The report notes that fees from ETFs and other index-linked products are a key source of revenues for index providers, but that because most of those assets—especially ETF assets—are U.S. assets, most indexes are geared to the U.S. market. This would indicate that indexes geared to international markets would be the next growth area in a growth-oriented industry.

Pension Plans

Pension plans and their use of indexes are, not surprisingly, key themes of the report, so I'm going to take a look at them separately. One of the report's key findings is that by 2009, nearly 70% of all pension plans, representing roughly $40 trillion, will use customized benchmarks. One of the drivers behind this is what is known as liability-driven investing (LDI), in which the benchmarks are constructed to reflect the liabilities or obligations of the fund—this approach often uses interest rate swaps to hedge interest rate risk, and thereby frees up more assets to be put into alternative investments. "Pension plans," the report says with regard to LDI, "are not looking to managers for cheap beta anymore but instead are allocating more assets to funds that are focused on alpha capture products."

Another driver for customized benchmarks is socially responsible investing. More restrictions being placed on pension funds with regard to where they can invest—many state plans, for example, are restricted from investing in tobacco companies, while companies with business activities in Sudan are also forbidden to other plans.

The report also cites a survey by TABB that found that 44% of investment managers and 46% of pension funds anticipate increasing the number of benchmarks they use over the next two years or so as they add further asset classes and geographies and expand into new types of investment vehicles.

Conclusion

"Benchmarks used to be an afterthought, now they are primary," the report says in its conclusion, adding that indexing has "opened the door to new markets, decreased the cost of beta, and uncovered new sources of beta."

Based on the report's findings, someone working within the indexing industry cannot help but note how it now seems to be operating from a position of strength. It has transformed from a haphazard collection of rough approximations of the market into an industry marked by competition and precision. Instead of simply tracking the movements of the markets, the indexing industry is actually defining and redefining those markets and providing more ways to invest in previously difficult asset classes. Looking at the report's, findings it appears that, between index improvements and the expansion of ETFs, the indexing industry has the capacity to change the way the world invests.

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