What’s the role of index providers in today’s markets? S&P DJI’s Brandon Hass joins Cerulli Associates’ Brendan Powers, Delta Wealth Advisors’ Niko Finnigan and Sunpointe Investments’ Rob Mooney for a deep dive into how advisors are putting an expanding range of index tools to work to build model portfolios, increase efficiencies and tailor strategies to meet client objectives.
[TRANSCRIPT]
Jeane Coakley:
Welcome to Asset TV.
The financial landscape is ever-changing, so what's the role of the index providers in today's market? Index providers play a pivotal role in the index-based products and asset allocation model portfolios now widely used in U.S. wealth management, but recent research suggests index providers are being underutilized.
Joining me today to explore the evolving trends redefining index usage are Brandon Hass, Managing Director and Head of Direct Indexing and Model Portfolios at S&P Dow Jones Indices; Brendan Powers, Director of Product Development at Cerulli Associates; Niko Finnigan, Partner, Delta Wealth Advisors; and Rob Mooney, Managing Director and Private Wealth Advisor at Sunpointe Investments.
And Brendan, we're going to start with you. Cerulli Associates' research piece, Redefining the Role of Index Providers, is the reason we're all here today, so can you set the stage with some of the key take-aways from your research?
Brendan Powers:
Yes, and I want to start with some context with the methodology. So, for this research piece, we built the foundation using a survey of about 300 financial advisors, and we paired that with executive interviews with 25 wealth management executives and financial advisors, and, at a high level, one of the things we learned in the research is that advisors generally want to use more index-based products. They allocate about 46% of their clients' book of business, an average client today, to index-based products. They plan to increase that to 49% by the year 2026.
Now, part of what's driving that is demand for lower-cost products, but that's not all the story. There is also an evolution of their value proposition, and we see advisors moving away from investment management as the thing they're pitching to their clients, and then moving more toward financial planning, and, as they do that, they're using more model portfolios, which has led to the demand for and use of more predictable, consistent building block, beta-like exposure. So, at a high level, that's the place the research starts.
Moving forward, despite the role of index-based products evolving and advisors, when they're selecting those products, telling us they care about index methodology, they're really underutilizing index providers, and, ultimately, the finding we were led to is that some of these advisors aren't aware of the scope, the scale, the breadth of the capabilities that these index providers can bring to bear and will be able to help these advisors navigate the more complex landscape they face today in terms of products, clients' expectations, etc.
Jeane Coakley:
And Brandon, I want to ask you, what trends have contributed to the rising use of index-based strategies?
Brandon Hass:
Yes, it's a great question, and I think Brendan hit a few of these points already. The concept that financial planning tends to be paramount to investment management for most financial advisors today, and that's a function of that's what clients are interested in, that's what they're demanding. They want a goals-based wealth management structure. A lot of these are based on asset allocation framework, and that asset allocation framework tends to come or is derived from index methodology. And, so, as advisors are building these financial plans, indices already play a major role.
And then when you kind of rewind the clock, many decades ago, when an index provider was more of a benchmark and a barometer for the marketplace itself. Obviously, we have things like ETFs today and other index-based solutions, so, it's not just a barometer anymore. It's actually the bedrock and the foundation of investable products through ETFs, and there's a wide breadth and depth to those product solutions.
We calculate over 800,000 indices every single day in the market. There's actually around USD 28 trillion that are linked and benched to our indices alone, so, you have kind of this extremely liquid ecosystem today that can be a tool and a solution to build that financial plan and, ultimately, deliver that scale across your client books. So, now you're creating a deliverable, scalable, repeatable process that can also be customized based on the client's unique needs.
Jeane Coakley:
And Brendan, I'm going to go back to you, because how are indices being used within asset allocation models?
