products to ETF operators for some time,” says Lucas Garland, global head of product management for Thomson Reuters Indices, “but in 2008 we formally ring-fenced all our 11 © The Economist Intelligence Unit Limited 2013 index-related assets to establish a more consistent strategy for the company as a whole.” He goes on to say that the company’s value proposition incorporates “our relationships with third-party data owners, our data management infrastructure and our proprietary distribution platform”, providing an alternative to existing indexes “that clients can use in their workflow within a very simplified commercial model.” An entirely new face in the index world is the Freedom Index Company, a not-for-profit business founded in 2012 by Carl Bacon, chairman of the StatPro Group and former head of performance at JP Morgan Investment Management Inc. Freedom’s objective is to provide free, open and independent indexes for a wide variety of securities in a format optimised for smaller asset managers. Its website provides daily data for basic starter indexes that are rebalanced quarterly. Users are encouraged to leverage this data to design their own indexes, which will be distributed free under the Freedom brand provided that they meet the organisation’s criteria for independence and consistency. Mr Bacon’s vision is to provide the building blocks for others to introduce their own intellectual capital. “Look at it as the Wikipedia of indexes”, he says, “we’re looking to finance this from voluntary contributions and we’ve got enough funding from subscriptions to keep this going for five years.” Freedom currently provides US and UK indexes and plans to expand as contributions permit.
  13. 13. Beyond the status quo Searching for value in index products 6 Get licence management under control Active asset managers often face complex licence management issues because index providers commonly require several licences for a single index, for different uses, by different people in different locations. Licence fees are usually paid in advance, even when based on a per-trade formula, causing some users to underutilise their licences. A centralised index licensing function is one solution, and a few expense management applications providers have entered this space. For example, in January 2012, Market Data Services Limited (MDSL), a provider of enterprise costmanagement solutions, hired Steve Ellenberg, formerly Global Index Licensing Coordinator for Credit Suisse, to lead the design and development of its MDM Index Licensing Module. Mr Ellenberg claims that, in addition to maximising the direct benefits from a company’s index licence spend, centralised licence management can obtain credits for underutilised licences, identify and allocate client-specific costs to make them more recoverable and also provide documentation to 12 © The Economist Intelligence Unit Limited 2013 support negotiations with index providers. These features are especially useful to active asset managers and asset servicers, Mr Ellenberg explains, because their index usage tends to be fragmented across multiple products “and their spend on benchmark performance reporting licenses continues to increase.” Index licence management solutions can also make it easier for passive asset managers to change indexes. Mr Ellenberg says, “An ability to model how a transition to a different index benchmark and a different fee structure will impact the index licensing spend is at the top of the wish list for index licensing coordinators.” He goes on to say that complex calculations are needed to link index licences to associated funds, ETFs and structured products and then calculate aggregated index licensing fee figures for each product. This is especially true when investment products are linked to a basket benchmark comprising several indexes.
  14. 14. Beyond the status quo Searching for value in index products 7 In-house data cleansing experts Another way to extract greater value from index products is to use more efficient tools for transforming raw data into specific products that the business requires. A large majority (71%) of the companies polled in the EIU survey say that index data management is handled by their organisation’s overall data management function. Nearly one-fifth (19%) have established a dedicated index team, and the remaining 10% are mostly light users with ad hoc index management policies that vary from project to project. Respondents from companies with a dedicated index team report more favourable business outcomes than other firms. Nearly one-quarter (23%) rate their effectiveness in use of index products as “well above average/industry leader” compared with only 7% of those with no dedicated team. Companies with dedicated index teams seem to do a better job of cleaning incoming data, with Q 51% saying they detected significant errors compared with only 40% of those using generalist data management. Respondents from these firms also report higher levels of satisfaction with every aspect of the index services they buy. This is true for the ability to use indexes across different platforms, the quality of analytical tools, customer support, technical support, data accuracy and timeliness. Another notable difference is that companies using dedicated index teams are somewhat more satisfied with the ROI from index products, even though their overall satisfaction level is still relatively low. Experts agree that effective data management is an essential part of extracting business value from index products. But they say that a rigid distinction between dedicated and generalist teams is an oversimplification. Although the need for specialised knowledge is greater for passive users who must process and “clean” large volumes of Index and benchmark management error rates (% respondents using each method) Index management is handled as part of our overall data management function 0-10% 49 34 11-20% 6 21-40% More than 40% 13 We have a dedicated index team 1 60 39 10 2 © The Economist Intelligence Unit Limited 2013 Source: Economist Intelligence Unit survey, February 2013.
