Evolving Index Landscape

Technology and ETFs have transformed indexes.

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Reviewed by: Heather Bell
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Edited by: Heather Bell

[This article appears in our March 2021 issue of ETF Report.]

 

Fresh out of college, I landed in the index world in 1998 with an editorial assistant job at Dow Jones Indexes. On my first day, I was informed that it was quite difficult to make money providing indexes unless you were S&P or MSCI.

While there were a handful of ETFs available at the time, index investing was still looked at sideways by most of the investment world. It’s doubtful Wall Street pundits fully realized the scope of the investing revolution that was coming at them.

I left the index and ETF space for a few years in the early 2000s to take an editorial role with Lehman Brothers. I returned to the index industry via ETF.com’s precursor, IndexUniverse, about a year before the Great Financial Crisis. To say the least, I found myself in a very different world.

ETFs then numbered in the hundreds; index-based investing was rapidly amassing credibility; and John Bogle was no longer viewed as a fringe agitator, but a living, breathing prophet. The ETF buzz was akin to the sound of bitcoin today.

Not too long after officially joining IndexUniverse, I witnessed the launch of the first-ever active ETFs. It’s been a wildly evolving ride ever since.

Inextricably Linked
Make no mistake: ETFs are why the indexing industry is now thriving. In 20 years, we’ve gone from benchmarks covering broad core asset classes, to indexes covering thematic niches of the equity markets and incorporating artificial intelligence into their methodologies.

Technology has been a key driver. Cheaper storage and faster computers have also played huge roles in the proliferation of indexes. With the lower costs and the better tech, it’s simpler than it’s ever been to create and maintain an index at the rapid speeds required.

But that doesn’t mean the field is wide open to all comers. Indexes are also far more complex than they’ve ever been, and expertise is more important than ever.

Despite the exponential increase in choices in the ETF industry, and growing innovation in the active space, the lion’s share of assets has predominantly flowed not into the shiny new products, but the tested, the plain vanilla and the most basic. All of the top 10 ETFs for inflows in 2020 were plain vanilla products and pulled in a combined $173 billion.

Changing Trend?
Maybe that overall trend is changing, as we see the rapid rise of actively managed ETFs like ARK Investment’s asset magnets, but for the first nearly 30 years of ETFs’ existence, it was the most boring index-based funds that saw the greatest investor dollars.

Even today, there are only four actively managed ETFs among the top 100 ETFs by assets. Two of them are issued by ARK, the $13 billion ARK Genomic Revolution ETF (ARKG) and the $28 billion ARK Innovation ETF (ARKK).

And as for the passively managed ETFs in the top 100, almost all are cap-weighted, with the exception of the Invesco S&P 500 Equal Weight ETF (RSP) and the Invesco QQQ Trust (QQQ), which uses modified cap weighting.

No matter how well the ARK funds or any of the new active players do in the near future, it’s going to be tough to move the needle. Plain vanilla index strategies in the ETF space aren’t going anywhere, even if they might lose a little ground to active management or more complex benchmarks.

Add to that the new investment spaces emerging in the ETF universe all the time—SPACs are the latest example—and the demand for new indexes is going to be steady.

Just look at what’s happening with ARK’s strategies. The ETF issuer’s embrace of (and success around) disruptive technology has been followed by any number of index strategies aimed at trying to capture the same space and similar performance success. Active can beget more indexing, not eliminate it.

The index revolution doesn’t look like it’s ending anytime soon.

Heather Bell is a former managing editor of etf.com. She has also held editorial positions at Dow Jones Indexes and Lehman Brothers. Bell is a graduate of Dartmouth college and resides in the Denver area with her two dogs.