Competition watchdogs use the Herfindahl-Hirschman Index (HHI) as one measure to assess how competitive or concentrated an industry is. Values above 2,500 describe a highly concentrated industry with limited competition. Or rather, they typically describe oligopolies where a handful of businesses control the market. Did you know that the HHI for the industry of ETF providers is 2,527 and the HHI for index providers is 3,293? In other words, if you buy an ETF you are dealing with two oligopolies. First, you buy an ETF that will almost certainly be run by one of five companies (BlackRock iShares, Vanguard, StateStreet, Invesco, Schwab).
Market share of largest ETF sponsors in the US
Source: An et al. (2021)
But these ETFs will almost certainly track indices from a select few providers.
Market share of largest index sponsors in the US
Source: An et al. (2021)
The problem is that investors like to look at certain prominent indices like the S&P500, the FTSE 100, or the MSCI World. Thus, ETFs tracking similar indices have a hard time gaining traction in the market. The result is that the index providers have large market power and can demand high licensing fees knowing full well that ETF sponsors don’t have anywhere else to go. Meanwhile, because ETFs are mostly about pricing power, smaller ETF providers have limited ability to compete with the dominating market players because they don’t have the same economies of scale. It may sound weird given the already very low fees for ETFs today, but researchers have estimated that 60% of index licensing fees are markups by the index providers to ETF sponsors and that ETF fees could be 30% cheaper in a more competitive market. It seems that while ETFs are efficient, the ETF industry is not and companies providing indices and ETFs have too much market power today.
This post is a real eye-opener.
An industry responsible for massive reductions in costs and increases in efficiency is itself keeping costs up and efficiency down....plus there's no easy way to break this in the way that indexing broke active management.
Is "direct indexing" + blockchain smart contracts the answer?
as a BLK shareholder I am quite happy. Although, indexes seem so easy to make i don't understand why so few do them? Whats the barrier to entery in this space?