October 7, 2012 / 7:58 PM / 8 years ago

Analysis: U.S. index providers brace for price war

NEW YORK (Reuters) - Vanguard Group’s move to shift nearly two dozen funds away from benchmarks provided by MSCI Inc (MSCI.N) may be the first shot in a coming price war among index providers.

Major fund companies such as Vanguard, Charles Schwab Corp (SCHW.N) and BlackRock Inc (BLK.N) are all looking to cut costs on their exchange-traded funds, which will likely put pressure on index providers to reduce fees, experts said.

Increased competition from within the industry will also exert fee pressure on top U.S. index providers, including MSCI, S&P Dow Jones Indices and Russell Indexes.

FTSE, which is owned by the London Stock Exchange Group (LSE.L) and is one of the dominant index providers in Europe, said it wants to increase its U.S. presence substantially beyond the 40 different product issuers FTSE currently serves.

“We clearly have ambition to grow our share of the ETF market further,” Jonathan Horton, president of FTSE Americas, said in an interview.

Horton declined to say whether FTSE plans to undercut its rivals on price to achieve that growth, after wrestling away six Vanguard funds from MSCI at least partly on the basis of cheaper costs. He said the resources that index providers need for research and innovation may prevent an all-out fee war.

But investors and analysts said cutting fees will be a tempting growth strategy at a time when funds are keen to lower costs. They fear that a price war could squeeze the margins of index providers or cause them to lose business.

Fees to license an index typically range from 0.02 percent to 0.30 percent of the fund’s assets. U.S. ETFs - baskets of securities like mutual funds that trade on exchanges like individual securities - hold more than $1.2 trillion in assets.

The concern is that Vanguard is the “first shoe to drop,” said Chris Wills, director of wealth management at R.W. Roge & Co, a Beverly, Massachusetts-based wealth management firm with more than $200 million in assets under management.

The Vanguard defection caused MSCI’s stock to post its largest single-day drop in its five-year history on Tuesday.


Large index providers say they have not yet felt pressure to cut fees, and they will strive to maintain profit margins by offering more customized indices. S&P Dow Jones and Russell said their storied brands give them some leverage with fund firms.

“The years of history backing our brand and our methodology are a differentiating factor in the marketplace,” said Alex Matturri, CEO of S&P Dow Jones Indices. The company owns benchmarks such as S&P 500 and Dow Jones Industrial Average.

For smaller index players, however, it’s a different story.

Fund companies looking to contain costs are turning to index providers to give them a break on licensing fees, said James Pacetti, head of business development for index provider S*Network Global Indexes LLC.

“The pressure on the big benchmark providers has a trickle-down effect,” he said. “We have had some pressure.”

Russell is “in constant contact with our ETF partners ... and thus far we don’t see an issue for Russell-based products in terms of fees,” said Ken O’Keeffe, managing director for Russell Indexes Structured Products.

He said his contact at Vanguard assured him that last week’s news did not affect Russell’s ties with the fund firm. A Vanguard spokesman confirmed the move from MSCI would not affect its relationship with Russell or S&P Dow Jones Indices.

Financial advisers are a big buyer of Vanguard’s ETFs, and they care about the benchmark names, some experts said.

By replacing MSCI, Vanguard is gambling that retail investors will make up for any business it might lose from institutional customers, said Luke Montgomery, an analyst at Sanford C. Bernstein & Co.

Vanguard, however, does not believe that will be an issue.

“Some plan sponsors have benchmarks that are tied to a specific provider, but I believe most investors are seeking asset class exposure, not branded asset class exposure, with the S&P 500 being a possible exception,” said Joel Dickson, senior ETF strategist at Vanguard.

“If an investor is so tied to a specific provider that they can’t invest in another, that’s a risk we’re willing to take.” (Reporting by Rodrigo Campos and Jessica Toonkel in New York, Aaron Pressman in Boston and Ryan Vlastelica in Chicago. Editing by Jennifer Merritt, Paritosh Bansal, David Gregorio and Maureen Bavdek)

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