Brendan Powers:
Good question, I think that's important. I want to define what these are because "if we asked 10 different people in the industry, they're going to give you 11 different answers" is a widely used term. At Cerulli, we think about asset allocation model portfolios as a portfolio construction solution for financial advisors to leverage. They're constructed using an asset allocation framework that then allocates to individual investment products to fill sleeves of that framework. Products like ETFs, mutual funds, even separately managed accounts now we're seeing. As Brandon mentioned, we see model portfolios as a way for advisors to create scale, grow, by putting investment management not on the side but spending less time on it and instead allocating that time saved to things like financial planning, coaching clients, business development, training staff, some of those other elements of their business.
So, with that definition out of the way, back to your question. Two ways we see index providers playing a role in model portfolios and asset allocation model portfolios is one, at the asset allocation framework construction. Index provider data is key to generating things like capital market assumptions that form the backbone of their models' framework.
The second place we see them playing a role is at the product selection level. Now, if you're a model builder and you're creating a model that allocates to an index-based strategy like an ETF, for instance, that process of deciding which product is going to involve a fair amount of diligence on the underlying index, its methodology, etc. One of the things we heard during our research with these executive interviews of folks who are building models is that, in addition to that diligence, one of the things they'll often look for is, is there an ETF out there that matches or tracks the index that we use to build the capital market assumption for that sleeve I'm trying to get exposure for? So, that is important to them, as well at that product selection level, in addition to really the main use case of the data at the asset allocation framework level.
Jeane Coakley:
Alright, let's bring Rob and Niko into the conversation. And guys, how do you use indices in your practice today, and how has that evolved in recent years? Niko, we'll start with you.
Niko Finnigan:
I think that how we're using indices obviously is in model portfolios, as both Brendan and Brandon were speaking about, and, in using these indices, we always talk around the office, we say, standardize the process, customize the advice. So, we're able to spend time with our clients during the work hours. Clients don't necessarily want to be having a meeting at 8:00 at night. That allows us then to do our investment research on the weekends and at nights outside of market hours, because when clients want to speak, they want to speak during normal hours, that is, right. So, using the indices, we're able to then build upon it over time.
And we're doing our methodology and our research on it, and so, if we want to plug and play a different index into the model, we want more exposure in one area, as you were talking about. We don't have unexpected surprises, where a manager decided to dial down risk, even though we thought that we were adding to risk by putting in a position, or vice versa.
So, by having an index, and that index is rules based, it really helps us have. We don't have defined outcomes, right, no one controls the market, but we do have some more control over. The nice things are, returns are expected, fees and taxes are guaranteed, right. And, on those two, we know what we're paying in fees, and we don't have unexpected tax consequences as well, which is something that's happened in the past. A mutual fund can have huge outflows, and, all of a sudden, you have a major capital gain that's unexpected. So, really, in having more certainty, because it is rules based, it helps us deliver what it is our clients are looking for over the long term.
Jeane Coakley:
Rob, your thoughts?
Rob Mooney:
Because there are so many indices and products that track those indices, we as advisors have the ability to make more granular models to target the specified outcomes that the clients want. And, some clients want us to build them a castle, other clients want us to build them a race car, and we're able to do that. And, whether the castle or the race car are all of the client's asset allocation, or a part of that, we can set that aside, knowing that the outcomes are not predictable but, at least, within the realm of the capital market assumptions. And, we can focus on the financial plan and helping the clients stay invested through regular meetings, especially when the markets get challenging and they don't want to stay the course.
Jeane Coakley:
I have a question for both of you guys. How do you evaluate the indices that sit underneath ETFs or SMAs that you use?
Rob Mooney:
So, if I'm looking at a really esoteric corner of the market, I look to see who built the index, and I'm embarrassed to admit it, but I do. And, I was really pleased to see in your research that other advisors feel the same way that I do. The other thing that's important to me when evaluating an index provider is, does the index provider have the capability and resources to evolve their index as the underlying companies evolve across time?
Niko Finnigan:
Yes, and to build off of that, one of the things that was interesting from the research was that methodology is the fourth most common criterion used in looking at an index. And, people always look at kind of fees and performance, that all makes sense. But, what's interesting is that that methodology, that philosophy, to go back to the old four P's, that philosophy on how you're going to approach that asset allocation, that's going to come through over time. And, you do see it when you have a strong index, where flows may come over time, and you see that fees come down because there's more interest in that space.
