The Science Of Indexing

November 01, 2007

Jim Wiandt

Jim Wiandt

There is no topic as central to indexing as correlation. Correlation gets to the bottom of what index investing is all about, which is diversification. Ultimately, the “science” of indexing is all about correlation, and the subject of correlation benefit is a topic of endless fascination for the indexing crowd. The recent market environment of historically high correlations has made this a real touchstone for debate of late.

So we could think of no better topic to build an issue of JoI around than correlation, and we have got some real humdingers here. Frank Nielsen, executive director and head of Core Equity Research for the Americas at MSCI Barra, submits an article that has its pulse on arguably the hottest topic right now regarding correlation: international small-cap.

Indeed, it's such a hot topic that Frank beat Steven "EAFE is obsolete" Schoenfeld to the punch in submitting the article (Steven had proposed to cover the topic as well). And if Steven is on it, you know it's hotter than a boom box being sold out of the back of a truck. Following Frank's submission, the always-entertaining Professor Israelsen takes a step back and does something that's (somehow) been missing from the literature: quantifying the actual value of building inversely correlated, well-diversified portfolios—particularly for folks entering retirement.

Next up is David Krein, with a very insightful piece on the limitations of using correlation when creating a diversified portfolio, and thoughts about a better approach.

Bringing us home are two quantitative gems in the vicinity of the topic. The brothers Blanchett look at how active managers can lay the best-laid diversification plans to waste through tracking error. They use the efficient frontier as their gauge. Finally, we've got a 130/30 piece that frames this year's institutional investing buzzword in an indexed light, modeling and all.

Topping off what I think is among our strongest issues ever is the transcript of one of the most entertaining panels I have ever participated on. It was the feature panel of the S&P 500's 50th birthday party, and I was honored to moderate a group that included David Blitzer, Jack Bogle, Kathleen Moriarty, Floyd Norris and Bob Shiller. We also have David Blitzer with a column as well … a nice one that looks at risky assets and the recent market turmoil. Bringing us around the bend, The Curmudgeon (more unseemly than curmudgeonly this issue) has an asset class with a correlation benefit (and other benefits) that will scandalize you.

This issue has got some real bite to it. I loved reviewing it. So if you're a real indexing geek like me, kick back and carve out a few hours of quality time with your favorite indexing journal, because you're in for some fun reading.

Jim Wiandt sign

Jim Wiandt


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