The Index Industry’s Changing Landscape

February 28, 2012

The Index Industrys Changing Landscape

We have reached a turning point in the history of indexes. Their influence on investors and on the markets has expanded greatly in recent decades, as these tools have gone beyond the task of measuring active managers to serving as the foundation for investment strategies. The market for index-based investment strategies, which began in 1975 with the introduction of the first index-based mutual fund by John Bogle and Vanguard, has accelerated and taken on new shape in recent years. Through a number of product innovations over the last decade, index-based investment strategies have emerged as essential building blocks for multi-asset portfolios. For this reason, I believe that indexing is probably at its greatest inflection point since the introduction of the Vanguard Index Trust. Indexes play a more vital role in helping investors invest today than at any point in their history.

Healthy Self-Examination
Indexes are enjoying strong growth as assets rapidly flow into index-based investment vehicles such as exchange-traded funds. It is an exciting time to be an index provider, as investor demand continues to fuel product innovation. However, this growth makes it critically important to consider the tough questions being asked about our industry. It is important to encourage an open dialogue in the interest of index users and take responsibility as stewards of the indexes.

Have indexes gone too far in pushing beyond market-capitalization-based indexes into so-called “strategy” or “alternative beta” approaches? Have index and ETF providers together diced and sliced the market in so many ways that they have lost sight of the original role of the index? Has the relatively recent introduction of ETFs into the equation made it too easy and quick to move money in and out of the markets, producing a product that is of more interest to short-term traders than to long-term investors?

These are all questions that John Bogle has raised in one form or another over the years, and rightly so. A truly healthy industry regularly analyzes the value it brings to clients and asks itself the tough questions to ensure it is taking the right steps to remain healthy in the future. Thanks in large part to the innovation started by John Bogle in 1975, index-based products are alive and well and continue to enjoy great popularity among investors. To continue to thrive going forward, however, I believe index providers must remain focused on innovation while staying true to the core principles of indexing.

From Passive To Active: The New Frontier
Before Russell significantly expanded the spectrum of market-capitalization indexes in 1984, the index industry was significantly smaller than it is today. Indexed assets were still a small proportion of investor portfolios. Institutional investors with specialist equity mandates generally used the S&P 500 in every case. And while the S&P 500 is still a widely used benchmark, the scope and scale of index products has increased exponentially over the last three decades (see Figure 1). In the 1980s and the first half of the1990s, this took the form primarily of product expansion into investment size and style (large-cap, small-cap, growth and value), economic sectors and expanded global markets coverage. Indexes covering fixed income were introduced as well. Mutual funds tracking these indexes were popular and grew quickly, contributing to this expansion.

Total Net Assets: Index Mutual Funds & Index ETFs

 

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