The index industry is in the midst of its fast fashion moment
Dr Christian Bahr, Head Index Services, Financial Information at SIX, writes that for what seems like an eternity now, the index business has been dominated by a relatively straightforward task of creating a benchmark representing a market, calculating it reliably and then allowing investors to measure themselves against it.
These big brand indices remain hugely important, but underneath them change is very much afoot. Every single week, it seems like a new tailor-made thematic index is being created. And it is not hard to see why given that every time an asset manager launches a new ETF or structured product, it wants a new investment strategy that gives investors yet another reason to buy the product.
Today that product could include companies supplying the infrastructure behind the data centre boom, or even a basket designed around companies expected to benefit from a renewed emphasis on clean energy investment in Europe. But tomorrow, it could be something else that changes the job of the index provider from building an index correctly to turning the next big investment craze into a functioning index delivered to the client in a form they can actually use.
This really does get to the heart of the matter because in today’s world of instant news, investment stories travel faster than ever. An unexpected fiscal or monetary policy can suddenly pique investor interest in a particular sector or group of companies which in turn leads a product provider to create an index and a structured product based on that theme. The trouble is that it is no good drumming up instant interest only for the investment product to arrive six months later.
This is where a less fashionable part of the capital markets comes into its own because as soon as an index is created, one client might want to see it on a website, while the other demands a data feed, only for someone else to ask for the CSV file. Another may want to receive their index data through another market data vendor.
This not atypical scenario means that it is imperative the infrastructure underpinning any index has to be delivered through the clients desired channel. This not atypical scenario means that it is imperative the infrastructure underpinning any index has to be delivered through the client’s desired channel. It is no good creating a clever thematic index quickly if the processes behind it cannot reliably support it once it becomes a real investment product.
This is why the growth of customised indices is starting to get very interesting because it is fundamentally changing what competition between index providers looks like. The established benchmarks inevitably benefit from enormous brand recognition and the amount of money already tracking them. But the market for new investment products creates a different competitive battleground. As such, the question now becomes who can take an investment idea and turn it into something usable quickly?
The commercial rationale is that asset managers and product providers looking for a customised strategy do not necessarily have to turn to the names traditionally associated with that part of the market. There is ample room for other index providers if they have the technology and infrastructure to manufacture these products efficiently.
Retail investors have also taken an interest in thematic strategies – leaving investment providers needing to continually put something new under the noses of investors. This has created a rather elongated chain that starts with investors taking an interest in the latest investment trend, the product manufacturers trying to come up with a way to package the trend, before an index is created and an ETF is built around it.
Identifying the next great investment theme may be in vogue right now. But the less glamorous part comes when trying to build the machinery that allows somebody to turn that idea into an index. Yes, the index might still end up looking like numbers on a screen, but its value is dependent on an industrial production line sitting behind it that needs to be maintained otherwise those numbers could be worth a lot less.