  15. 15. Beyond the status quo Searching for value in index products data, Mr Toutouchi maintains that they don’t necessarily need a dedicated specialist index team to do that. “You need a dedicated team responsible for all the data coming into the company, and, within that team, you need to have subject matter expertise. What you don’t want is people who are only operators loading the data into their systems—the team needs to have subject matter experts as well.” He adds that many quality control checks can be automated to look for obvious errors that would waste fund managers’ time. If they receive data that’s already been cleaned up by the data management team, they may still find errors 14 © The Economist Intelligence Unit Limited 2013 but only subtle ones that are not expensive to fix. Mr Agather says much the same thing from the perspective of an index provider. “Companies that have an integrated market data function tend to see data acquisition as a bucket of costs,” he says, “and they don’t necessarily recognise all of the value of what they’re buying.” He goes on to say that if index experts are involved in the process of integrating index products with other data, they tend to discover more efficient ways of using it. “So they get better value from their index spending and they tend to be more satisfied clients.”
  16. 16. Beyond the status quo Searching for value in index products 8 Overcoming obstacles Financial services executives seeking to extract increased business value from index products are pursuing a wide range of strategies, including switching providers, using alternative data acquisition approaches, more proactively managing licences and employing experts to improve data quality internally. They face a number of internal obstacles, however, that can make them less demanding customers. Respondents to the EIU survey were asked to identify the two biggest internal obstacles to obtaining greater value for money spent on index products. The most frequent responses relate to lack of capacity, including technical skills (31%) and financial resources (26%). Inability to present Q compelling business cases for alternative strategies (22%) is also related to lack of internal capacity. Although they rank somewhat lower, stakeholder attitudes about index products can also contribute to organisational inertia. Nearly one-quarter (22%) point to excessive reliance on big-name proprietary index products as one of the two most significant obstacles; another 18% cite excessive concern about continuity of index use. Executives responsible for procuring index products may believe that stakeholders will object to new approaches that would make well-established index brands less prominent and also generate transition costs. Obstacles to generating better value from index products (% respondents) Lack of internal technical skills to evaluate index products 31 Inadequate budgets to procure better index products 26 Over-reliance on proprietary index products 22 Inability to present compelling business cases for alternative strategies 22 Excessive concern about continuity of index use 18 I don’t see any obstacles Lack of senior management understanding of index products 15 © The Economist Intelligence Unit Limited 2013 14 13 Source: Economist Intelligence Unit survey, February 2013.
  17. 17. Beyond the status quo Searching for value in index products 9 Characteristics of high performers Survey respondents were asked to assess their company’s track record relative to its peers in terms of how effectively it uses index products. Only about 10% of respondents rate their firms as high performers in this respect (“well above average/industry leader”), but it’s worthwhile to review the characteristics they have in common: l Increasing index use. High performers can be found on every part of the usage spectrum, but more than 80% report increased use compared with an average of just over 50% for all respondents. This could be interpreted as success breeding increased applications for indexes. l Specialised index data experts. High performers are more than twice as likely as all firms to employ a dedicated index team, which can be interpreted as including index subjectmatter experts on the teams that prepare data for use by analysts and asset managers. l High reliance on index data accuracy. High performers report higher potential for severe impact on their organisations from errors in index products compared with other respondents. This is true across all index types. l Strong interest in the quality of index products. High performers are much more likely than the average respondent to consider technical aspects, including accuracy, adaptability, delivery platforms, pricing model 16 © The Economist Intelligence Unit Limited 2013 and quality of analytics, when making purchase decisions. l Mixed view of brand and reputation. High performers are twice as likely to give weight to brand value and brand familiarity to stakeholders but, paradoxically, are not more likely to pay attention to the provider’s independence and integrity. This implies a pragmatic approach that does not necessarily value the brands themselves but rather their commercial advantages. l Greater satisfaction with index products. High performers are much more likely to be extremely satisfied with every aspect of their index purchases, including flexibility of licensing products and ROI. These common characteristics reveal that high performers are those that have successfully overcome the limitations of index products, including negotiating satisfactory licensing terms with index providers. Despite much greater reluctance to change providers—or perhaps because of it—they generally claim to have negotiated satisfactory deals with their biggest providers. About 55% say they can share access to data internally without limits or additional fees, compared with 30% overall, and 47% say the licensing policy of their biggest provider is “very reasonable” compared with 15% overall.
