SPECIAL REPORT: SHARE INDICES
fundamental indices are simply broad market indices with a tilt, and you could argue that they are really an active management product disguised as beta,” says Daniel.
FURTHER EVOLUTION Many ESG-related indices are being created – albeit establishing what is and is not a ‘sustainable’ or ‘responsible’ company remains extremely objective – as are other bespoke indices to match the growing number of bespoke ETFs. Mark Northway, however, says
that innovation should be around the investor experience, with the focus on removing inefficiencies that index users can suffer due to the way ETFs operate at present. So far, changing client demand, new
sources of risk and return, and changing markets have all contributed to the evolution of indices, with institutional clients increasingly seeking new thematic indices and retail investors increasingly engaging in direct indexing. Direct indexing involves an investor
buying each stock of an index – such as the FTSE 100 – within a taxable account rather than buying a fund that holds them. What this allows investors to do is to engage in tax-loss harvesting, which involves selling positions that are down, ‘harvesting’ or recognising those losses, and then using those to offset capital gains from other positions. David Sol adds that regardless of the
evolution within indices, all his company’s more than one million indices are rule-based, providing a systematic way to construct a theoretical investment strategy that people can pursue.
// ABOVE ALL, TRANSPARENCY IS KEY //
“As an analogy, we are in the business
of making recipes, as these tell you which ingredients to add, in which order, and how high to heat them,” he said. “Anyone following the recipe ends
up with the same dish – they know the price of the constituents in the index, which companies are in the index, and their weight.” As the evolution of indices continues,
though, there could be some challenges to overcome.
CISI.ORG/REVIEW
OPERATIONAL HURDLES Gareth Parker believes index providers will need better technology to handle increased amounts of data as indices become more specialised and thematic. The ability to handle data from various sources will be key, he says. Elsewhere, if direct indexing continues
to rise in popularity, an operational imperative could arise whereby index providers deal more directly with platforms or custodians. Mark Northway says he can envision
ETF providers being removed from the equation if direct indexing becomes more popular, with platforms potentially able to offer direct indexing in some form of tax wrapper. Steve Kowal adds that direct
indexing in the US is becoming more popular because of ‘tax-loss harvesting’, which, as previously mentioned, is where investors offset tax gains from successful investments with tax losses from unsuccessful ones. One challenge is that direct indexing puts the onus on the adviser or wealth manager to monitor the selection of individual investments made by their clients. “It is not a free lunch and comes at a
cost,” Steve said. “If you want the MSCI World Leaders, you can probably get that for 20 basis points, but if you want a personalised version, then you’ll pay more, possibly more than double.” Direct indexing is also more popular
in the US because of the number of self-investment platforms with commission-free trading, something that is less ubiquitous in Europe. Regardless of how indices develop from
here, one overarching factor will always be a vital consideration: regulation. As the aforementioned consultation
by the SEC suggests, regulators around the globe will be keen to ensure that consumers are fully aware of the risks associated with new types f indexing or emerging asset classes. With around 180 countries having some form of regulatory framework for their respective financial services industries, there is perhaps an argument for a greater level of global coordination. Above all, transparency is key.
Investors need to know exactly what they are putting their money into, so they can best assess the risks and weigh them up against the potential rewards.
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