So, because you have that rules-based index in the methodology, that you can approach it, that's really critical, because it allows us to back-test over time, and we can say, okay, look, if inflation spikes, what does it do to this part of the portfolio, and then, like what you were saying earlier for the analogy, where you have a castle and a race car, it gives clients the comfort where they say, okay, I have my safe money being safe, and I can have my grow money grow, right.
And they understand, sometimes maybe that race car is in the shop, because we're in a bear market. It happens, right. But, you have more comfort around the safe money being safe because these are rules-based indices over time. You can test against different scenarios, you can talk to clients proactively and say, look, if we see inflation do this, if we see these types of events occur, another bear market, global financial crisis, here's how each part of the portfolio responds, and then, aggregate, here's how it works as well.
So, again, coming back to that methodology, that gives us so much more comfort in being able to build plans for the long term, so you can spend time speaking with the clients, specific to what it is that they need from their money, as opposed to what the market gives them.
Jeane Coakley:
Alright, Brandon. Let's get back to what role does direct indexing play in expanding index use, and how is index design evolving to support that?
Brandon Hass:
Yes, it's a good question, and let me also just really quick say, Rob, I would like both a race car and a castle.
Rob Mooney:
We can do that.
Brandon Hass:
We'll talk after this.
So direct indexing has been around for a while, it's been around for over 30 years. So, it's not a new solution. But, there's a lot of reasons that it's recently kind of caught a lot of wind in its sails. A convergence of multiple factors, things like, fractional shares, technology interfaces that exist, kind of that are a little bit more ubiquitous across wealth, trading infrastructures that make it much more cost efficient. And, so, direct indexing, what we've seen was a solution that was not reserved, but typically accessible, to the ultra-high-net worth, is now still relevant to ultra-high-net worth, but is coming down into the high-net-worth market and mass-affluent market. So, it's a really exciting space to be in.
And, there's a handful of things that you can do with direct indexing that are fairly unique, when you're comparing them to other conventional wrappers like ETPs and mutual funds. So, within a direct index, you own the underlying securities, and, so, what you're able to do is address this concept of scale that we've talked about with financial planning and rules-based structures, but also customization, and those two things tend to be historically oxymoronic, or, at least, kind of a zero-sum game, where you have to kind of weigh the benefits of customization or scale.
And, what we're finding is, based on this convergence of factors, that a lot of asset managers and wealth managers alike can deliver both at the same time, right. It's no longer a zero-sum game, and, so, as we think about this as an index provider. I mean, indexing is in the name, direct indexing, right. So, we are product-agnostic, we are wrapper-agnostic, and, so, most direct indexes or indices exist within an SMA, or within now a UMA structure, but the index itself is still kind of the bedrock of the intellectual property, is what kind of guides the investment solution, or the investment solution that tracks the benchmark or the index itself. And, so, if you look at the market and the landscape today, a lot of that is still in large-cap core.
So, obviously, we're known for the S&P 500, but, as I mentioned earlier, we calculate over 800,000 indices a day. And, so, what we're seeing is large-cap core continues to, or tends to be, the largest allocation for a U.S. wealth client, but there's a lot of other sleeves, right. And, so, within a direct index, you can start to reflect this customization inside of one sleeve, or a combination of sleeve, a lot more seamlessly inside of kind of this tech-enabled wrapper, right. So, what we're seeing now is platforms are starting to expand their offering, offering complements to the conventional large-cap core only, and that could still be in that sleeve.
So, for example, maybe you have an income tilt, or you want to reduce volatility, or you want a multi-factor approach. A client wants to express some of their values or exclude positions. They want to reduce a concentrated stock position. And, we're also seeing offerings across asset segments, right. So, it's not only U.S. or U.S. equity anymore, it's in international equity, and it's even fixed income components. And, so, it's a really exciting place to be.
