[This article appears in our March 2021 issue of ETF Report.]
Indexing started in journalism as a way for newspaper editors to give readers a snapshot of the market’s performance, starting with the Dow Jones Transportation Average in 1884.
Active managers used them as a measuring stick for their success or failures, but they were never considered money-makers. The birth of modern finance gave academic underpinning to the idea that indexes could be a proxy for a market portfolio, explains Aye Soe, global head of product management for S&P Dow Jones Indices.
The first index-tracking product available to individual investors was the now-called Vanguard 500 Index mutual fund in 1976. Rich Powers, head of ETF and index product management at Vanguard, says that the asset manager was “more or less a lone wolf” since very few fund houses offered index funds.
It wasn’t until the 1990s that exchange-traded funds arrived on the scene, with the SDPR S&P 500 Trust ETF (SPY) the first. “Investors know exactly what they’re getting in an ETF, and with that evolution, the index basically becomes the portfolio,” said Sean Wasserman, vice president, global head of index and advisor solutions at Nasdaq.
ETFs and indexes took off in the 2000s, Soe said, “when people realized you can access a lot more strategies and themes than just broad-based market portfolios.”
Now indexes are an industry unto themselves, and they’re key to ETFs because their methodology dictates the selection and weighting an ETF may attempt to track. Roughly 80% of the existing 2,400-plus U.S.-listed ETFs track indexes. Following are rundowns on four of the top index providers.
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S&P Dow Jones Indices
S&P Dow Jones Indices is the world’s largest provider of financial market indexes, and its most important index is the most widely followed one, the S&P 500. According to the firm, there’s more than $11.2 trillion indexed or benchmarked to the index, with $4.6 trillion of it passively managed.
There are 14 U.S.-listed ETFs that follow the S&P 500 Index, and SPY remains the biggest by assets under management. Total ETF assets following the S&P 500 are around $760 billion.
The S&P 500 launched in 1957, and is one of the few indexes wherein components are decided by committee, rather than rules. The S&P 500 committee uses eight criteria for eligibility, including market cap, liquidity and being based in the U.S.
Over the years, S&P has gathered other well-known indexes under its umbrella, including the Dow Jones indexes, which includes a commodities franchise with the S&P GSCI, as well as the Dow Jones Industrial Average, the S&P 500 VIX volatility indexes, several fixed income indexes and multi-asset indexes. The company states more than one-quarter of all ETFs are linked to an S&P Dow Jones Index.
“We’ve really grown to where we have a footprint in almost every asset class,” Soe said.
Soe says they’ve seen greater interest in their S&P 500 equal-weight index, as represented by the Invesco S&P 500 Equal Weight ETF (RSP), especially as discussion around midcap and small cap indexes grows after years of the market-cap-weighted indexes dominating investing.
Most of the major indexes are focused on large cap stocks, but the Russell family of indexes was launched in 1984 to measure U.S. market segments. The Russell 3000 is the broad-market index and includes the popular Russell 2000 small cap index. FTSE acquired Russell in 2014.
There are nine ETFs following the Russell 2000 Index, with total assets reaching $70 billion. The largest by AUM is the iShares Russell 2000 ETF (IWM).
Ken O’Keeffe, global head of ETFs, says the Russell indexes were historically used for a better understanding of the small cap space versus the large cap, as well as value and growth. The FTSE 100 gives a view of how U.K. equities differ from the U.S., since it represents the 100 biggest market-cap companies listed in London. There’s about $16 trillion benchmarked to FTSE Russell indexes, O’Keeffe says, with ETFs making up about $860 billion of that total.
He says the index provider is looking now toward working with clients to create indexes that meet their specific needs: “The days of licensing the Russell 1000, 2000, 3000, FTSE emerging and developed [indexes] is pretty much all done.”
Some of those indexes include environmental, social and governance indexes, including one for Vanguard that’s part of the FTSE Global Choice Index Series, as well as fixed income indexes for Goldman Sachs, such as the FTSE Goldman Sachs Investment Grade Corporate Bond Index, which underlies a $770 million ETF.
“There’s a greater demand for ways to meet a slightly different investment outcome,” O’Keeffe said. “Where we’re helpful to clients is helping them understand what makes an index more investable.”
The Nasdaq Composite debuted in 1971 as the first electronic stock market, as a way to showcase the performance of the overall market. In 1985, the Nasdaq-100 was launched as a growth index containing the 100 largest nonfinancial U.S. companies listed on the exchange.
The biggest ETF that tracks the Nasdaq-100, the Invesco QQQ Trust (QQQ), was originally created by the exchange in 1999, after seeing the success of SPY, Wasserman notes. With the advent of ETFs, the exchange saw how the vehicles could provide investors exposure to Nasdaq’s listed companies.
Given that QQQ debuted in 1999 as the dot-com era dawned, ETFs “really catapulted us into space,” Wasserman says, by getting the brand wider exposure at a time when investor demand for technology stocks was strong.
There are now nine ETFs tracking the Nasdaq-100, with total assets under management around $169 billion.
“The Nasdaq-100 provides that unique blend of U.S. large cap growth heavily tilted toward technology, which is really capturing the essence of the overall U.S. economy,” Wasserman explained.
He notes one area where Nasdaq sees new developments is in the options space: “We’re just scratching the surface in terms of investor adoption of the options-based strategies on the Nasdaq-100.”
MSCI is best known for its international indexes, which started in 1969 with the MSCI World Index. Raman Aylur Subramanian, head of equity solutions research for Americas and EMEA at MSCI, says with the creation of modern portfolio theory in the 1950s, the capital asset pricing model in the 1960s, and a general idea about market portfolios, some sophisticated investors were interested in looking beyond their home market to invest in Europe and other regions.
In the late 1960s, the World Index was the only non-North American developed-market index accessible to investors, and the accessibility philosophy carries through today. “As we build an index as a benchmark, we want to ensure that countries or stocks are both investable and accessible,” Subramanian said.
MSCI indexes followed the opening of global markets, he says, including the emerging markets in 1987, while the All-Country World Index launched in 1995. Until then, there was no index that included all countries, including emerging markets.
Subramanian says the ACWI IMI Index is the most prominent index for investors, as it acts as a performance benchmark for many of the institutional investors.
There’s now $12 trillion in AUM benchmarked to MSCI indexes, with more than 1,300 equity ETFs based on MSCI indexes. Some of the biggest international ETFs use MSCI indexes, particularly the iShares brand, including the $15 billion iShares MSCI ACWI ETF (ACWI).
The fastest growth they are seeing is in the MSCI ESG and climate indexes, which Subramanian says is one of the biggest shifts he’s seen in investor behavior: “What we’re seeing is investors saying, ‘I want to capture market beta, but I want to capture the ‘good’ side of market beta, rather than the ‘bad’ side.”