Financial Planning - December 2012

going to have a meaningful impact,” says Erika Safran, a New York City-based planner. She observes that ETF sponsors “have long-term relationships with the index providers.” Safran even thinks operational efficiencies could cause license fees charged by SPDJI to the ETF sponsors to decline a bit.

That’s in line with historical precedent. Justice says fees charged by the index publishers “have actually been coming down pretty sharply over the last few years.” The net result is lower costs for ETFs. In 1998, Select Sector SPDRs — ETFs that track sector and industry slices of the S&P 500 — launched with a 0.65% expense ratio. They now cost 0.18%.

One reason for the slide in ETF
expense ratios is that many index provid-
ers offer similar product lines. As a result,
will, over time, merge closer to each
other,” Matturri says. The exception will
be any index that now underpins an ETF.
“We have to uphold our obligations to
our customers,” he says.

NE W COMPETITION

These independent index providers, of all sizes, are facing competition on another front, however — from their best customers. ETF companies such as IndexIQ, Van Eck Global and Wisdom Tree not only produce investment products, but also the indexes that drive them.

So far, these shops account for a small percentage of ETF assets. But if major ETF players shift a large portion of their products to so-called self-indexing, both big and small providers of indexes could take a major hit.

Fees charged by index publishers ‘have actually been coming down
pretty sharply.’ The result: Lower costs for ETFs.

ETF sponsors hold some cards in negotiating licenses with index companies. The creation of SPDJI doesn’t change that. “It’s not going to have monopolistic pricing,” Schoenfeld says.

REDUCED OFFERINGS?

If SPDJI doesn’t have pricing power and licensing fees are already sloping down, cost cutting would seem to be in order. “There are certainly cost synergies that come from the merger of two index businesses,” says SPDJI’s Matturri, who adds that the operation doesn’t need two sets of everything.

Back-office functions will almost certainly be streamlined, but what about the index portfolio? The S&P 500 and the Dow are safe. But what of the 130,000 indexes that came from the Dow side?

Both S&P and Dow have international index products that compete with MSCI’s stable of benchmarks. “Those

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NICHE INDEX PROVIDERS

One group that could be affected by the
changed landscape: the niche index
providers that have emerged as rivals to
broad market indexes. Many advisors
now say that the days of buy-and-hold
indexed ETF portfolios are gone. Tulsa,
Okla.-based RIA Richard Hoe takes issue
with the time frames advocated by index
boosters. “They’re taking about 10 years,
15 years, 20 years,” he says. “But a lot of
people don’t have those slices of time.”
For many clients, Hoe says, the
answer lies in tactical allocation, using
more narrowly focused investments
— including those based on benchmarks
from smaller index providers. Justice
says this is an area where smaller index
companies can still make money. He
cites Alerian’s strong business in indexes
based on master limited partnerships.

Even though the giants of the indus-
try, including SPDJI, have specialty
Matturri argues self-indexing can hurt
investor confidence in a benchmark, cit-
ing the scandal surrounding the calcu-
lation of the London Interbank Offered
Rate. “LIBOR has highlighted where
there are conflicts of interest,” he says.

Joseph Lisanti, a Financial Planning contributor in New York, is a former editor-in-chief of Standard & Poor’s weekly investment advisory newsletter, The Outlook.