Mind the fintech gap in indexing

Passive investing is evolving rapidly – its supporting tech needs to catch up

Roby Muntoni

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The growth of indexing and passive investing has been one of the most discussed stories in finance over the last decade, impossible to miss considering its magnitude is conservatively estimated at $17trn, growing by $500bn a year and expected to surpass active investing in just five years.

What is perhaps less discussed is the technology and infrastructure that supports this industry and the evolution needed to fuel its transformation. Today, the industry is dominated by a small number of large index providers, with technology built around traditional index strategies. These systems are efficient for their purpose but have not been built to accommodate the sophistication, customisation and scalability needs brought on by the industry’s transformation as it evolves and innovates.

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

This big 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 on their flagship indices, which has diminished their desire to invest in new technology that would, comparatively speaking, yield marginal revenue gains, would detract resources from their core business and would present great integration challenges.

This mismatch born from the surge and transformation of passive investing has created an opportunity to address the growing gap between demand and availability of fintech-driven solutions. The increasing popularity of cloud computing is empowering a new era in speed, scalability and cost efficiency and investors are looking for innovative passive investing solutions that capture these capabilities. The trends are clear, as reported in TrackInsight’s July 2022 report showing 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 to address their growing client requests for more sophistication. It is not surprising that conversations revolve around technology-empowered solutions.

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

With the recent evolution, the need for innovation has become paramount. The much broader investor base and the ease of market access have generated a demand for hyper-customisation that can be achieved at scale and with cost efficiency using today’s latest technology. Bolt-on legacy systems were not built for that and lack the agility and flexibility necessary. The evolution of technology has once again provided the answers.

A great example is the application of fintech in another significant trend, ESG investing, with individuals looking for customisation to express their values and support their beliefs through their investments. We see a high degree of variations driven by individual preferences. The need for hyper customisation requires sophisticated technology able to process disparate data sources, offer the agility to pivot based on clients’ beliefs and still deliver at scale, with speed to market and cost efficiency.

In summary, passive investing is evolving rapidly, offering solutions in an increasingly broader universe of asset classes, styles and themes. What was once considered active investing, today is available through rules-based strategies, blurring 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 investing to transform and expand. Its impact has been key in democratising investing as first evidenced by the introduction of ETFs in 1993. Investors all over the world now have easy access to investment strategies through low-cost 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 is time to bring Silicon Valley to indexing.

Roby Muntoni is chief commercial officer at MerQube

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