  18. 18. Beyond the status quo Searching for value in index products 10 Conclusion Users of market indexes are clearly challenged in their attempts to extract full business value from the products they buy. Licensing restrictions are a major part of the problem. A small group of successful index users say they have overcome these problems and are very satisfied with their licensing deals. Many others, however, feel powerless to achieve satisfaction, in part because index providers sense their tendency towards inaction owed in large part to the complexity of the make or buy decision-making process. Indeed, a solid majority of survey respondents agree that index providers “exploit our reliance on them to increase fees for add-on products”. Buyers tend to interpret this situation as inadequate competition, which survey respondents rank only slightly behind lack of regulatory oversight as the biggest single problem with and within the index industry. But they may not perceive their own role in limiting competition through organisational inertia stemming from stakeholder preferences for certain established brands. Clearly, brand value does confer commercial benefits to users, but more than twothirds of respondents say that the strongest brands charge prices that are high relative to the quality of 17 © The Economist Intelligence Unit Limited 2013 their services. Many buyers say they put up with this only to satisfy stakeholders who are not directly involved in the purchasing decision. Some companies may be able to address this through strong negotiating tactics. As this report has pointed out, however, other companies with lesser clout or skill are not without solutions. Companies that don’t feel free to switch providers or engage providers with more broadly based business models can often improve performance through more effective management of both licences and index products. Over the longer term, some buyers may be encouraged by higher levels of competition in the passive asset management segment as pressure on ETF management fees spills over into the index market. Mr Garland believes that current economic conditions are driving similar competitive pressures across the industry. “From my point of view,” he says, “the smaller asset managers, and especially the asset servicing firms, are beginning to evaluate how to leverage some of the lower-cost alternatives.” As this re-evaluation spreads, he adds, “We might just see these kinds of changes accelerate.”
  19. 19. Beyond the status quo Searching for value in index products Appendix: survey results Percentages may not add to 100% owing to rounding or the ability of respondents to choose multiple responses. Are you personally involved in the selection and/or use of index products by your organisation? (% respondents) Yes 100 Compared with its peers, how effective do you consider your organisation on each of the following performance indicators? (% respondents) Well above average/ Industry leader Somewhat above average Average Somewhat below average Well below average Profitability 23 39 27 7 4 Market share 14 35 30 15 7 Earnings growth 15 33 36 12 4 13 4 Effective use of index products 10 29 45 Client satisfaction 23 44 27 5 2 To what extent does your specific business unit rely on index data? (% respondents) Our business unit does not use index products directly, but we receive interpretations from specialists in other parts of our organisation 26 Our business unit directly uses index products for a significant part of our work, but we could get by without them if they were not available 34 Our business unit directly uses index products and depends on them for a significant part of our work 27 Our business unit is a heavy user of index products but they are not essential for every aspect of our work 9 Our business unit relies on index products for virtually every aspect of our work 4 18 © The Economist Intelligence Unit Limited 2013
  20. 20. Beyond the status quo Searching for value in index products To what extent has your specific business unit changed its use of index products over the past three years? (% respondents) Increased 52 Decreased 10 Stayed the same 39 To what extent will your specific business unit change its use of index data over the next three years? (% respondents) Increased 57 Decreased 10 Stayed the same 34 How does your organisation manage index data and benchmarking? (% respondents) Index management is handled as part of our overall data management function 71 We have a dedicated index team 19 Other 2 Don’t know 8 Based on your experience over the past 12 months, please indicate the number of benchmark data errors detected as a percentage of the total data population: (% respondents) 0-10% 59 11-20% 34 21-40% 6 More than 40% 1 How often does your organisation experience data errors across the following asset types: (% respondents) Very frequently Frequently Neither frequently nor infrequently Infrequently Very infrequently Equity 7 20 34 26 13 27 13 Fixed income 4 20 36 Alternatives 6 19 24 © The Economist Intelligence Unit Limited 2013 41 20 9
