London Stock Exchange Group's FTSE Group is planning a major expansion in the United States that will challenge rivals and could trigger a price war among providers of stock indexes for use by fund groups eager to cut costs.
On Tuesday, FTSE lured away Vanguard Group from MSCI Inc for six international stock funds with $170 billion of assets, as the largest U.S. mutual fund manager looked to cut costs.
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"We clearly have ambition to grow our share of the ETF market further," said Jonathan Horton, president of FTSE North America.
Horton said FTSE serves 40 different product issuers today, but wants to increase that number substantially.
FTSE's expansion plans challenge rival index providers to find ways to keep selling their products to the funds they rely on for much of their revenue. Fees to license an index typically range from 0.02 percent to 0.30 percent of the fund's assets. U.S. exchange traded funds, or ETFs - baskets of securities like mutual funds that trade on exchanges like individual securities - hold more than $1.2 trillion in assets.
After the Vanguard deal, FTSE will have the money it needs to build a stronger brand in the United States, said an executive at an exchange-traded funds firm that has funds tracking FTSE indices.
"One of the challenges with working with FTSE is that they do not do a lot of marketing support like webinars and education to clients," the executive said, requesting anonymity as he was not authorized to speak to the press. "Now that they walked into this brand-new money, I think you will see a brand lift."
Horton noted that index providers require expensive research and innovation, which may limit fee cuts. But other experts said cutting fees will be a tempting growth strategy at a time when big fund companies such as Vanguard, Charles Schwab and BlackRock are looking to cut costs.
"If I was at S&P or MSCI, I would expect phone calls from State Street and BlackRock when it comes down to negotiation time," said Dave Nadig, director of research at ETF industry tracker IndexUniverse LLC.
Vanguard's incoming chief investment officer has vowed not to be undercut by rivals. When the company replaced MSCI on Tuesday as index provider on 22 funds with indexes from FTSE and a small Chicago firm, MSCI's stock posted the largest daily percentage decline in its five-year history.
Index-fund provider shareholders fear the companies could lose business and have their margins squeezed further unless they can prove the value of their data to these fund companies.
The concern is that Vanguard is the "first shoe to drop," said Chris Wills, director of wealth management at R.W. Roge & Co, a Beverly, Massachusetts-based wealth management firm with more than $200 million in assets under management.
"ETFs are continuing to grow in popularity and as they do, there is going to be more competition for their business among the index providers," Wills said. "The concern is that BlackRock is going to be next and try to play hardball."
Another money manager, who asked to remain unidentified because he is not permitted to speak publicly about individual holdings, had already been trimming his position on MSCI and sold his remaining positions after the Vanguard announcement, calling the news a potential "thesis breaker" for the company.
COUNTING ON BRAND
Large index providers said they have not yet felt pressure to cut fees. Well-known names like Russell hope their storied brands will give them leverage if pressures do surface. They can also strive to maintain margins by offering more customized indices, experts said.
Russell is "in constant contact with our ETF partners ... and thus far we don't see an issue for Russell-based products in terms of fees," said Ken O'Keeffe, managing director for Russell Indexes Structured Products.
He said his regular contact at Vanguard assured him that this week's decision "does not affect the Vanguard ETF space on Russell indexes."
A Vanguard spokesman confirmed that the decision with MSCI would not affect its relationship with Russell or S&P Dow Jones Indices.
"I think we price our products in line with what the market will bear," said Alex Matturri, CEO of S&P Dow Jones Indices, home of benchmarks such as S&P 500 and Dow Jones Industrial Average. "The years of history backing our brand and our methodology are a differentiating factor in the marketplace."
By replacing MSCI, Vanguard is betting retail investors will make up for any business it might lose from institutional customers, said Luke Montgomery, an analyst at Sanford C. Bernstein & Co.
That is a big bet. Financial advisers are a big buyer of Vanguard's ETFs, and many advisers care about the benchmark names, said James Pacetti, head of business development for index provider S*Network Global Indexes LLC.
Vanguard, however, does not believe that will be an issue.
"Some plan sponsors have benchmarks that are tied to a specific provider, but I believe most investors are seeking asset class exposure, not branded asset class exposure, with the S&P 500 being a possible exception," said Joel Dickson, senior ETF strategist at Vanguard. "If an investor is so tied to a specific provider that they can't invest in another, that's a risk we're willing to take."
The smaller index players also tell a different story about the fee pressures they are feeling.
As fund companies feel the fee squeeze, they are turning to index providers to give them a break on licensing fees to help them contain costs and boost revenues, S*Network's Pacetti said.
"The pressure on the big benchmark providers has a trickle-down effect," Pacetti said. "We have had some pressure."
(Reporting by Rodrigo Campos and Jessica Toonkel in New York, Aaron Pressman in Boston and Ryan Vlastelica in Chicago. Editing by Jennifer Merritt, Paritosh Bansal and David Gregorio)