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Why You Shouldn’t Overpay for Market Beta

Market benchmarks representing the same segments are essentially interchangeable

Dan Lefkovitz


Think back to February, when volatility roiled long-placid equity markets. Stocks plummeted early in the month, then bounced back, before ending down. How did various equity market benchmarks gauge the volatile month?

U.S. Equity Market Benchmarks: February 2018 Performance, Source: Morningstar Direct


The market benchmarks displayed above vary in their methodologies and index parameters. Some target the higher end of the market, while others are comprehensive. Some use a fixed constituent count system; others capture a percentage of market value. But thanks to the commonly applied market capitalization weighting approach, these indexes delivered nearly identical returns in February 2018.

While strategic beta indexes can carry enormous complexity, market benchmarks are commoditized. Investors can reduce their costs, and thereby improve their outcomes, by paying as little as possible for market beta.

Market benchmarks: The Vanguard precedent

In 2012, Vanguard shocked the asset management industry by swapping benchmarks tracked by 22 index funds and ETFs.

“There were three main reasons for this change and its cost, cost, and cost,” said Vanguard executive Joel Dickson in a 2012 video interview for®. He said Vanguard was reacting to rising index licensing fees, which represent an ever-larger percentage of index-tracking funds’ expense ratios.

As a firm owned by his fund holders, Vanguard constantly looks for opportunities to cut costs and pass along savings. “Through a series of best practices that most of the index providers have converged to over the years, the differences between a lot of providers are relatively small,” Dickson said.

This observation was echoed by a 2016 paper published by the Spaulding Group in conjunction with BNY Mellon, State Street, and Northern Trust: “There is minimal difference between several index providers that serve the U.S. and global equity markets in terms of performance; while methodology varies among indexes, those variances are largely tempered by capitalization weighting.”

Market benchmarks are interchangeable: A case study

The interchangeability premise is borne out in the following comparison. The Russell 1000 Index and the Morningstar US Large-Mid Cap Index look remarkably similar from both returns-based and holdings-based perspectives.

Russell 1000 Index /Morningstar US Large-Mid Cap Index: Calendar Year Returns Comparison, Source: Morningstar Direct


Morningstar Open Indexes Project

The paradox of rising index costs at a time of downward fee pressure in the asset management industry drove Morningstar to act in 2016. Inspired by the concept of open source software, Morningstar launched a disruptive initiative to make benchmarking more accessible.

The Open Indexes Project offers a subset of Morningstar equity market indexes to financial services firms for general benchmarking at no cost. Morningstar is also working to make investment products tracking beta benchmarks more affordable.

Morningstar research has demonstrated repeatedly over the years that fees are a significant driver of relative performance. Lower-cost investments possess an inbuilt advantage. Because index licensing fees are ultimately passed along, the lower the costs of benchmarking, the better the investor experience.

Read the full research paper “Market Beta is a Commodity. Don’t Overpay.”

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