  21. 21. Beyond the status quo Searching for value in index products Considering your organisation’s exposure to these asset types, what is the impact of index data errors on your business? (% respondents) Very severe Severe Neither severe nor moderate Moderate Very moderate Equity 5 19 34 21 21 Fixed income 6 17 36 19 22 Alternatives 3 14 42 18 23 Which types of products does your organisation purchase from index providers and for what business/client requirement do you use them? For supporting proprietary accounts Select all that apply. (% respondents) Price and total return data series 61 Index constituent fundamental data 49 Index constituents, changes and weights 46 Index constituent corporate actions data 41 Other products 9 Which types of products does your organisation purchase from index providers and for what business/client requirement do you use them? For supporting client accounts Select all that apply. (% respondents) Price and total return data series 49 Index constituents, changes and weights 45 Index constituent fundamental data 44 Index constituent corporate actions data 42 Other products 7 Which of the following criteria influence your purchase decisions for index products? Select all that apply. (% respondents) Relevance of index and/or its constituents to our business 61 Relevance of index and/or its constituents to the needs of our clients 57 Availability of analytics 43 Availability of disaggregated data 29 Client familiarity with underlying concepts 22 20 © The Economist Intelligence Unit Limited 2013
  22. 22. Beyond the status quo Searching for value in index products To what degree are the following criteria factored into your selection of index product providers? Please rate on a scale from ‘Very strongly’ to ‘Not at all’. (% respondents) Very strongly Somewhat strongly Moderately Minimally Not at all Brand value of the products 22 35 32 8 3 Accuracy of data products 45 33 19 2 1 Perceived independence and integrity of provider 35 34 25 5 2 Quality of analytics provided 32 32 28 7 2 Ability of provider to innovate to adapt index products to a changing business environment 17 34 38 7 3 Familiarity of stakeholders with the brand 14 34 38 10 4 Pricing model 20 33 37 8 2 Ability of provider to deliver single-window service across multiple index products 16 25 42 12 5 How would you rate the index providers that you use based on the following? (% respondents) Extremely satisfied Somewhat satisfied Neutral Somewhat dissatisfied Extremely dissatisfied Ability to use across different platforms 13 42 40 4 1 32 5 Analytical tools 14 49 Customer support 13 45 36 6 Data accuracy 18 48 28 5 Return on investment (ROI) 12 38 44 51 Technical support 15 34 41 10 Flexibility of data distribution (licensing) policies 11 27 48 13 2 Timeliness of data 19 41 33 6 Please indicate your level of agreement with the following statements about the index industry generally. (% respondents) Strongly agree Somewhat agree Neither agree nor disagree Somewhat disagree Strongly disagree Index providers tend to offer reasonable prices for base products 11 38 34 16 1 Index providers exploit our reliance on them to increase fees for add-on-products 15 44 32 8 1 Index providers with the strongest brands tend to charge prices that are high considering the quality of the services offered 18 50 26 5 1 Index providers have raised prices significantly in recent years 17 37 39 61 There is sufficient competition among index providers 7 24 40 24 5 Prices have been stable or fallen as a result of intense competition among index providers 6 21 45 23 4 We are reluctant to change providers, as we must maintain consistency and continuity in our own services 15 21 © The Economist Intelligence Unit Limited 2013 45 30 9 2
  23. 23. Beyond the status quo Searching for value in index products Please select the statement below that best characterises the pricing policies of the index provider you use most frequently. (% respondents) They are generally prepared to negotiate 28 They adopt a take-it-or-leave-it attitude about pricing 26 They clearly explain their pricing practices 17 They consider renewals as business that can command higher prices than new clients generally pay 9 They offer loyalty discounts for renewals that are lower than prices offered to new clients 7 They understand our needs 7 They will adapt their product offerings to ensure that we get what we need at an affordable price 7 Please select the statement below that best characterises the licensing policies of the index provider you use most frequently. (% respondents) We can share access to data internally across our organisation without limits or additional fees 30 We must pay extra fees to this provider to obtain sector data (eg, energy sector) on index constituents 37 We pay extra fees to this provider whenever we cite an index for comparative purposes. This provider restricts our ability to redistribute index data with non-employees (eg, consultants, outside managers/clients) 21 We disagree with this provider’s licensing policies but we have not been able to negotiate more reasonable arrangements 12 To what extent do you consider this licensing policy to be reasonable? (% respondents) Very reasonable 16 Somewhat reasonable 55 Somewhat unreasonable 27 Very unreasonable 3 Compared to other providers, to what extent has the provider been open to negotiations? (% respondents) Much more open 1 Somewhat more open 23 Neither more nor less open than other providers 51 Somewhat less open 22 Much less open 4 22 © The Economist Intelligence Unit Limited 2013
