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Blog Posts — April 25, 2018

Q&A: Index Industry Association’s Rick Redding

PULSE ONLINE recently caught up with Rick Redding, chief executive officer of the Index Industry Association. We asked him about the association’s work in representing the industry and the tasks ahead for providers in a market that’s quickly embracing indexing.

The IIA in January published its first global survey, which showed the association’s 14 members compile 3.29 million indices. The IIA estimates this represents approximately 98% of all indices available globally.

STOXX Ltd. is a member of the IIA.

Rick, what does the IIA do?

The IIA is a non-profit organization that was set up to do two things: provide education on indices and do advocacy work where needed across the globe. All of our members have to be independent index administrators, meaning that they can neither trade the underlying securities in the indices nor do they directly create products.

Why is that distinction in place?

Among our members’ common interests is the strict adherence to intellectual property rights. But the other reason is, if there’s independence in three of the functions: trading, index administration and product creation, you have checks and balances in each step of the value chain. You avoid a conflict of interest and you preserve best practices. This is an important issue that gained attention around the LIBOR scandal. The first index goes back to 1896, and there’s never been an issue around any of the independent index administrators because they have those checks and balances.

You recently presented a survey of the indexing industry. What were some of the main takeaways from it?
We thought this was something that was really necessary for the marketplace because no one really knew how many indices are out there. Our members calculate 3.29 million indices. A couple of findings to pull out of the survey: firstly, roughly 95% of the indices are in the equity space; secondly, many were surprised by the small number of fixed-income indices; finally, the survey also showed that the Americas has the fewest number of indices among the three regional categories.

Given that there’s roughly 5,300 exchange-traded funds (ETFs) listed globally, another key conclusion for us was that the primary use of indices is still benchmarking.

That’s a staggering number. Are there too many indices in the world?

The reason why there are so many indices is that there are many sector and industry classifications, so when you multiply that by the number of countries the tally grows pretty quickly. On top of that, you can have each index offered in multiple currencies. Separately, there are custom indices created specifically for institutional clients to better reflect or measure their active portfolio managers.

Each index caters to a specific demand. Indices don’t necessarily approach each market in the same way, and that’s a good thing for investors because it brings choice. Clients love having options and it secures them the best possible price from providers. And managers can efficiently express their philosophical approach to how they run their portfolios.

Smart beta and factor-based indices have become very popular. Was that reflected in the survey’s findings?
The survey covered a category we defined as smart beta/thematic/factor indices, which is broad enough to cover providers’ different definitions. Less than 6% of indices belonged in this category. As we produce this survey in coming years, it will be interesting to see what trends emerge.

What else are you working on?

One of the things that the IIA is undertaking is our educational mandate. One initial focus in that sense is to educate market participants around index methodology. A great thing in the move towards indexing is that indices are very transparent. An investor can read about the methodology and understand with detail what’s going on in terms of strategy, something that is not always the case when investing in a mutual fund. For example, when you buy an ETF that says ‘high dividend,’ what does that really mean? A lot of the products sound very similar, but in fact looking at the underlying methodology is critical. In a rising interest rates environment, your high-yield investment may be very interest-rate sensitive. So it may actually not do well if your portfolio has a high exposure to utilities, as opposed to having a large percentage of banks.

Looking at the methodology is almost as important as figuring out who the manager is in an active portfolio.

Could indexing eventually take the largest role in the asset management industry, to the detriment of active management?

I’m not convinced that that will happen. As more and more people go into indices, it would seem to me that there should be opportunities for active managers to outperform. If indexing is on the periphery, it’s harder for active managers to do enough analysis to outperform. But as more money flows into indexing, you should start to see areas in the market that seem less efficient because all the other asset managers have had to buy that stock. In that environment, I would think that active managers and people with a longer time horizon should actually do quite well.

In any case, I don’t think it’s an either-or alternative. The institutional world is using a combination of both index portfolios and active management, and that segment usually gives you an idea of what will happen in the retail world.

The new European benchmark regulation has recently kept you busy. What has the IIA done in this respect?
There was a lot of work around education and advocacy with the European Parliament. It was important for us to explain how the independence factor is so important. Unlike what happened in the LIBOR scandal, all our members seek the best possible price, because if you don’t trade your index and you’re not creating products, you’re trying to find the best representation of the market you’re covering.