If Tesla is included in the S&P 500 stock index this year, it would be a major win for the electric-vehicle manufacturer and its shareholders. This is because money managers who track the index or compare their performance against it must buy Tesla shares. No The owner of the stock (ticker: TSLA), even though it has already risen 259% this year, but Tesla has a market value of $ 278 billion, which could mean a large-cap fund manager’s performance marks the index Will increase immediately, no money. Managers specializing in the largest stocks want to take a risk.
This same concern about underperformance helps to illustrate that many technology stocks, including Apple, AAPL), Amazon.com (AMZN), and Microsoft (MSFT), have been filled in the stock market rally over the past few years. It now dominates the capitalization-weighted S&P 500. This is the strength of the index, and index providers such as S&P Dow Jones Indices, which is owned by S&P Global (SPGI). They set the rules by which companies are recruited into stock indexes — rules related to market-capitalization, corporate domicile, and financial viability, for example — that affect asset flows, demand for individual securities, and In many cases, the structure of our portfolio.
More than $ 8.5 trillion of funds have been benchmarked across various indices, representing more than 14% of the fund industry’s assets in 2005, 41%. Stock index funds account for 14% of the domestic stock market, down from 4% in 2005. According to the Federal Reserve Bank of Boston. According to Blackbock, more than 18% of global equity is in index-based products, with the majority of it outside of mutual funds and exchange-traded funds. Fund managers, consultants and analysts look at the percentage of total index funds, which further reinforces the role of index providers in making investors’ choices and appointing market winners.
This development is dominated by a handful of veterans. According to Burton-Taylor International Consulting, London Stock Exchange Group (LSE.UK)-owned S&P Global, MSCI (MSCI) and FTSE Russell control 70% of the market, totaling $ 3.7 billion in revenue last year. Was revenue. . Other index providers have emerged over the years, including Dure Borsey (DB1.Germany)-owned Allerion, Bloomberg, Nasdaq (NDAQ), RAFI and Qontigo / Stoxx, but none matching the Big Three in revenue. is.
“Large index providers are implicated,” says John White, a former executive at State Street and FTSE Russell. “They have data, history and brand recognition, and it goes a long way.”
Index providers generate revenue by indexing banks, fund companies, and other financial firms to build investment products and internal use. The business is surprisingly lucrative; MSCI reported operating profit margins of 73% in its index business, making it one of the most attractive sectors in financial services. The three major companies in the industry also sell other services: S&P runs a bond-rating business, MSCI Analytics Services, and LSE operates trading services, among other services.
The rise of sequestration has not affected individual securities alone. Countries and geographic regions can see huge stock market inflows, depending on how they are classified into an index. Take the MSCI decision in 2018 to include China’s mainland A shares in its emerging markets index. Adding 472 A-shares companies saw China’s total weighting increase from 28% to 41% (partly due to market growth in other China-listed shares). According to Refinitive, more than $ 282 billion were either indexed or benchmarked against the MSCI Emerging Markets Index. MSCI estimated last year that including the A shares in the index could add $ 80 billion to foreign inflows into China’s stock market.
However, MSCI criticized China A shares for adding them to its index. The Wall Street Journal reported in early 2019 that the Chinese government would have pressured the company to include A shares. And Florida Sen. Marco Rubio last year sharply criticized MSCI, saying in a letter to the company that MSCI was providing an “imprimatur” of legitimacy to invest in companies controlled by the Chinese Communist Party.
Henry Fernandez, CEO of MSCI, says, “We don’t bend rules for anyone.” “Countries try to explain why they should be in a better position. We say, ‘Here is the methodology and the criteria here, and it is up to you that you want to attract global investors.’ ”
When asked about the Chinese government’s potential impact on the MSCI decision, Fernandez said “there was absolutely no one.”
The impact of indexing has increased greatly in recent years with the rise of exchange-traded funds. Global ETFs had assets of over $ 6 trillion in 2019, up from $ 1.3 trillion in 2010. Almost all new ETFs track an index (different from some actively managed products). ETF assets are concentrated among three large fund sponsors: Vanguard, the Eicher unit of Blackrock (BLK) and State Street Global Advisors, a unit of State Street (STT). These companies rely heavily on the indexes of MSCI, S&P and FTSE Russell, although Vangard, seeking lower costs, dropped MSCI in 2012 for some of its international index funds.
Environmental, social and corporate governance-focused investment, known as ESG, is a particularly fertile area for new index products and related services. Institutional investors such as pension funds and endowments are increasingly scrutinized for ESG criteria and require reporting in areas such as carbon emissions and labor practices. S&P launched a new ESG valuation service in its ratings division last year and acquired the ESG ratings business in early 2020.
Index providers face many headwinds, including tougher regulations in Europe. The European Union released a comprehensive set of “benchmark rules” in 2018 to address conflicts of interest in the industry, following a series of scandals, such as interest rate indices, such as the London Interbank Offered Rate, Or Libor, were manipulated by banks. . The new rules are intended to prevent the benchmark from being manipulated and include new governance and reporting procedures.
Index providers also face pushback on fees. Blackrock recently negotiated a new licensing deal with MSCI for its iShares ETF, possibly reducing MSCI’s revenue based on ETCI’s assets. And fresh competition is emerging: some fund companies, notably Fidelity, are building and running their own indexes, with the aim of reducing license costs. In-house index design is one reason why Fidelity can offer zero-fee index mutual funds.
But industry experts say that disliking large providers will be much higher than the invention of the new index. There are many benefits to being displaced, including the scope of historical data and trusted brands. “Self-indexing has always been a fear, which has never really happened,” says BMO Capital Markets analyst Henry Soo Chien.
Fernandez doesn’t sound worried, either. “It’s more competition, but we welcome it,” he says. “We do not think it is an existential threat.”
Write Daren Fonda at [email protected]