What Lies Beneath

For most investors, an index is a number. The number tells them something about the current state of a market for stocks, bonds or some other instrument, be it foreign or domestic. For those that have invested in an index fund, the change in that number from day to day closely represents the movements of their portfolio.

Not many think much about what it takes to produce that number, and the few that do usually regard the process as a bit murky no matter how clearly stated the index methodology may be. Imaginative folks may envision a troop of grumpy gnomes scribbling with quill pens, feeding their handiwork to awaiting index fairies who deposit the results under the pillows of financial publishers everywhere. In truth, of course, the process involves complex computer systems and endless cycles of research and adjustment. Like an iceberg, the visible part of an index misleads even informed viewers about the immensity - and the importance - of the work that lies beneath the surface.

We'll skip the parts about conceiving an index, developing its methodology, establishing a data and component history, and then launching it onto data screens around the world. That's the "glamour" of indexes, such as it is. After that, the index provider faces a forever of daily monitoring, research and auditing to keep all of its indexes before investors' eyes. If an index provider does not do this job well, its index numbers sooner or later will be wrong, which probably will cost investors some money beyond what the market itself may inflict. In turn, investors will stop using indexes from that provider. This is not a business model the index provider wants to follow. To illustrate the process we will focus on Dow Jones Indexes, where the care and feeding of indexes is primarily in the hands of two groups: index support and production. Every index provider, though, faces similar issues and challenges, which demand enormous investments of resources to handle.

Index Support
The support group is responsible for researching and recording all changes to the components of a stock universe from which hundreds, if not thousands, of indexes have been derived. The group also notifies licensees of these changes in great detail.

Quick Facts: What's at stake...

MSCI estimates that $3 trillion is benchmarked against itsindexes.Figures for how much is indexed directly to its products range from $250 to $600 billion, with most of that allocated to the MSCI EAFE index.

Standard & Poor's says about $1 trillion in assets is indexed to the S&P 500 and about $3 trillion is benchmarked against it.

FTSE Group also claims that $3 trillion is benchmarkedagainst FTSE indexes globally, including $2.5 trillion to the FTSE All-World Index globally, and another $500 billion to other FTSE indexes.

Dow Jones Indexes says about $600 billion in assetstracks the Dow Jones and Dow Jones STOXX indexes worldwide.

Russell places the assets invested in index funds tracking its 21 U.S. indexes at $214 billion as of the end of 2001. Almost half of that - $95 billion - was indexed to the Russell 3000.

Who's on guard...

The S&P 500 is monitored by a seven-member committee, three of whom are full-time analysts dedicated to monitoring the index and its components.

FTSE Group employs 35 full-time analysts. Five are dedicated free-float analysts; five are dedicated index review specialists, while the remaining 25 monitor global corporate actions and market activity

At Dow Jones Indexes, a team of four analysts within the index support group monitors the components of the Dow Jones stock universe, excluding Europe. They, along with seven additional analysts, are also responsible for the periodic index reviews.

The Russell indexes have 11 full-time analysts monitoring corporate activity and share adjustments, and creating daily deliverables.