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Morningstar’s Bundy: Why the index industry needs a reset

With this growth has come the emergence of a huge array of market benchmarks that help investors track investment performance, and, even more consequentially, underpin investment products such as ETFs which have been at the heart of the passive investing revolution.

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The index industry has spent 50 years fuelling an investment revolution, and as a whole, now needs to change quite fundamentally to position itself for the future, or risk losing its relevance.

The truth is that the industry’s recent record has been mixed.

There is a need for enhanced innovation, particularly in thematics, multi-asset and strategic beta. There is a need for more customisation, so that the promise of direct indexing, enabled by technology, can reach mainstream investors. And above all, there is a need for more competition, with a more diverse range of providers delivering better value for the investor.

Industry competition has always driven better customisation, choice and value for investors. And over the last five decades, index providers have been a catalyst for positive change. Yet, at present, index providers risk becoming victims of our own success.

While I can attest to the fact that the index industry is competitive, competition does not seem to be working especially well for the investor.

It seems wrong to me that, after twenty years in which retail fund and ETF fees have more than halved, the percentage fee for the index data component of some ETFs has risen year after year. These data fees inevitably get passed on to investors.

This phenomenon is not visible to most investors and has been hidden to some extent by rising markets and the stickiness these conditions can create.

I am not complaining, and I am not simply observing. In conversations day in day out with investors and asset managers, we are hearing calls for an alternative to the index industry incumbents.

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We are increasingly seeing a shift, both in broad market benchmarks as clients are realising the opportunity for cost savings in a largely commoditised market, and in new areas such as thematics and ESG where clients are looking for more insightful research-led indices that deliver better outcomes and fee structures that leave more money in the pockets of investors.

A philosophy that is being adopted is a more open and transparent approach to indexing which is built around the concepts that core beta should be inexpensive and deliver better outcomes and be reasonably priced. Better interchangeability is becoming the norm in many parts of the investment landscape and indexes is bound to be a part of that secular trend.

In five years I fully expect to see a bigger, more diverse, and more competitive index industry with a more diversified and robust set of leading players.

And I expect investors to be more fully reaping the benefits of this competition.

Ron Bundy is president at Morningstar Indexes

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