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Vanguard Benchmark Trade Shakes Up Index Industry


Vanguard’s decision this week to replace the benchmarks at 22 of its funds and ETFs is reverberating in the index-licensing business, typically a staid and academically-minded corner of the asset-management industry.

On Tuesday, Vanguard said it is swapping out of MSCI indices in several funds and ETFs, in favor of benchmarks managed by FTSE and the University of Chicago’s Center for Research in Security Prices (CRSP). [ETF Fee Wars Spill Into Index-Licensing Business]

MSCI shares were up 4% Wednesday morning after tumbling 27% the previous session on the Vanguard bombshell. [MSCI Shares Drop]

“Given Vanguard’s status as a key MSCI customer, the long-term implications of its decision to part ways with MSCI are worth evaluating carefully,” said Morningstar analyst Swami Shanmugasundaram in a note Tuesday.

MSCI said its annualized revenue and operating income associated with the Vanguard funds being transitioned are approximately $24 million.

The main reason Vanguard seems to have made the switch is that it will pay lower index-licensing fees to FTSE and CRSP.

“We negotiated licensing agreements for these benchmarks that we expect will enable us to deliver significant value to our index fund and ETF shareholders and lower expense ratios over time,” Gus Sauter, chief investment officer at Vanguard, said in a Reuters report.

Henry Fernandez, chief executive at MSCI, on a call Tuesday said ETF managers’ choice of index provider “may not be as sticky as we all thought,” according to the story.

“Although the direct fallout from Vanguard’s move is significant, it will pale in comparison if other ETF sponsors (BlackRock in particular) decide to follow suit. BlackRock is MSCI’s largest client, accounting for about 8% of MSCI’s total revenue. Within this pie, a large portion (about 80%) comes from fees based on ETF assets linked to MSCI’s equity indices,” said Shanmugasundaram, the Morningstar analyst.

“If BlackRock either decides to switch to a different service provider or use its own indices, it will be a devastating blow for MSCI. As with Vanguard, MSCI would be able to absorb any loss in revenue from BlackRock, but the impact on margins will be severe,” he added. “With BlackRock already talking about developing its own indices, we think MSCI is on shaky ground.”

However, Mark Wiedman, global head of BlackRock’s iShares, said the ETF manager plans to deepen its partnership with MSCI.

“MSCI is the gold standard of global and international equity indexes – the near-universal choice of professional investors,” Wiedman said in a statement Tuesday. [Vanguard Sets Showdown in Emerging Market ETFs]

Still, Vanguard’s index swap puts benchmark providers on notice that they can be fired by asset managers. The move could also encourage other ETF managers to negotiate lower index-licensing fees.

“Vanguard cited pricing as one of the main reasons to switch its index provider, which has now put pressure on MSCI to revisit its pricing policy. Given the fee war among ETF sponsors, and licensing fees comprising a large portion of a fund’s operating expenses, it wouldn’t surprise us if MSCI were to lower its fees,” Morningstar noted.

Standard & Poor’s Ratings Services on Tuesday said the Vanguard announcement does not affect its ratings on MSCI.

“This announcement does not affect our view of MSCI’s ratings or outlook. Although the Vanguard business represents a meaningful loss for MSCI’s asset-based fee business, both in revenues and prestige, it is a small part of  the overall revenue base (under 3%) and EBITDA (near 5%),” S&P said. “Further, MSCI’s adjusted leverage, at about 2.3x as of the June quarter, is relatively modest  for the ratings and we do not believe that the loss of the Vanguard revenues will affect its ‘intermediate’ financial risk profile nor its ‘adequate’ liquidity profile in the near term.”

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