By Geoff Hecht, CIPM
I had the opportunity to attend the FTF Performance Measurement Conference in New York City a few months ago. Of the many interesting sessions presented, “Solutions to Sourcing Index Data” stood out as a particularly relevant topic advisers often inquire about. The panel consisted of individuals in performance analysis and investment valuation roles.
The first topic addressed the best approach to sourcing index data. There are a lot of new indices flooding the market and data has become more expensive. This has caused advisers to determine whether it would be more cost efficient to gather the data in-house (internally source) or outsource to a third-party provider (externally source). A big challenge in determining cost efficiency is putting a dollar figure on the implicit costs of build vs. buy. Cost of data, labor and other costs such as future conversion from internal to external sourcing or vice versa need to be taken into consideration. Size and complexity of the adviser will also affect the cost. Equally important is determining the importance of data knowledge and employee focus. Internal sourcing is a lot of work, but you get a good understanding of the data. That being said, do you really want your performance people spending time pulling index data when it can be outsourced? If external sourcing is chosen, your employees can better focus more on analyzing and interpreting the data. Externally sourcing can also aid in the recruitment area. In addition to hiring someone that knows performance, you also need to take into consideration their knowledge of your system. Outsourcing eliminates this issue. Another option is using a mix of internal and external sourcing to get index data. Regardless of the initial decision, an adviser should always continue to assess whether it would be worth switching from one data source to another. It was noted that more asset management firms are looking at third parties to lift out services. This especially makes sense for smaller firms to outsource services such as performance and index data. In light of the LIBOR scandal, advisers in Europe are moving towards using outsourcing (index aggregators) for index construction as customizing indices in-house can be risky.
The discussion then moved on to data governance and proper licensing. Due to index licensing restrictions, an adviser with office locations in multiple cities could be subject to additional fees if individuals in multiple offices “touch” the data. Index providers are now performing due diligence by going to advisers websites to see if presented indices are being paid for and used properly. As it is not always easy to manage governance, it was mentioned that an outsourcing service for governance would be a good idea. However, it does not appear that a service currently exists for this.
Alternatives to traditional indices were also briefly mentioned (e.g., The Freedom Index). Up until this point, alternatives have not gained a lot of traction. One reason for this could be that clients like the familiarity of the big-name published indices (e.g., S&P 500). A positive of using alternative indices is an adviser can customize them for institutional clients and build an index to match a client’s exact needs.
Finally, the participants of the panel addressed benchmark selection and gave the opinion that the adviser should be making the recommendation of the index, not the client. In general, advisers need to do a better job of educating their clients when it comes to indices as they are a hidden cost to the client. It is important that each client understands the criteria for an appropriate index.