Be aware of the Fintech gap in indexing

by James · January 25, 2023

LONDON – The growth of indexing and passive investing has been one of the most talked about stories in finance over the past decade, impossible to miss considering that its volume is conservatively estimated at $17 billion, growing by $500 billion a year and expected to surpass active investments in just five years.

What is perhaps less discussed is the technology and infrastructure that supports this industry and the developments necessary to drive the transformation. Today, the industry is dominated by a small number of large index providers, with technology built around traditional index strategies. These systems are effective for their purpose, but have not been built to meet the needs for sophistication, customization and scalability resulting from the industry’s transformation as it evolves and innovates.

This is completely understandable, considering that these large, traditional index providers have a big responsibility to take. Their flagship indices represent the health barometer of the financial markets, they are the pillars of the stock market with trillions of dollars tied to their performance and the eyes of the world on them.

This large responsibility has led to their need for a conservative approach, focused on maintaining the technology that supports these flagship indices. Their revenue generation is also concentrated in their flagship indices, which has reduced their desire to invest in new technology that will provide relatively marginal revenue gains, will draw resources from their core business and present major integration challenges.

This mismatch resulting from the rise and transformation of passive investing has created an opportunity to address the growing gap between demand and availability of fintech-driven solutions. The growing popularity of cloud computing is ushering in a new era of speed, scalability and cost-effectiveness, and investors are looking for innovative passive investment solutions that capture these qualities. The trends are clear, as reported in TrackInsight’s July 2022 report, which shows that ETF investors are increasingly shifting towards high-value propositions that require sophisticated fintech.

In my new role, I work with powerhouses in investment banking, asset management and other financial institutions to discuss how they can meet their growing client demands for more sophistication. It is not surprising that conversations revolve around technology-based solutions.

Closing the fintech gap will result in a new era of passive investment and rule-based solutions. When the forerunner of the S&P 500 was first conceived in the early 1920s with 233 stocks, it was published weekly, and no computer had the computing power to calculate such large baskets of stocks. The stock market was not easily accessible and reserved for a very selective investor base. Technology has transformed the industry and is now the backbone of the financial markets, allowing everyone to participate and develop at an incredibly fast pace.

Demand for hyper-customization

With recent developments, the need for innovation has become paramount. The much broader investor base and ease of market access has created a need for hyper-customization that can be achieved at scale and cost-effectively using today’s latest technology. Bolt-on legacy systems were not built for that and lack the agility and flexibility needed. The development of technology has once again provided the answers.

A good example is the use of fintech in another important trend, ESG investing, with individuals looking for alignment to express their values and support their beliefs through their investments. We see a high degree of variation driven by individual preferences. The need for hyper-customization requires sophisticated technology capable of processing disparate data sources, offering the flexibility to pivot based on customer beliefs and still deliver at scale, with speed to market and cost efficiency.

In summary, passive investing is evolving rapidly, offering solutions in an ever-widening universe of asset classes, styles and themes. What was once considered active investing is now available through rules-based strategies, which blur the lines between active and passive. Cloud computing and cloud-native systems are the latest game-changer enabling these new strategies. Leveraging cloud computing in indexing is in its infancy, with so much room to grow.

The evolution of fintech will continue to create opportunities for passive investment to transform and expand. Its impact has been key to democratizing investing, first evidenced by the introduction of ETFs in 1993. Investors worldwide now have easy access to investment strategies through affordable ETFs. Cloud computing will enable the next phase of innovation in indexing. Making this happen means embracing technology and closing the fintech gap in the market. It’s time to bring Silicon Valley to indexing.

Roby Muntoni is commercial director at MerQube