The Market for Fund Benchmarks: Evidence from ETFs

Abstract

The market for passive ETFs and passive ETF benchmarks has exploded in the past decade, with assets now at $4.5 trillion. Index benchmarks are provided by an oligopoly of brand name index providers (e.g., S&P, Russell, MSCI), a large number of smaller providers, and a growing group of self-indexing firms. We investigate how investors view these different benchmark types. Few passive ETFs share the same benchmark, highlighting the role of product differentiation in this market. Benchmark provider choice is an important element. Overall, we find a significant branding benefit, as ETF benchmarks with larger index providers are able to attract more capital from investors. We also find a clientele effect, with institutional investors exhibiting a strong preference for brand name benchmarks, and no such preference from do-it-yourself retail investors. This “institutional” preference actually comes from financial advisors who invest on behalf of individual clients, and even more specifically, on behalf of wealthy individuals. On the other hand, we find no evidence that any type of investor either values or devalues self-indexed benchmarks, after controlling for indexer size. In an event study type of framework, we show that ETFs that change benchmarks, have 7% higher flows in the subsequent three months, again driven by institutional flows.