Solactive’s Scheuble: Index Costs Matter
– August 30, 2012
[This article was originally published on our sister website, IndexUniverse.com]
When the head of the company behind Solactive indexes spoke recently with IndexUniverse.com Managing Editor Olly Ludwig, they talked about the ETF industry outlook, some of the more prospective areas of fund development and also about the nuances and limitations of a trend toward ETF sponsors creating their own indexes.
Ludwig: You’re up against the MSCIs and the FTSEs and the S&Ps of the world—all of whom cast a long shadow in this business. And yet you have clearly demonstrated you’re getting traction. So tell me a little bit about how you see the challenge and how it’s going at Structured Solutions AG.
Scheuble: Actually, the starting point had nothing to do with Structured Solutions. The starting point of our company was in 2006, when I was working for Deutsche Bank in the structured product business. We were searching for a very fast index provider.
Ludwig: “Fast” meaning what?
Scheuble: “Fast” means you can launch a structured product with within one day. With an index provider that can launch an index within one day, you can launch an exchange-traded product within 24 hours. If you went to the traditional index providers back then, it took weeks to get an index up and running, because they were not used to the regulatory framework in the German structured product business. We have now managed to cut down the time needed to launch an index to something like five minutes—something that is very valuable to structured product issuers, delta 1 trading desks, etc.
The second thing behind the creation of Structured Solutions was, really, pricing. You probably know about the pricing schemes of the big index providers. In our opinion, it’s definitely possible in many cases to offer this service cheaper with the same quality and significantly more customized. Just being cheaper is not going to work; it may be a door opener, but in the end you have to deliver at least the same quality as the established competitors.
Ludwig: Let’s talk about that for a moment. My understanding is that, in the traditional arrangement, it’s a percentage-of-assets proposition, a basis point structure on an ongoing basis. And that would seem to be just fine if your fund is a small one. But if you reach the scale of a SPY, suddenly that’s a lot of money. So what you’re serving up is an alternative to that?
Scheuble: We offer different fee models. So if you come to us, you can actually have a basis-point model that is linked to assets under management.
But in general, we believe that we don’t contribute too much to huge assets under management in most cases. You can launch an ETF and you can use a Solactive index. But you are responsible for the marketing and the distribution of the product. And if you are responsible for the marketing and the distribution, I do not necessarily have to participate in the assets under management, because I’ve done nothing for that.
Ludwig: So what you’re getting at is, what, a flat fee? You’re saying: “We’re going to make this index. It’s going to be a good one. We’re doing serious work. We’ll charge you right up front for what you’re getting. And then you’re on your own in terms of sales and marketing. And we’re confident that, with this index, you will be able to confidently market your product.” Is that fair?
Scheuble: Exactly. I just charge a fixed fee if the client wants to have that. So, the client has the full upside. And we get a fixed fee, that’s what it is. Our job does not really become much different if there is US$1 million or US$1 billion invested in a product linked to one of our indices.
Ludwig: And would you say that that has contributed to some of the success you’ve had? Global X uses quite a lot of Solactive indexes. Is that part of the allure to a company like Global X when they’re doing business with Structured Solutions AG?
Scheuble: I don’t want to comment on the pricing model with Global X.
Ludwig: Fair enough.
Scheuble: I believe there are some index brand names that definitely add value. If you talk about a global index, it’s the MSCI World. And if you talk about a European index, it’s the Euro Stoxx 50. And, of course, there’s the S&P 500. You cannot substitute that for the Solactive 500 because you will have a hard time gathering assets since people tend to trust the brands they know—even though, to be honest, hardly any investor would be able to explain how the S&P 500 actually works or why it may be a better index than any other U.S. benchmark.
I would say there are 10, 15, probably 20 global benchmarks that add value to a financial product; that’s it. And a brand name itself really adds value.
Ludwig: Yes. So where is the opportunity if all those swaths of the market are accounted for?
Scheuble: Sectors, themes, enhanced-beta strategies and things like that. I would say that there, the brand name is, by far, less helpful.
Ludwig: I have a suspicion that price has a lot to do with this self-indexing trend that seems to be developing in the States. Moreover, I wonder if these companies filing to self-index are really interested in doing it. I wonder if they want to take to the table a threat in a negotiation with an indexing partner, and say, “If we don’t get a better price, we’re going to do it ourselves.” And by doing so, they’d be kick-starting a whole new negotiation. Is that a hypothesis that has any resonance in your judgment? Or do you think these companies would like to take matters into their own hands and primarily cut costs by doing the self-indexing?
Scheuble: I believe it’s a mixture of both. First of all, you want to put pressure on prices, and it’s a good time for that because the index world in general is changing. How it all ends up is something different.
Self-indexing starts with putting your brand name on it. But, often, somebody else is calculating the index, and that’s OK. We can do that as well.