As we think about what can we do to be at the forefront of that as an index provider is having conversations like this, right. Okay, listening to what are your clients interested in. What's the demand? We don't operate in a vacuum, although, sometimes, folks think we do. We take a lot of considerations to say, okay, what's the market demanding today and how do we think it'll evolve going forward, and how do we innovate and evolve our index methodology to support that ecosystem on a go-forward basis.
And, so, one of the things we're seeing right now is kind of this resurgence into long-short, right, kind of offering this long-short solution, but based on our intellectual property. So, like a S&P 500 130/30 Quality Index (Long-Short) is an index that we manage, and we see solutions like that becoming interesting to the market, among others.
Jeane Coakley:
Alright, so Brendan. What does the Cerulli research suggest about how advisors view index providers today?
Brendan Powers:
Yes, that's the core of what we tried to get at in the research, right. And there's an exhibit in the white paper, we asked advisors, how do you engage, or how do you interact, with index providers? We gave them an option to just say, I purely use index-based products, I use content or thought leadership from index providers or I actively engage with index providers, maybe have phone calls, quarterly or standing Zoom meetings, or something of that nature.
And, interestingly, partially due to the parameters we set around what advisors we were focused on, we required advisors to have at least 10% of their client assets in ETFs, nearly all said they're using index-based products to some degree. But just 33% told us that they were using thought leadership or other content from index providers, and a lesser 27% are actively engaged with index providers. And, so, we really want to focus in on those content users and those that are actively engaged to really understand what's driving their motivation, how do they get access to this information, how are they using it. And, so, what we found is that those users, they're really keyed in on a couple different types of data, and I'd be curious, I think hopefully we'll hear from Niko and Rob on actual use cases. But, in generalities here, they're interested in performance data, index performance data, they're interested in performance attribution analysis. They're looking for information, details on index design and methodology, to Niko's earlier point. And then, any updates or changes to the indices, rebalancing information. And then, general thought leadership as well.
How that's typically applied, the advisors we spoke with during those executive interviews were able to tell us that they're primarily using them for investment decisions. There's also a use case for facilitating client conversations. One of the more common examples that we came across was, across index providers, including S&P Dow Jones Indices, these, what I'll call active versus passive scorecards as a general category, and these are documents where, or thought leadership where, the index providers, or even other asset managers, are helping the advisors understand where is it more or less common for active management to beat the benchmark over time. Advisors are using that to make investment decisions, where do I go active, where do I go passive, or choosing models. Because, as we know, model portfolios, there are thousands upon thousands of iterations out there. Some all active, some passive, a lot of a mix. So where do you want to go active, where do you want to go passive, to create that more cost-efficient portfolio for the client. And then, having that information from a third party to add credibility goes a long way in bolstering how you explain that to your clients.
Jeane Coakley:
So, why do you think some advisors still underutilize index providers, and how do you think they could change that?
Brendan Powers:
Yes, so going back to that data we just discussed. There's a gap between those who are using index-based product and those who are engaging or are using content from index providers. How do we see that gap closing? I think one of the issues preventing that from closing right now is advisors frankly don't know the resources are available. When they're using index-based products, they tend to get information from asset managers that are building those products, but they're not going necessarily to the source who are building the indices that that product is constructed off of. So, as awareness of the index providers' role grows, and the awareness of the breadth and depth of capabilities that they can bring to bear in terms of educational content, thought leadership, index-level information, we do think there'd be a benefit for advisors to tap into that.
As it relates to how that occurs, one of the factors we see driving it is the greater use of more complex product types that are tracking indices, like direct indexing. As Brandon mentioned, there's a lot of product proliferation going on there. We're seeing more types of indices across the equity spectrum, but into bond ladders and fixed income as well, which we could get into a debate whether that's direct indexing or not. But data is important there.
And then, in the ETF space even, we do see more demand and use of complex products that are tracking more complex indices. So, as the advisors are trying to grapple with this, this current industry that they're participating in, where these complexities exist and the need to discuss these products with their clients and these portfolio construction methodologies, going right to the source for the index construction, to the index providers, is a critical source of information for them.
