The owners of the two biggest names in U.S. market benchmarks merged to form S&P Dow Jones Indices over the summer. The resulting giant publishes 830,000 indexes daily, including the S&P 500 and the Dow - as well as benchmarks for commodities, foreign equities, the U.S. housing market, health care costs, consumer credit default rates and more.
In fact, SPDJI publishes indexes covering just about anything that advisors and their clients would want to invest in, track, compare their performance to or hedge against. "In terms of asset classes, we think we have the broadest product array," says Alex Matturri, CEO of S&P Dow Jones Indices.
So will that product heft translate into pricing dominance? Because indexes dominate the ETF industry - less than 0.6% of assets held in U.S. exchange-traded funds are in actively managed products - advisors could find that the index-based ETFs they use cost more. The merger could also change the landscape for smaller index firms that compete with the benchmarking giant. What exactly will the merger mean for investors and their advisors?
One of the first concrete consequences of the deal was a shift in who determines the Dow's composition.
For most of the 116-year history of the Dow, the editors of The Wall Street Journal made decisions about alterations in its composition. That changed in September, though: When Kraft exited the Dow, to be replaced by UnitedHealth Group, the move was made by an S&P Dow Jones committee that includes a sole editorial representative of The Journal.
One reason for that: In many respects, the joining of the Dow and S&P index businesses was more a takeover than a merger. McGraw-Hill, S&P's parent, owns 73% of the joint venture. Futures exchange operator CME Group, which bought controlling interest in the Dow Jones index operations in 2010, holds 24.4%, and News Corp., owner of Dow Jones and The Wall Street Journal, owns the remaining 2.6%.
A few observers suggested that any monopolistic fears are overblown. "There are those who could worry that S&P Dow Jones will now have greater pricing power," says Steven Schoenfeld, managing partner of Global Index Strategies, a consulting firm focused on the financial services industry. Still, Schoenfeld notes, the new giant "still has a lot of competitors - among them MSCI, FTSE, Russell and, in Europe, Stoxx."
Schoenfeld is not alone in thinking that the merged organization, despite its size and scope, will not overrun the index world. "S&P doesn't really have any notable dominance once you get outside that S&P 500 index," says Paul Justice, director of ETF research at Morningstar. Justice notes that MSCI overshadows SPDJI when it comes to indexes of foreign markets, both developed and emerging, as well individual country indexes in both those areas.
On the ground, too, there seems to be little worry about the combined strength of the S&P and Dow Jones index businesses. "I think, for the advisor, it's not 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 providers offer similar product lines. As a result, 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.
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 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.
Despite the efforts at removing duplication, sometimes the joint venture will maintain existing indexes. One example: Both S&P and Dow calculated Sharia-compliant indexes, designed to eliminate companies whose products or practices would violate Islamic law. But both sets of Sharia indexes will likely survive because of regional issues. The S&P version caters to the Middle East market, where interpretation of the rules is stricter; by contrast, says Matturri, "the Dow product was much more prevalent in Southeast Asia, where the interpretations are a little bit looser."
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 industry, including SPDJI, have specialty benchmarks, Justice contends the brand value they bring to these niche indexes doesn't count for much. "We're still seeing that this market is influenced by first-mover advantage," he says.
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 WisdomTree 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.
Matturri argues self-indexing can hurt investor confidence in a benchmark, citing the scandal surrounding the calculation of the London Interbank Offered Rate. "LIBOR has highlighted where there are conflicts of interest," he says.
An independent index shop, by contrast, doesn't set prices on the input side and doesn't issue products. "Everything that's going on in the industry highlights the value of an independent index provider," Matturri says. The owners of S&P Dow Jones Indices are betting that advisors and their clients will agree.
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.
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