What asset managers demand of index providers in evolving investment landscape

Key Takeaways

• Asset management needs new solutions for fresh market challenges.
• Index providers are highly rated but more innovation required.
• Closer regulation of powerful indices might benefit asset managers.

The investment landscape is fast evolving, driven by artificial intelligence (AI), ESG demands, and the growing importance of private markets. As a result, asset managers face new complexities, requiring fresh skills, resources, and stronger partnerships with index providers.

The Index Industry Association (IIA) recently released its findings from its Survey of Global Asset Managers, offering insights into how asset managers and index providers are collaborating.

The use of index or benchmark providers, such as the big three (MSCI, S&P Dow Jones Indices, and FTSE Russell), is prevalent, with over 87% of asset managers relying on them. About 39% use five or more and the industry average is four. Index providers play a critical role in their success and over 52% of firms predict that they will become more important in the next year.

Asset managers highlight the “reliability of data, the scope of indexes, and the provision of standardized reporting” as areas of strength for index providers. On the other hand, “innovativeness and development of new products” is seen as a relative weakness (though highly rated).

Growing importance of index providers

Indexing started as a rough measure of financial markets, calculated manually by financial newspapers targeting niche readers. Over time, it became a profitable and influential business controlled by a few dominant companies. In 2023 alone, the indexing businesses of MSCI, S&P, FTSE Russell generated revenues of USD 6.5bn, the FT reported.

Index providers use a unique, rules-based methodology to build their benchmarks, which helps to ensure consistency and transparency in market representation.

The decisions made by index providers heavily impact the fast-growing passive investment industry, including most exchange-trade funds (ETFs). Decisions by index committees around which securities to include and weightage can greatly influence these funds.

For example, owing to the rapid growth of tech companies like Nividia, S&P this year has twice tweaked the methodology for its 11 Select Sector indices. These are tracked by  42 ETFs holding a combined USD 303.6 billion in assets.

Indices have become incredibly diverse. An index no longer simply measures a broad market or segment. Nowadays, it often serves as the foundation for an investment theme, dissecting the market into a myriad of exposures and outcomes

Key demands and concerns

The Survey of Global Asset Managers reveals that index providers already offer support in sustainable investing, direct indexing, thematic investments and other areas. In the months to come, asset managers would like to see more:

• Focus on environmental, social, and governance (ESG) and sustainability, which remain the top priorities for asset managers
• Advanced analytics and data services, the second most commonly mentioned need as asset managers define their strategic goals
• Application of artificial intelligence (AI) and technological innovations in general
• Application of generative AI and increased private market offerings, which are identified as long-term drivers of change
• Greater specialization, from more customized indexes and direct indexing solutions to thematic and sector-specific indexes

How regulators are changing their approach

As the benchmarking business has boomed, regulators are adopting different approaches to oversee the sector.

For example, EU regulators believe index providers should operate as independent and objective data providers. The US Securities and Exchange Commission (SEC), on the other hand, is still contemplating whether index providers should be regulated as investment advisers. It argues that index providers create, run, and update the indices, directly affecting how money is invested. Hence, they cannot be treated as neutral data providers, a PWC report says

Earlier this year, in India, which has been at the forefront of the global rise in passive investment, primarily through ETFs, stock market regulator SEBI made it mandatory for major index providers to register in efforts to bolster accountability and transparency. They must have a minimum net worth of INR 250m (c. USD 3m) and at least five years of experience in managing indices. The index providers are also required to set up an oversight committee to review the index design and ensure the methodology matches the index’s name and description.

Beneficial relationship

The role of index providers will continue to evolve as market demands drive the creation of more sophisticated indices. They are also likely to see more regulation. Alex Matturi, the former CEO of S&P Dow Jones Indices, said that this would make the larger providers more dominant, allowing them to leverage their broad asset class coverage and global presence to better support clients across diverse regions.

Such developments benefit asset managers, who will be able to offer diverse, efficient, and compliant investment products to clients globally, and counter some of the challenges that they have faced. Market volatility and uncertainty driven by geopolitical and health crises, demand for ESG considerations, and competition from low-fee/no-fee platforms have made it difficult for them to deliver consistent performance. They will be better placed to succeed with efficient, automated workflows in place and if index providers cater to their needs in the short term.