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As of 2025, around $36trn-worth of capital was in passive investment funds. These automatically track decisions by MSCI, FTSE Russell, S&P Global and the like to determine what to buy, and how much. Many trillions more are supposedly invested actively, but by “closet index-huggers”—timid managers who fear straying too far from their benchmarks.
But markets are not perfect and index rebalancing is large enough to move them. Goldman Sachs, a bank, reckons $7.8bn could flow out of Indonesian stocks if the country is downgraded to a “frontier market” by MSCI in June. The share price of Robinhood surged by 16% in September after it joined the S&P 500 index. South Korean bonds’ entry into the FTSE World Government Bond index this year may drag in as much as $60bn-worth of foreign investment.
In two separate months last year, index-rebalancing strategies run by Millennium Management, a hedge fund, came a cropper in this way and booked losses worth hundreds of millions of dollars, snapping long winning streaks. They did so just as momentum reversed (meaning that winners began to lose and vice versa). When momentum becomes unreliable, as it has sometimes been recently, so too are index-rebalancing strategies.
Norway’s gargantuan sovereign-wealth fund has $2.3trn in assets, much of it in effect invested passively. Yet it made $4bn last year through arbitrage, including around the rebalancing of indices.
Many so-called tracker funds in truth exercise far more discretion than the label suggests. This might be necessary to avoid being the “dumb money” on the other side of index-rebalancing trades.
MSCI, which was spun off by Morgan Stanley, an investment bank, in 2007 and has a market capitalisation of $45bn, has two main revenue streams from indexing.
The first is benchmarking. It has more than 280,000 equity indices around the world that tell investors what is going on in the public markets, and provide a measuring stick against which to judge fund managers’ performance. If a fund puts all its money into small-cap Japanese stocks, for instance, and MSCI’s medium- and large-cap Japanese equity indices do better, it underperforms. Almost $15trn of assets are benchmarked in such a way globally.
The second revenue stream is enabling investment managers to create financial products, such as ETFs, based on its indices. Almost $1.5trn of ETF assets are linked to MSCI’s indices, a nearly five-fold increase in a decade. BlackRock, the world’s largest asset manager, is the biggest client. Its boss, Larry Fink, and Mr Fernandez have been kindred spirits for decades.
MSCI’s first foray into the private realm is via benchmark indices. Since 2021 it has spent almost $2bn buying two data-gathering firms that create indices for private assets, from real estate and infrastructure to private debt.
As Mr Fernandez explains, such indices enable a property investor to decide the relative merits of putting money into, for example, offices (which crashed during the pandemic) versus data centres (which soared).
And yet Mr Fernandez believes that some parts of this opaque hinterland, such as private loans, are more liquid than others. “My bet is that over time there will be the development of a secondary market for private credit,” he says.