But Dan Draper, who took over the CEO slot at S&P Dow Jones Indices in June, thinks the year’s ETF headlines are a sideshow compared to the ongoing big picture: the tectonic shift from active to passive investment management.
“Every geopolitical shock we’ve had has accelerated the transition of active to passive,” Draper told MarketWatch in a (virtual) sit-down conversation. That was true after the dot-com crash, the 2009 financial crisis and the European debt drama, Draper said. And he sees no reason the corona crisis will be any different.
Draper’s own transition, from head of ETFs at asset management powerhouse Invesco, to arguably the top spot in the world of indexing, mirrors another big shift among ETF players this year: some are finding the challenge of creating the intellectual property — the indexes that underlie funds — is more rewarding than dealing with the headaches of managing money.
MarketWatch spoke with Draper about the success of indexing, how ETFs have helped democratize finance for individual investors , and much more. He was unable to talk about two of perhaps the most newsworthy topics for his new company — its acquisition of IHS Markit and the decision to include Tesla Inc. in the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +0.93% — even though we couldn’t resist asking.
The interview that follows has been lightly edited for length and clarity.
MarketWatch: You’ve come to S&P Dow Jones Indices, one of the world leaders in indexing and harnessing data, from Invesco, an asset manager. What attracted you to this role? What are some of the challenges that you get to think about and address in this environment compared to fund management?
Dan Draper: Being the CEO of S&P Dow Jones Indices, the world’s largest and foremost index provider, was just a great platform. From the leadership perspective, having been a client for over 15 years in the ETF and asset management businesses, I knew it was a great organization. Looking out across some of the key secular trends, I really felt like it was an exciting platform.
MarketWatch: One of the big stories of this year has been the popularity of thematic investing in ETFs. It’s obviously not something S&P has been involved with as much as some of the other players in the market, but you do have a smaller presence, with the Kensho lineup. Where do you see thematic funds fitting into the fund landscape broadly, and how will S&P Dow Jones be thinking about them?
Draper: You make a great point. They’re definitely topical and we see them as a great growth area. We have a pretty rich history in thematics. The size and scale of the traditional business means it gets a lot of attention. For investors who are looking to either run more tactical asset allocation strategies or just supplementing their portfolios through those themes, the Kensho suite gives us an incredible opportunity. (MarketWatch note: S&P Dow Jones Indices reminded us that “nearly $2 billion in assets track the S&P Kensho index family.”)
Marketwatch: One of the other big themes of the year may be that indexing has driven fees so low that the industry is now in a relentless push for scale . It seems like a lot of big market participants are trying to be all things to all people. How does a brand like S&P distinguish itself when big beta is essentially commoditized and firms are trying to offer the same lineups as each other?
Draper: I think it’s a great observation. In my old world of asset management, there had been a lot of talk about consolidation, and you could see margins compressing. This year there’s really been a breakthrough on that. I think it’s more thinking about what the business model is in terms of consumers and what they’re looking for. That’s obviously been accelerated by the transition from active to passive and it’s one of the reasons I took this job. This brand, we’re going to celebrate its 125 anniversary this year (MarketWatch note: the Dow Jones Industrial Average will turn 125 in 2021).
It’s been a great journey. If you think about Charles Dow, the former editor of the Wall Street Journal, who started the index, he was trying to get a barometer of the economy, and now we have the S&P 500, which is around 65 years old. Now the barometers and benchmarks in the digital age have become the intellectual property and the drivers of innovation. In a digital age, we’re refining better risk and return characteristics in portfolios to create better outcomes. So now investors of all ilks, from sovereign wealth funds down to individual investors, the ability to customize for particular outcomes has never been greater. The democratization to the end investors is big disruption. We see it.
MarketWatch: Another surprising theme this year has been active management staking a claim in the ETF world. One of the biggest stories has been the success of Cathie Wood’s ARK funds , both in terms of performance and asset-gathering, and this was also the year when the first mutual funds started to convert to ETFs. What are your thoughts on the two structures, and do you think ETFs will inevitably win out because of all the benefits they offer compared to mutual funds — the tradability, the tax benefits and so on?