Scheuble (cont’d.): So then there’s the self-indexing only at the brand-name level, that’s it. The methodology, the development and all that is done by somebody else. The ownership remains with the ETF provider.
From my perspective, at the end, it’s a matter of cost. It might make sense to build one’s own index calculation and index infrastructure, index maintenance and such. But I believe it will not be efficient unless you calculate a lot of indices. Because if you just calculate, say, 100 indices, it’s not worth building the necessary infrastructure, hiring staff, etc. It’s cheaper to do it externally, actually.
Ludwig: Right. So that means that, if they can’t achieve economies of scale, the whole prospect of saving money—whether for the fund company or for the shareholders—is something bordering on fiction? Is that what you’re saying?
Scheuble: Well, it may come cheaper than paying millions of dollars in a basis-point model to an established index provider, but it is certainly not the most cost-effective way possible.
Ludwig: So Structured Solutions AG enters, and you say, “There’s all this song and dance at the SEC regarding self-indexing filings, and a definite downward pressure on pricing. And here we are with different pricing schemes. We can do it for you, and we can do it for you faster than MSCI, S&P and FTSE. So let’s have a discussion.” Is that a valid premise for a discussion you would have with a potential client?
Scheuble: Exactly. But I cannot tell you too much. You know there are deals out there that are already visible. So for example, you might know the SWM indices, for example. We calculate them.
Ludwig: Which indices?
Scheuble: The Sustainable Wealth Management indices. It’s the Sustainable Oil Sands Index, Sustainable Oil Index and things like that. I don’t want to purely focus on costs, but, if you have a choice between, let’s say, an expensive provider and a cheap provider offering the same quality, you may go for the cheaper one. Or, if having a big brand name is important for you, paying more might make more sense even if the quality is not necessarily higher. I guess that is not different than in any other industry.
So choosing an index is definitely a combination of quality—which we offer—and pricing. One of these two things would not be enough. Being cheap without quality is not sufficient. So it’s really the combination of aggressive pricing with high quality.
Ludwig: So is it fair to say you’re not a real believer that there is a bona fide self-indexing trend under way, that there are too many impediments to really achieve those economies of scale as well as the savings that seem to be implicit in these sorts of pursuits?
Scheuble: Yes. You need to keep in mind there are huge costs associated with calculating indices; therefore, I am very much looking forward to what will happen in this area.
Ludwig: Let’s return for a moment to the markets you do compete in. You talked about enhanced beta and some of the more niche strategies. The ETF industry is still expanding rapidly, but the rate of growth seems to be decelerating a little bit. So as you survey the competitive landscape, describe to me a little bit what you see as the best opportunities that are out there, now that the low-hanging fruit has been picked.
Scheuble: If you’re an ETF provider and you want to differentiate, it doesn’t make sense to launch SPY No. 2—you can never attract the volume. SPY No. 1 is by far more liquid, far better known, more tradable and things like that.
So in the ETF space, you need to find new concepts, yes. In my opinion, there’s definitely a trend towards bond ETFs. There will also be, in my opinion, a trend to multi-asset-class ETFs. And there will be a trend toward, in general, a little bit more complex ETFs, such as long/short products; alpha-generating products, taking out market risks, and things like that. Because there, you can definitely add value.
Ludwig: So you’re talking about getting away from pure beta. You’re getting into things like asset allocation as an asset class. You’re getting into rules-based funds that are really more strategies than they are beta products, yes?
Scheuble: Exactly. In our company, we call it enhanced beta.
Ludwig: So are you implicitly casting doubts that actively managed ETFs will ever really get serious traction? Rather, will it be these enhanced-beta products that Rob Arnott at Research Affiliates described to me as “active management in drag?” Are you saying that that’s probably the future more than, let’s say, an actively managed portfolio, the way actively managed mutual funds are?
Scheuble: Yes. Because for me, the ETF world is rules based, and actively managed, in general, means the traditional mutual fund.
Ludwig: So you see a clear separation there? And in your judgment, it’s a separation likely to remain in place and grow more pronounced over time, not less so?
Ludwig: So do you have any strong feelings in terms of projecting future growth rates? Obviously growth in the ETF industry is decelerating. There’s little disagreement about that. But do you think that, over time, the ETF in its various guises will obscure the mutual fund as the principal vehicle that investors use to access financial markets?
Scheuble: That’s a good question. I cannot seriously predict any growth rates in absolute terms. But I am still convinced in general that low-cost beta and low-cost strategies are growing in relative terms. The ETF industry in general will pick up market share from actively managed funds. So you will definitely see a relative growth. But predicting where it will end is like trying to say where the stock market will be in 12 months.
Ludwig: Understood, and spoken like a real indexer! But you are saying it does appear to be a zero-sum game, but where it ends, you would not venture a guess?
Scheuble: That’s right. Exactly.
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