The concepts of indexing and trading don’t sit naturally together.
After all, index-based investing has always sold itself as an alternative to active fund management, with the index tortoise beating the hyperactive portfolio manager hare.
If you buy and hold an index fund based on a traditional, capitalisation-weighted benchmark, very low trading activity is what you get. As Konrad Sippel of STOXX, author of one of the articles in the current issue of the Journal of Indexes Europe reminds us, a typical cap-weighted large stock index produces internal index turnover of only a few basis points (hundredths of a percent) a year.
But low activity and indexing are no longer seen as synonyms. For a start, ETFs have transformed index concepts into real-time trading vehicles, and not to everyone’s liking. John Bogle, founder of Vanguard, has railed against what he sees as the corruption of the original idea behind passive fund management. Although Bogle is in an increasingly small minority, his views carry a lot of weight.
And indexing itself has changed. So-called “smart beta” indices are being developed at pace, with many new benchmarks being based on systematic trading strategies that generate internal index turnover of hundreds, even thousands of percent a year.
So indexing and trading, or more specifically the tradeability of the securities underlying an index, are an increasingly important topic for anyone interested in investing in an index-based vehicle, ETF or otherwise. And that’s what the contributors to the September/October Journal of Indexes Europe have addressed.
Konrad Sippel’s examination of the effects of varying levels of turnover in risk control strategy indices provides an excellent illustration of why trading costs need to be factored in when we’re considering a new systematic investment idea. Xiaowei Kang and Daniel Ung of S&P Dow Jones Indices evaluate index tradeability from a broader, cross-asset class perspective.
Russell Indexes’ Gareth Parker surveys a variety of index construction methods from the perspective of trading costs and impact, speed of execution and index capacity, revealing highly diverse results. And Ruben Kersbergen and Christiaan Scholtes of market-making firm Nyenburgh demonstrate the direct relationship between the creation and redemption costs for an exchange-traded fund and the secondary market tradeability of the fund.
There’s food for thought in this latest JoI Europe issue for anyone interested in newer index ideas, trading, and how the costs of investing should be measured. I hope you enjoy reading it.
As a reminder to those of you who are still unfamiliar with the publication, which was launched last year, a print subscription to the Journal of Indexes Europe is free for financial professionals, and available at a modest annual fee to anyone else. You can sign up here. The online version is currently free.