“Advocates of self-indexing see it as a way to offer investors lower fees, provided they’re willing to accept an exchange traded product that tracks a non-branded index,” Kellett notes.
Conversely, opponents say having benchmark construction and portfolio management under the same roof may create a conflict because the firm may try to create indices that are easier to track, but are not necessarily in the best interests of investors.
“Additionally, self-indexing providers may be tempted to choose constituents that are likely to be valuable in the securities lending market, which could give the firm an additional revenue boost,” Morningstar points out. “But these concerns could be effectively mitigated by a firewall between the index maintenance and the portfolio management teams. There is another concern that a self-indexing fund provider would tamper with the index rules in an attempt to boost performance.”
Adam Phillips, chief operating officer at Van Eck, in an interview earlier this year, said there is separation between the ETF manager and the index provider.
“There are safeguards in place, and we received self-indexing relief from the SEC which comes with guidelines in terms of firewalls,” the Van Eck COO said. [Van Eck Among ETF Firms Using Home-Grown Indices]
“As competition intensifies among ETP providers, it is inevitable that there will be a temptation to look more closely at index licensing fees, which are typically tied to assets under management, as a cost-cutting opportunity. In practice, the benefits of self-indexing are perhaps not as significant as they first appear, but neither are the risks as grave,” Morningstar concluded.