ETFs are touted as low-cost, and perhaps more reliable, ways to get market beta, but they are actively marketed—while protecting their proprietary components.
Case in point: Rob Arnott, who pioneered fundamental indexing as an alternative to market-capitalization formulas, has dropped his patent infringement lawsuit against WisdomTree.
Arnott’s fundamental indexing relies on such factors as total cash dividends, free cash flow, total sales and book equity value. Some have argued that, in effect, fundamental indexes are tapping well-known value and small-cap premiums.
WisdomTree was founded on similar principles. Influenced by Jeremy Siegel, WisdomTree created a set of ETFs using factors such as dividends and earnings.
What the ETF methodologies share is a departure from market-cap weighting—with some degree of success. Arnott’s firm, RAFI, has licensed its index to providers, running $87 billion in assets, while WisdomTree has $16.7 billion in ETFs.
Assets like these are more than enough to keep the ship afloat. But sometimes the competition is too stiff—for ETF providers, and for index providers. Canada has already seen a number of retreats on the ETF front, with State Street Global Advisers exiting the business and Claymore being bought by BlackRock. In Europe, Credit Suisse is poised to sell its $17 billion ETF business.
Even index providers are not immune to change. The dominant franchises have been Standard & Poor’s and Morgan Stanley Capital International (MSCI). Both Vanguard and Lyxor are shifting from MSCI to FTSE indexes on some of their products. In large part it’s because—no surprise here—some index providers are cheaper than others.
Then there’s the get-big-or-go-home story.
In the U.S., Standard & Poor’s, which made cap-weighted indexing the industry benchmark, is merging with Dow Jones Indexes, which at first sight makes for an unlikely pairing, since Dow Jones is famous for its index of 30 stocks weighted by price. Meanwhile, IndexUniverse reports that NASDAQ OMX Group is buying Mergent’s dividend index business. Imagine that: hitching high-tech growth to dividends.
As both index and ETF providers fuse, mixing methodologies and philosophies, it pays to look under the hood. Otherwise, you may be trying to hit a moving target.