State Of The Index Investing Union
So I reached out to Rick Redding, CEO of the Index Industry Association, an industry group that pays attention to this kind of thing.
ETF.com: What do you see as the definition of an index today? Is it the same as it was 20 years ago?
Rick Redding: An index is still an index.
ETF.com: Is index investing a different animal than it was 20 years ago?
Redding: It’s gotten a lot more difficult to define what that means. A lot of it has to do with the growth of the ETF industry. By definition, to have an ETF, you have to have an underlying index. We've kind of gone from a world where it was pretty much a market-cap weighting, or you would have something like the Dow, but it was pretty simple what an index fund was.
Now, almost anything that's put into an ETF, by definition, has to have an index created for it. Active and passive doesn't make that much sense anymore. It's become rules-based investing versus active investing.
Rules-based is just more transparent. That's why I'm using the term “rules-based,” because in order for it to be out there, it has to establish rules that are transparent for people to see, whereas in the active days, you or I could claim to be a value manager, and “value” is kind of what we perceive value to be.
ETF.com: What are some of the pitfalls with factors, academically proven or not, as the index engine?
Redding: Companies are getting harder to put in categories. For example, take GE leaving the Dow and the recent GICS sector change around communications. When you think of the communication sector, you think AT&T and Verizon, but that's not all that's in the box anymore. How do you classify some of these more digital companies that touch on so many areas? They have content, technology.
It’s becoming a lot more difficult to put them in these boxes that we've had historically. Thinking long term, looking at it in a different way and classifying companies a different way will ultimately lead to a whole bunch of different types of indexes and investable products in the long run.
My Conclusion
Who in the industry hasn’t been at an ETF conferences where “education” is stressed over and over, but then the industry turns around and keeps morphing old definitions—indexing—into new animals, or creating new terms like “smart beta,” as opposed to the dumb old thing you have?
Redding’s definition of “rules-based,” as opposed to the sheep’s clothing of “passive,” should be high on the education agendas at ETF conferences. From there, you can dive into the passive or active examination.
Retail investors are not easily fooled. They’ve learned from the financial crisis that owning the market is OK; beating it is hard. The learning curve for them is that indexing can be both.
Drew Voros is Editor-in-Chief of ETF.com; he can be reached at dvoros[email protected]
