In the current climate, the global investment community is undergoing a gradual shift from active strategies to passive management.
Achieving alpha and outperforming industry benchmarks, which have come to be expected but not always achieved by active managers across the globe, is now being replaced amidst the global economic downturn. At the same time the global investment community is now displaying renewed needs for transparency and reliability.
Given this, passive management models, such as indices, which are used to mirror the market performance, are once again in the limelight for both institutional investors and individual asset owners.
The dilemma that asset owners and high net worth individuals are currently facing is: what allocation and which tool? With increasing fees, investors are shying away from reliance on active managers and moving towards tools such as tracker funds.
Within this, indexing plays a vital role in providing investors with investment opportunities in a transparent, risk managed and cost effective way. On the institutional front, this strategy is symbiotic with that of the long term outlook deployed by pension funds.
However, it is important to note that index innovation over the last few decades now also caters for individual investor needs and the ability to use indices and related products in much the same way as active managers have in previous years. Through such innovation, index providers including FTSE Group, have been able to draw on the recent success of active strategies, wrapping them into risk managed and often customised indices.
In this way, investors are able to draw upon specialist index providers to create tailor-made solutions, helping keep costs low and ultimately seek out better performance in both market downturns and booms.
Investors and indices
From its humble beginnings the index has grown to be much more than a value which represents the performance of a group of companies. Though a common misconception, indices are now also much more than a simple country benchmark, such as the FTSE 100 and FTSE Group now calculates over 120,000 indices worldwide across a range of continents, investment themes and strategies.
Investors need to understand that an index cannot be invested in directly, but that investment is made within an index fund. Such funds are the basic investment products bought primarily by investors’ eg mutual funds or exchange traded funds (ETFs) and mirror the market they are stated to represent.
These funds are a common way for individual investors to take advantage of an index, providing a cost effective and simplistic way of accessing a basket of stocks within any given index.
Changing role of the Index
The current environment has created a significant opportunity for index providers with a new resurgence from investors for index tracked investments.
Index providers such as FTSE Group, are now working more closely with institutions such as stock exchanges and specialist investment organisations, to create new regional and partner indices for market exposure. This offering includes an expansion of the FTSE Global Equity Index Series, to include rapidly growing frontier markets. Going forward and through differing market capitalised indices, it will be vital for investors to spread investments globally, diversifying between clearly and objectively defined developed and emerging markets.
The main benefit of indexing is that it provides a low cost way for index fund investors to achieve the returns available in a given market, without worrying about trading individual stocks or positions. As the popularity of index investing has grown, so too has the number of indices. With thousands of ways to ‘slice and dice’ the world of investment, if there is a market or market segment, there is probably at least one index that tracks it.
In the past few years’ creation of newer and more innovative ways to benchmark both existing and new asset classes has become a key priority for index providers.
Just as importantly, the range of products available to investors in addition to tried and tested market capitalised indices, including new themes and strategies and products created off the back of indices has grown considerably, such as the explosion of ETF activity.
Investment strategy indices
Wealth based indices such as the FTSE RAFI Index Series and FTSE GWA Index Series’ have grown significantly in popularity. These indices look at factors such as; dividends, cash flow, net earnings and book value.
As wealth weighted strategies behave differently to market capitalisation-weighted indices, over the longer term they are often believed to outperform. This is because they do not systematically overweight overvalued stocks or underweight undervalued stocks – hence staving off the effects of bubbles.
