William & Mary Business Law Review
Abstract
The entrenched and highly profitable business of licensing indices for passive management is puzzling. The largest equity indices, like the S&P 500 and FTSE Russell 1000, are merely market-capitalization-weighted portfolios without meaningful creative input. The largest passive fund managers could offer and promote “private label” market-capitalization-weighted funds at lower cost—certainly zero and possibly with a basis point or two rebate—at a huge savings for end-investors.
I explore a plausible explanation for the strange dominance of index providers. I explain how index providers are akin to a “hub” in a hub-and-spoke relationship that facilitates a form of price-fixing in the market for fund management. Index providers allow passive fund managers to keep the prices of their passive offerings higher than they otherwise would be in private label competition. This benefits the largest passive fund managers because they also sell much more lucrative actively managed products. Index fees that are passed on to end-investors make those actively managed products look relatively better than they otherwise would, while providing hundreds of millions of dollars in licensing fees annually to index providers for a product that has no marginal value over the freely available strategy of constructing a private label market-capitalization-weighted portfolio.
Because passive fund managers and index providers can operate in the open, their conduct need not involve any illegal behavior. Rather, each large passive fund manager can enter into independent agreements with index providers to the detriment of passive investors without actually forming a horizontal agreement to do so, leaving their conduct (absent more) completely legal but to the detriment of investors who, by virtue of the already low cost of passive fund management, do not even realize that they are overpaying.
