Fund managers stand to lose approximately $12bn (e16bn) a year in potential management fees, according to TABB Group.
With nearly $1 trillion currently invested in the United States in index-based products such as exchange-traded funds (ETFs), a serious threat to active managers is posed, says TABB.
In a report called Performance Anxiety: A Buy-Side Study of Benchmarks and the Investment Process, research director Adam Sussman says: “The appetite for index-based funds is nearly insatiable, with index-based assets under management increasing by 2,610% since 1993. Global indices today cover 58 countries, grouped into five regions, market capitalisations and style. When you look at the different categories used to crate equity indices, there are 48,256 possible indices, just a smidgeon more indices than the 40,365 publicly-traded companies.”
Over the past five years alone, he says, independent index providers have seen revenues climb at a 22% CAGR (compound annual growth rate). By 2009, TABB Group forecasts that they will take in more than $1bn a year in revenue.
TABB says that institutional investors have been at the heart of the change within the benchmarking space. “Local governments imposed socially responsible investment constraints that required a redefinition of the opportunity set and a recalculation of the best possible performance. These constraints blossomed into a new industry of research and indexing allowing people to tailor their investments along social, moral and political beliefs.”
Sussman claims that by 2009 nearly 70% of all pension plans representing $40 trillion will be using customised benchmarks, This will create more sophisticated investments as pension plans are exploring different views on asset allocation and portfolio construction, examining risk-adjusted returns, complex correlations and liability matching, he says in the report.
A more refined approach to measuring performance, he adds, is causing institutional investors to trade exchange-traded and over-the-counter derivatives that attempt to capture beta on the cheap, hedge against interest-rate risk and buy alpha. As the cost of beta plummets, investors are willing to pay more for alpha.
“There’s no slowing down the tide of indexing,” says Sussman.
© funds europe February 2008