Koenig: Know What’s In Your Index

December 05, 2013

Knowing what’s under the hood has never been so important.

An index is an index, right?

Clearly, that’s not correct. Indexes are not all created equally. And no two indexes are alike. Indexes that target the same objective or asset class can take very different construction approaches. And these differences in methodology can lead to very different exposures and performance characteristics.

In evaluating and selecting investment managers for client portfolios, financial professionals typically conduct significant due diligence into a manager’s philosophy, process, people and performance—commonly known as the four P’s.

When it comes to index-based strategies, however, investors sometimes spend time examining the characteristics of the end investment product, but might put less rigor into understanding how the underlying index is constructed. Although it is of course critical to have clear insight into the end investment product, it’s equally important to understand how the index is built.

Simply knowing that the investment product is a small-cap value fund or a low-volatility fund is not enough. But where can investors look for education about their indexes? With thousands of indexes in the marketplace, it can sometimes be challenging to know exactly where to find the best information. Investors have numerous resources accessible to them and should look to the index methodology document on the index provider’s website, the fund prospectus, fact sheets and other materials.

Here are some tips for educating yourself on indexes:

  • Index methodology document: Index providers typically publish detailed methodology documents on their websites.
  • Fact sheets and other materials: Most index provider and fund provider websites also include fact sheets, research papers and other materials that include overviews of index construction, historical performance, fundamental characteristics and other information.
  • Fund prospectus: All fund providers’ websites include a fund’s prospectus with information about the benchmark. Taking a few minutes to read the prospectus is an important step in understanding the index and the fund.
  • Webinars: Index providers and others offer educational webinars that provide insight into index construction and how index-based investments can fit into an investor’s portfolio.
  • Independent research: IndexUniverse, Morningstar and others publish a wide body of materials about indexes and hold conferences and other educational events where investors can gather information and have the opportunity to ask questions.
  • Telephone: Don’t forget that index and fund providers are only a phone call away and welcome the opportunity to answer any of your questions.



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