Increasing number of ETF providers look to self-indexing to cut costs

Increasing number of ETF providers look to self-indexing to cut costs

Increasing number of ETF providers look to self-indexing to cut costs

A number of asset managers are looking at self-indexing the ETFs they launch in order to avoid the high fees from index providers and differentiate themselves from their peers.

Although not a new phenomenon, ETF providers are increasingly looking at ways to save costs and improve margins in a low- yield environment, with self-indexing one of the potential options.

Since entering the European ETF space last October, J.P. Morgan Asset Management (JPMAM) has launched two “alternative beta” products and seven fixed income vehicles, all of which are self-indexed.

This is also the case for Franklin Templeton Investments which, after entering the European ETF market in September 2017, self-indexed its LibertyShares smart-beta ETF suite.

One key issue industry commentators have highlighted is the high fees index providers charge for replication. For example, for tracking the S&P 500, State Street pays 0.03% of the AUM and $600,000 in annual licence fees to S&P Global Advisors for its $255bn SPDR S&P 500 ETF.

According to Peter Sleep, senior investment manager at 7IM, reducing costs is one of the main reasons asset managers are self-indexing. He said asset managers were looking to other methods instead of paying high fees to the likes of MSCI and FTSE Russell.

“It makes sense if you want to create a bespoke ETF to design the product yourself,” he added.

Managers reconsider use of index providers amid ‘eye-watering’ costs

Ben Seager-Scott, chief investment strategist at Tilney Group, said the pressure on fees in the ETF space across mainstream asset classes was the key motivation for self-indexing.

In March, Lyxor threw down the gauntlet to its rivals by launching a core ETF range, charging between 0.04% and 0.12%.

With total expense ratios being pushed down, Seager-Scott said this made the fees to index providers all the more important.

He added: “Self-indexing offers a route to further cost cutting. Some retail investors might be put off by the absence of a well-known index provider, but I think many professional investors will embrace it. Either way, it will challenge the established providers, which should help push costs lower over time.”

Further advantages

In its 2018 Global ETF Handbook, JPMAM said the three key advantages for self-indexing are cost saving, flexibility in the benchmark design and the ability to control the index rebalance date and schedule.

The report calculated ETFs benchmarked to the MSCI World index suffered an extra nine basis points worth of implicit trading cost each year by trading on the set date rather than the previous day. Furthermore, for ETFs tracking the MSCI Emerging Markets index, investors saw added annual costs of 29 basis points for trading on the set date.

“For example, the MSCI Global indices are reviewed quarterly and researchers from buy side and sell side firms spend a significant amount of effort in forecasting the index reconstitutions, enabling arbitrageurs to pre-trade the expected changes,” the report said.


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