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How Index ETFs Could Get Even Cheaper

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The cheapest mutual funds and ETFs, namely index funds, could get even cheaper if there were more competition among index-licensing firms, according to a new report from Morningstar.

Unbeknownst to many investors and possibly advisors as well, index licensing fees have been rising and at a faster rate than inflation, according to the report written by Morningstar Indexes Strategist Dan Lefkovitz, who also wrote an accompanying blog post. Anecdotally, some fees have even doubled or tripled over a five-year period because consolidation in the industry has created an “oligopolistic market,” according to Morningstar.

Currently three providers dominate the market for stock and bond indexes — MSCI, S&P Global and FTSE Russell. Their indexes form the foundations for passive mutual funds and ETFs and are the benchmarks against which actively managed funds are measured. Moreover, “for the same market segments [they] are often interchangeable,” according to Lefkovitz.

With more index licensing firms, investors could be paying even less for passive and active funds because “index licensing fees have definitely been passed down to investors,” Lefkovitz tells ThinkAdvisor. “There is room for costs to come down.” 

That’s what Vanguard found when it switched from MSCI to the University of Chicago’s Center for Research in Security Prices for 22 of its index mutual funds and ETFs in 2012. At the time, Vanguard executive Joel Dickson told Morningstar that the three three main reasons for the change were “cost, cost and cost.”

Lefkovitz notes that indexes for small-cap and non-U.S. equities, including emerging markets, have the most potential to move lower if there were more competition among index licensing providers.

“Disruption on the index side is inevitable,” according to Morningstar, which has launched its own Open Indexes Project that offers a subset of its global market-cap equity indexes, about 125 indexes, to asset managers at no cost for benchmarking purposes.

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