Draper: Let’s take that as two parts. One part is the ETF wrapper itself. The other is the content or the strategy inside. There are, as you say, huge benefits of the wrapper, such as the tax efficiency versus a traditional mutual fund. The ETF as a newer innovation comes at lower price points. And ETFs have almost predominantly been passive, and offered transparency. That’s a dynamic combination that investors around the world have adopted. The mutual fund, with its incredible rise in popularity, from the 70s to the 90s, it’s helped investors enormously. I view it as a form of analog technology. The ETF is like a mutual fund but it’s transforming analog technology into digital, moving from daily pricing to listing as a stock on the exchange. That intraday pricing, net asset valuation, is powerful. Again, I equate that, as we’ve seen in other industries that have had transitions from analog to digital technology.
At the heart of it is the index, and the transparency is absolutely crucial. The wrapper has been a huge success, it’s been a journey for many investors, to understanding the importance of asset allocation, whether short term trading or long term retirement strategies, understanding that the majority of their success is going to be based on successful asset allocation.
That’s where you’re seeing index-based strategies dominate. We saw years ago the rise of smart beta, the shift from traditional indexes like the S&P 500 to things like value and growth. Moving from the traditional benchmark, starting to become more active. We’ve really seen it more in fixed income than in equities. What’s interesting for me in equities is the rise and overwhelming success of smart beta and factor investing. They’re taking more from active mutual funds. In active management there is some talent, people who can add alpha. The great thing about the ETF wrapper is that it’s a place for all kinds of strategies. But i think the jury is going to be out for a while on active non-transparent ETFs and the long term value relative to the cost.
MarketWatch: Can you say a little more about the point you just made about transparency and investors being able to understand their asset allocation? If I understood you correctly, you’re alluding to another benefit of ETFs, how they’ve democratized finance.
Draper: Yes, absolutely right. When I got involved in ETFs over 15 years ago it was exciting then to think I could buy, for a couple thousand dollars, six or eight ETFs that could give me a diversified portfolio. But in today’s world, with digitization, I don’t have to pay commission and we have fractional shares. If I’m an investor on Robinhood and some of these other platforms, for a couple dollars, I can get the tax efficiency and the ability to do dollar cost averaging which is really powerful for younger people. All that technology really empowers investors. This is where we invest a huge amount of time and effort. We work with our clients: asset allocation matters. Technology has never offered more potential inclusion of a broader range of investors than ever
MarketWatch: What are your thoughts on what’s sometimes called direct indexing — the complex software that allows financial advisors to help individual investors essentially create their own portfolios?
Draper: It’s an interesting emerging trend. We’re engaged. Through our indexes and intellectual property, we engage across a number of partners. From ETFs and traditional mutual funds to futures contracts, options, structured products, and now direct indexing, this is yet another venue for us to be able to engage. It’s an area that has seen some growth. It just gives investors more choice. Overwhelmingly the benefits of ETFs remain strong, and investors will figure out what’s best for them.
MarketWatch: So it doesn’t sound like you think direct indexing will put asset managers out of business.
Draper: Look, there are a lot of factors that go into being a fiduciary. There are a couple of large players, as you know, that have been involved in acquisitions so it’s already in asset management. The key is, by having the underlying indexes which can be licensed and made available across a number of wrappers, what makes our brand differentiated is our commitment to education. Regardless of how a fiduciary delivers to the end client, the fact that we can help educate our clients and on to their clients, that’s paramount. Rather than just issuing product, we’re always trying to stay on top of thought leadership.
MarketWatch: Dan, you’ve lived all over the world. Are you excited about coming to New York, once everything settles down and it’s safer?
Draper: I have lived around the world, including on and off in New York for just under three years earlier in my career. Absolutely. It’s an incredible city. It’s the world’s financial capital, still. It’s the U.S. financial capital and arguably the world’s. Though to be honest, I’m really excited to travel anywhere right now.