The rise of environmental, social and governance (ESG) investing is disrupting the balance of power within the index provider space which is currently dominated by the ‘Big Four’ of MSCI, S&P Dow Jones Indices, FTSE Russell and Bloomberg, according to a new report -Indexing: Prepare for sustainability-driven disruption by not for profit financial think tank Planet Tracker.
The report argues that the rise of passive investing since the global financial crisis has inadvertently increased the influence of the heavyweight index providers.
However, it notes that the subjective nature of ESG investing combined with the huge inflows into sustainable strategies is driving greater demand for choice and new entrants in the indexing arena.
In general, falling fees, profitability attracting competition and demand for consumer choice, as well as lack of customisation and transparency over sustainability metrics, are drivers for change.
John Willis, Director of Research at Planet Tracker and co-author of the report, believes that growing sustainable investing demand means smaller, innovative index players are responding with offerings that address these flaws.
“The index majors are often out of the spotlight, but sustainability has thrown them into the spotlight and there is a second tier coming up who are adaptable and driven by the sustainability theme,” Willis says.
“This offers sustainable investors an opportunity to invest in line with their personal principles, rather than taking the templates on offer. For the braver ones, direct indexing is an option.”
He adds, one of the challenges is that bespoke offerings can undermine the profitability of the existing business model, especially in relation to the most popular indices – e.g. S&P 500, FTSE 100, MSCI World etc.
Planet Tracker estimates that according to EDITDA, the margin on an index is 75% a year. “This means that for every pound invested in the index, I get 75p profit,” says Willis. “Do you want to change that if you are one of the big players?”
The report cited the example of Legal & General Investment Management which launched a range of fixed income ESG ETFs last December.
“[LGIM] commented that a number of index providers spoken to, other than JP Morgan, ‘could not or would not help create LGIM’s preferred benchmarks ‘because it undermined their existing business,” the report said.
However, Willis believes that change is on the horizon. “If corporate management teams become convinced that the inclusion of their company in an index is one of the most important drivers of a share price, then there could be a scramble to adopt more sustainable and ESG strategies, to both win access to these indices and possibly lower their cost of capital,” he adds.
©Markets Media Europe 2021