  24. 24. Beyond the status quo Searching for value in index products Over the past five years, has your organisation discontinued the use of an index service? (% respondents) Yes, we ceased doing business with at least one provider 29 No, we have been satisfied with our existing provider(s) over this period 54 No, we have been dissatisfied with our existing provider(s) but have not been able to find an alternative acceptable to our key stakeholders 17 How many index services has your organisation discontinued over the past five years? (% respondents) One 48 Two 42 Three 7 Four or more 2 Have you replaced any of these providers with others? (% respondents) Yes 69 No 31 In your opinion, to what extent are the following factors important in determining the business value of the index that your company uses most? (% respondents) Essential/ Very highly important Somewhat highly important Moderately important Minimally important Not important at all The brand name, which creates credibility in the minds of our key internal and external stakeholders on the grounds that it is well-known 23 37 33 6 2 The technical methodology of the index creation process, which allows us to demonstrate credibility to stakeholders 25 38 30 6 1 The scope of the index and its constituents is closely aligned with key business objectives, demonstrating credibility through relevance 23 42 30 4 1 The electronic delivery platform, which facilities use of index products in a wide variety of business decisions, generating maximum benefits from our spending on index services 26 35 31 6 2 The vendor’s licensing policy which allows us to disseminate index-based analysis widely both inside and outside our organisation 21 36 36 5 3 From a buyer’s perspective, what do you see as the single biggest problem with the index industry? (% respondents) Lack of regulatory oversight 25 Inadequate competition 22 Continuously changing product offerings and/or underlying methodologies 14 Excessive number of proprietary products 13 Providers selling the same product to multiple clients as “custom” work 13 A pattern of mergers and acquisitions that threatens continuity of index products 4 I don’t see any problems 9 23 © The Economist Intelligence Unit Limited 2013
  25. 25. Beyond the status quo Searching for value in index products What are the biggest obstacles to your organisation obtaining greater value for money from index products? Select top two. (% respondents) Lack of internal technical skills to evaluate index products 31 Inadequate budgets to procure better index products 26 Over-reliance on proprietary index products 22 Inability to present compelling business cases for alternative strategies 22 Excessive concern about continuity of index use 18 Lack of senior management understanding of index products 13 I don’t see any obstacles 14 In which country are you personally located? In which country is your company headquarter located? (% respondents) (% respondents) United States of America United States of America 23 India 33 India, United Kingdom 16 13 United Kingdom Canada 13 4 Canada Italy, Australia, Germany, Switzerland, Portugal, Nigeria 5 2 Singapore France, Netherlands, Spain, China, Finland, Japan, Pakistan, Singapore, Thailand, Austria, Belgium, Israel, Luxembourg, Saudi Arabia, South Korea, Sweden, Tanzania, Vietnam 3 Italy, Germany, Portugal, Australia, Spain, Switzerland 1 2 Finland, France, Hong Kong, Nigeria, Vietnam, Indonesia, Luxembourg, New Zealand, Pakistan, Thailand, United Arab Emirates, Bahrain, China, Japan, Mexico, South Africa, South Korea, Tanzania In which region are your company’s global headquarters based? 1 (% respondents) North America In which region are you personally located? 37 (% respondents) Western Europe 30 Western Europe 31 Asia-Pacific 23 Asia-Pacific 29 Middle East and Africa 29 Latin America 6 North America Middle East and Africa 7 Latin America 3 Eastern Europe 2 24 © The Economist Intelligence Unit Limited 2013 3 Eastern Europe 1
  26. 26. Beyond the status quo Searching for value in index products Which sub-sector of the financial services industry is your organisation most engaged in? What is your main functional role? (% respondents) (% respondents) General management 20 Asset management/Custodian 14 Risk analysis/management 17 Wealth management 12 Strategy and business development 11 Financial services consulting 10 Portfolio management 9 Investment banking 10 Customer relationship management 8 Retail banking 10 Accountant 6 Corporate banking 10 Research 5 Private equity/Venture capital 5 Compliance management 3 Diversified banking institution 5 Data manager 3 Non-life insurance 4 Performance measurement 3 Broker-dealer 3 Institutional investor 2 Capital markets 3 Registered investment advisor 2 Life insurance 3 Broker 1 Central bank/Regulator 3 Legal 1 Hedge fund 2 Asset servicing 1 Trading 2 Consultant to pension fund/endowment 1 Real estate/Leasing 2 Trading analysis 1 Credit card issuer/services 2 Custodial management 0 Stock exchange/Trading system 1 Other 7 Reinsurance 0 Which of the following best describes your job title? (% respondents) What are your organisation’s global annual revenues in US dollars? Board member (% respondents) 4 CEO/President/Managing director 19 CFO/Treasurer/Comptroller $500m or less 5 Other C-level executive 14 $5bn to $10bn 16 Head of business unit 7 Head of department 8 Manager 18 Other 5 © The Economist Intelligence Unit Limited 2013 8 $10bn or more 8 SVP/VP/Director 25 12 $1bn to $5bn CIO/Technology director 45 $500m to $1bn 11 22
  27. 27. Beyond the status quo Searching for value in index products Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this white paper or any of the Cover: Shutterstock information, opinions or conclusions set out in the white paper. 26 © The Economist Intelligence Unit Limited 2013
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