Jeane Coakley:
And Brandon, what are some of the underutilized capabilities that the index providers offer beyond just benchmarks themselves?
Brandon Hass:
Yes, I think Brendan hit a lot of them. You know, I said before, like we don't operate in a vacuum, right, and we build indices and we publish these indices publicly, in a public vein. So, you can go online, you can Google any index S&P, and the methodology deck is right there. But, that's one of the things that we do, right.
The other thing that we do is we do a ton of research around our own indices and competitor indices. We do a ton of research, to Brendan's point, on active versus passive. It's called SPIVA. We're on our 21st year now. So, SPIVA stands for S&P Indices versus Active. So, we look at the entire active universe and compare it to its appropriate index. What outperforms, what underperforms, how does that tend to trend through time? We look at persistence, so ability to consistently outperform or remain in top quartiles. A lot of that research is written for consumption for financial advisors. And, so, we have people that can communicate that to advisors. Folks that can work with the asset managers that are building products around the things that they might want to get this word out about. So, a lot of it does revolve around education and communication.
And, the last thing that I'll say is that we love getting feedback, and we actually actively seek public consultations in our existing indices. Not only that, but in the construction of new indices. So, we consistently, we have a whole business dedicated to creating custom indexing, where somebody will come to us, and they'll say, hey, I want a little bit of this, and a little bit of this and a little bit of this. And, we'll say, okay, we'll go to the lab, we'll put it together, does this look right to you? So, we consistently do create indices on a customized basis and solicit proactively or sometimes reactively feedback from the users on how they want the indices developed. So, this is certainly a two-way street, and our door is open. It is interesting to kind of see this research and figure out why there's a rational kind of gap here, and realistically, we have a lot of resources to close that gap.
Jeane Coakley:
And, Rob and Niko, you're both ahead of the curve in terms of how you're using indices and working with index providers. What are some of the tools provided by S&P DJI that you've found most useful in this practice?
Rob Mooney:
So, S&P Dow Jones Indices has a white paper for seemingly everything. And, SPIVA is a go-to to help inform or reinforce the belief active makes sense here, passive makes sense here, here, here and here. Another white paper that my clients have enjoyed is small companies with earnings provide free alpha versus an index that tracks small companies that don't have earnings. Dividend Aristocrats really resonates with clients, especially in inflationary times. And, lastly, there is the Daily Index Insights e-mail, a must-read.
Niko Finnigan:
One of the things that Brandon touched on earlier is, in working with advisors and providing a toolkit, we probably get a dozen, two dozen calls, emails, every day, of somebody trying to say, here's this new investment strategy, it's outperformed in the past three months. Great. I'm trying to build a portfolio for three decades, right. I want the facts. And, so, one of the things I like working about with S&P DJI is, it's just like, look, here's a number of facts, work with it as you want to.
And then, also, if knowledge is like an island, the bigger it gets, the more there is to explore. And, so, we're always trying to say, okay, well, we understood this about the index, how can we take it to the next level, where can we learn about this or that. And, so, like you were saying, having those white papers, you can consume it when you want to consume it, right.
And you're not being pushed into a product. And, so, you're just, it's education, you're saying, okay, do I want more of this in my portfolio, do I want less of it? And, if I did, where do I swap it? And then, because it is rules-based, you can go and back-test it. So, I always tell our clients, we look at making trades is like taking a test. You want to spend more time preparing for the test than actually taking the test. So, you want to be researching and studying ahead of time, not just making willy-nilly trades in the force of a market, ripping up or down, right.
Jeane Coakley:
Alright, well that wraps up our discussion. Thank you all for your insights today. Of course, we all look forward to seeing how the role of the index provider continues to evolve.
And, to read the paper, Redefining the Role of Index Providers, and to explore S&P DJI's range of indices, its direct indexing capabilities and to stay up-to-date with the latest research and index data, visit the link below.
I'm Jeane Coakley for Asset TV. Thanks for watching.
