FIRST, A QUICK PRIMER
WHAT IS AN INDEX?
An index is a basket of securities selected on specific criteria and aims to track a particular investment theme, such as a market, a region, an asset class, sector, industry, or strategy. Generally, the goal is to accurately represent the risk/return profile of that theme.
KEY TERMS
WHY INDEXES?
Markets or individual market sectors can be enormous, including hundreds and even thousands of securities.
Buying all these securities just to access one market or trend can be expensive and time consuming. And it can be ineffective. That approach inevitably would include securities with negligible influence on the portfolio.
Indexes are comprised of only the securities most relevant to their investment theme, allowing you to follow market trends without having to track the entire available universe of securities. Essentially, an index acts as a yardstick, capturing representative exposure to a particular market or sector.
Chances are, if you can imagine it, there’s an index for it. And you can use indexes in a variety of ways:
Assess a given market's performance
Gauge how well an active strategy is working
Serve as the foundation for investment products, such as ETFs or mutual funds
Evaluate a market's risk profile or its diversification benefits
Measure passive risk premia
INDEXES AS THE BASIS FOR
INVESTMENT VEHICLES
Because an index is a hypothetical basket of securities, it cannot be invested in directly. However, indexes are often licensed by fund managers to be used as the basis for passively invested products that track an index, such as:
Let’s say you feel strongly that the large-cap US equity market is going to outperform the small-cap US equity market over the long term. You may seek exposure to only the large-cap US equities market segment then.
Rather than purchasing each US large-cap stock individually, you adopt a passive strategy. You choose an investment product that tracks an index designed to represent precisely just the US large-cap equities market.
CHOOSING PASSIVE
INVESTMENT PRODUCTS
While some investors prefer actively managed investments, which rely on a manager’s stock selection skills, others turn to passively managed investment products for the following reasons:
