Planet Tracker : Greater demand for sustainability-linked investment products is reshaping the industry
John Willis, Director of Research at Planet Tracker
The largest index providers, MSCI, FTSE Russell, S&P Dow Jones and Bloomberg, are being challenged by innovative competitors – including their own clients. The findings published in a new report by financial think tank Planet Tracker, suggest that these “index majors” should prepare for disruption driven by rising demand for sustainable investment.
Indices are used in many areas of the investment process, including index-linked product creation (e.g., ETFs, futures and options), performance benchmarking, portfolio construction and rebalancing, risk assessment, broker-dealer structured products and asset allocation. With the growth of passive investing, the role of benchmarks and indices has grown.
But current offerings from the index majors – such as S&P 500, FTSE 100, MSCI World – are being criticised because of their lack of customisation and transparency over sustainability metrics. Growing sustainable investing demand means smaller, innovative index providers are responding with offerings that address these flaws, with ESG indices rising by 14% across both equities and fixed income in 2019. What’s more, self-indexing and direct indexing are becoming increasingly prevalent among financial institutions and investors respectively to support their shifts to sustainability.
John Willis, Director of Research at Planet Tracker, commented: “The index production landscape is evolving to meet the demands of sustainability-based investment products. Declining fund fees, rising competition in index production and demand for greater consumer choice have all arrived at the same time as the upswing in sustainable investing.”
He added: “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. As for corporates, being included in a popular sustainable index could provide a cost of capital advantage.”
Analysing communications from indices and banks, the report gives three reasons why disruption is inevitable:
- Falling fees: Those financial institutions which have index fees based on assets under management will be keen to ensure they remain competitive.
- Profitability attracting competition: the index majors face rivalry from their own clients. In its 2020 10-K filing, MSCI states, “growing competition also exists from industry participants, including asset managers and investment banks, that create their own indexes’ and revealed dependency on the largest financial institutions with BlackRock accounting “for 11.0% of […] total revenues”.
- Demand for consumer choice: Demand for ESG and sustainable offering are likely to continue for both equity and fixed income assets. PwC forecasts that ESG investing is ‘the growth opportunity of the century’.
The report provides the following recommendations for each stakeholder in the index landscape:
- The largest index providers must balance rising demand for specialisation against the profitability of delivery.
- Asset managers and financial regulators need to ensure new benchmarks are appropriate and true-to-label.
- Investors need to understand the implications of using highly specialised indices when considering their investment goals.
- Corporates will be watching whether index inclusion results in an uplift in their share price, in turn reducing their cost of capital
The unintended consequences may be of most interest to supporters of sustainability and ESG strategies.
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 by executives to adopt more sustainable and ESG strategies, to both win access to these indices and possibly lower their cost of capital.