Active Fund Managers Lose $12 Billion in Potential Management Fees a Year in US as Investors Move $1 Trillion to Index-based Investment Products.

Index Providers' Revenue to Top $1 Billion a Year in 2009, Climbing at a 22% CAGR 

70% of all Pension Plans, Representing $40 Trillion, Forecast to Use Customized Benchmarks by 2009, Says TABB Group

NEW YORK -- With nearly $1 trillion currently invested in the United States in index-based products such as exchange-traded funds (ETFs), active fund managers stand to lose approximately $12 billion a year in potential management fees, a serious danger to the active management community. According to TABB Group in a new industry research report, "Performance Anxiety: A Buy-Side Study of Benchmarks and the Investment Process" written by research director Adam Sussman, hedge fund replication strategies could easily cost active asset investment managers billions more a year in lost management and performance fees.

Investment-performance measurement has undergone a great transformation, Sussman explains. Instead of comparing a manager's returns against a broader market index or ranking similar funds' performance against one another, the benchmark process has become granular and precise. "The appetite for index-based funds is nearly insatiable, with index-based assets under management (AUM) increasing by 2,610% since 1993. Global indices today cover 58 countries, grouped into five regions, market capitalizations and style. When you look at the different categories used to crate equity indices, there are 48,256 possible indices, just a smidgeon more indices than the 40,365 publicly-traded companies."

Over the past five years alone, independent index providers have seen revenues climb at a 22% CAGR (compound annual growth rate), he adds. By 2009, TABB Group forecasts that they will take in more than $1 billion a year in revenue.

Institutional investors have been at the heart of the change within the benchmarking space. Local governments imposed socially responsible investment constraints that required a redefinition of the opportunity set and a recalculation of the best possible performance. These constraints blossomed into a new industry of research and indexing allowing people to tailor their investments along social, moral and political beliefs.

As the world continues to polarize into extremes, the investment industry will create more ways for people to invest. As such, Sussman claims, by 2009 nearly 70% of all pension plans representing $40 trillion AUM will be using customized benchmarks, which will create more sophisticated investments as pension plans are exploring different views on asset allocation and portfolio construction, examining risk-adjusted returns, complex correlations and liability matching. A more refined approach to measuring performance, he adds, is causing institutional investors to trade exchange-traded and over-the-counter (OTC) derivatives that attempt to capture beta on the cheap, hedge against interest-rate risk and buy alpha. As the cost of beta plummets, investors are willing to pay more for alpha.

"There's no slowing down the tide of indexing," says Sussman. "Pension plans need better ways to measure the performance of alternative asset managers. ETF, exchange-traded note and other index-based managers will need more products in the pipeline. The fallout from the current credit crisis will create pressure on the industry to develop more transparent indices for OTC products. While Standard & Poor's, FTSE and Russell will continue to push out new products, it is only a matter of time until there's an index of indexers."

The 37-page report with 27 exhibits was based in in-depth interviews with 38 pension plan and investment managers in the US, the UK and across the European Union responsible for or actively managing investments worth $2.32 trillion dollars. TABB Group also spoke with investment consultants regarding their role in the asset-allocation and benchmark-selection process covering: the rise of indexing and trends within benchmarking such as customization, global-index families, socially-responsible investing (SRI) and liability-driven investing (LDI); desirable characteristics of a benchmark; leading hedge fund index providers; and satisfaction levels with current index providers and how services could be improved.

The report can be downloaded by TABB Group Research Alliance clients and pre-qualified media at https://www.tabbgroup.com/Login.aspx. To request an executive summary or to purchase the report, please visit http://www.tabbgroup.com or write to [e-mail].

About TABB Group

TABB Group is the New York- and London-based financial markets' research and strategic advisory firm focused exclusively on capital markets. Founded in 2003 and based on the proven interview-based research methodology of "first-person knowledge" developed by founder Larry Tabb, TABB Group analyzes and quantifies the investing value chain from the fiduciary, investment manager, broker, exchange and custodian, helping senior business leaders gain a truer understanding of financial markets issues. For more information, visit www.tabbgroup.com.