Microsector Index Futures

January 01, 2004

For money managers looking for a more efficient way to realize and communicate their financial goals, current market conditions may invoke a sense of déjà vu from 20 years ago.

By most accounts, the early 1980s were a difficult environment for trading securities. In August 1982 the Dow Jones Industrial Average was down 25%, to 776, from a high of 1000 reached in 1973. The world was questioning the value of holding equities, and money managers were struggling to find a benchmark they could use to accurately report their funds' performances in a clear and digestible manner to customers.

When Congress passed the Shad-Johnson Accord in 1982 it paved the way for the widespread use of equity indexing, which at that time was still in its infancy, and the financial industry was changed forever. Broad-based market indexes began to proliferate, followed by broad-based sector indexes, exchange-traded funds and a whole array of new index-related products. Fund managers had benchmarks to compete against, and investors had a standard to which they could compare their investments' performance.

Now, fast forward to late 2003. The DJIA was struggling to stay above 10,000 after ascending to 11,351 in January of 2000. Though a more educated public may understand that if the markets are all going down their investments must naturally slide with them, money managers are once again looking for ways to better communicate the performance of their investments.

For many financial managers, using a broad-based index as a benchmark does not cut it in today's increasingly sophisticated and specialized investment schemes. Sector indexes are a step in the right direction, but specialized, more flexible instruments would be more effective.

In June 2003 Dow Jones Indexes, the calculator of the DJIA and a whole family of other indexes, began calculating Dow Jones MicroSector IndexesSM (which we'll refer to simply as the MicroSector Indexes), narrow-based security indexes that include five of the largest and most actively traded stocks in an industry sector. Two weeks later, the OneChicago exchange began listing 15 futures on the MicroSector Indexes for trading.

The idea is that futures on these microsector indexes can be inserted in a pyramid of indexing tools, allowing money managers both increased flexibility and more highly correlated benchmarks by which their investment performance can be more accurately measured.*

With each step up in the pyramid of equity products, flexibility increases. The idea of being able to move from one industry, sector, or set of investments to another has grown in popularity. Suddenly, ways to compound gains and reduce losses have grown exponentially.

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