Math Geeks Behind ETFs Scramble to Defend $1 Billion Bonanza

Who are the biggest winners of the shift to passive investing: investors who appreciate the cheap products, asset managers who sell them in bunches — or the index firms that create the benchmarks backstopping it all?

It’s a serious question for the market, considering there are now more indexes than there are U.S. stocks. For years, the designers of these gauges have been raking in cash, primarily from licensing them to exchange-traded products and mutual funds.

But all that could be about to change.

The proliferation of passive strategies that’s driven profits for the benchmark behemoths has also raised the stakes for asset managers. Lower fees have become an important tool in winning flows. So some firms have decided to save cash by working with cheaper index providers, while others are building their own benchmarking teams in-house.

“In the great cost migration, nothing is safe,” said Eric Balchunas, an ETF analyst with Bloomberg Intelligence. “You can probably count on one hand how many indexes are at the rock-star level where the ETF issuer will probably never mess with them but everybody else is vulnerable.”

S&P Global Inc., MSCI Inc. and the London Stock Exchange Group Plc’s FTSE Russell — three of the largest benchmark providers — surpassed $1 billion in index revenue in the six months through June, up from $858 million for the same period last year, according to earnings reports.

For that they can thank ETFs, index-based portfolios that have ballooned to $3 trillion in the U.S., up from about $400 billion 10 years ago. Issuers typically pay indexers a fee based on a percentage of the fund’s assets. MSCI’s fees, for example, averaged 3.08 basis points in the first quarter. That would translate to $30,800 for a $100 million ETF or $308,000 for a $1 billion fund.

Roughly 60 percent of income for S&P’s benchmarking unit is based on assets, with the rest derived from annual subscription fees for data and transaction-based fees from exchange-traded derivatives.

Bloomberg LP, the parent of Bloomberg News, owns an indexing business that competes with S&P, MSCI and FTSE Russell.

Issuers are taking a hard look at their expenses as investors increasingly funnel cash into the cheapest strategies. Of about $500 billion that’s flowed into index funds over the last year, more than 70 percent has gone into those charging ten basis points or less, encouraging a wave of cost-cutting, according to Bloomberg Intelligence.