![]() ESG indices all have their own definitions on what that means and the restrictions they impose. Beyond what the index name implies, are there other important index restrictions? Some are restricted by asset-type, thus excluding whole segments like REITs or BDCs.When the evaluation occurs, what's the impact on the components? When the Russell 2000 was reconfigured in June 2021, 271 stocks joined and 323 left the index.Most that use selection rules will go through the process as often as quarterly but never less than annually. How often is the index evaluated or rebalanced? Even committee-determined indices are usually reviewed on a time table.How are the components in the index weighted? While market-cap is the most popular, equal-weighted ETFs are becoming more available.Others have detailed selection rules they follow. What are the rules for a stock entering or leaving the index? Some, like the DJIA and S&P ones have committees that make the final call.With so many to pick from, here are some questions to answer when doing due diligence on the index: There are broad indices like those discussed here, down to sub-industry ones. There are over 5,000 (that's not a typo) indices based on some part of the US equity or fixed income markets. With over 7,600 ETFs worldwide, investors can invest passively while simultaneously being an active investor by their choice of which sector, asset-size, geographic, or niche index-based ETF they pick.With an index-based fund, you know what you own and should expect low turnover in the stocks within that index.For funds investing using the same index, the lowest fee one will always "win". By definition, an index-based fund will underperform its benchmark by the fees charged.That is a risk non-index funds should not experience. When the Asia Crises hit in the late 1990s, several Emerging Market funds, over-weighted in those countries, took large hits and trailed their benchmark for years afterwards. Active managers, when "swinging for the fences" to enhance performance, could start "striking out" big time.That said, some funds have market-beating track records. While active managers might beat their benchmark, it is hard to do in every market climate.Here are some common thoughts on this topic: When I worked for a pension manager, they moved from passive strategies to active ones based on factors that indicated that Alpha was available by taking on the added risk of going "active". Of course, the ability to "beat the benchmark" varies according to the market. With data showing up to 80% of funds failing to beat their benchmark, having at least part of your portfolio on auto-piloted index-based funds seems to make sense. Active or Passive Investing: Which is better?īefore we get to the index comparison, the above question should be addressed. If asked, I would give a Bullish rating to Index Analysis/Review. ![]() Knowing the risks your index-based ETFs have because of the market exposure is more critical now to understand and evaluate. It has been a year since they have seen a 10% correction. US equities largest drawdown in 2021 is around 4%. One purpose of this article is to cover why every investor should be also doing due diligence on the index too.Įquity markets are at record levels. If so, that is a potentially critical oversight as the fund's prospectus probably just mentions the index used without going into the details of how it is built or maintained. While most investors probably read a fund's factsheet and visit its home page, much fewer probably do the same for the underlying index if there is one. Today, it is common to start an index after Backtesting the concept and launching an ETF based on that index. While some MFs started being passively managed as early as 1973, it wasn't until the 1990s when ETFs took off that there were funds available that actually invested based on an index. While not tied to any index, most measured their success against the S&P 500 index if they invested in US equities. That means the managers have the discretion to pick any stock covered by their mandate, which originally was usually the entire market asset class. For investors, indices take on greater meaning if they invest in Mutual Funds (MFs), Closed-End Funds (CEFs) or Exchange-Traded Funds (ETFs). Klenger/iStock via Getty Images IntroductionĪnyone who watches the Nightly News hears about how the market did based on how the Dow Jones or S&P 500 index did that day.
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