FiduciaryNews

Michael Krause of AltaVista Research Explains the Evolution of Indexing

November 17
00:11 2009

The typical ERISA fiduciary strives to reduce personal fiduciary liability. Often, education represents the best path to accomplish this goal. Among the many items the fiduciary must learn, the most difficult might be the ever evolving terminology surrounding the investment industry. Perhaps the word “index” stands out as one term worth looking at.

348329_7573_men_walking_evolution_royalty_free_stock_xchng_300Michael Krause, president of AltaVista Research, recently offered his take on what he called “the evolution of indexing” during the annual Art of Indexing Summit held at the New York Helmsley Hotel last month. He presented a fascinating historical review of indexes through the decades. Fiduciary News summarizes his time line below (and adds a bonus for those who read to the end):

Dow Jones Industrial Average (1896)Index as an indicator of investor sentiment – Charles Dow initially created an index in an attempt to determine the strength of the industrial sector of the American economy. Over time, it became apparent moves in the Dow reflect not merely economic fundamentals but outside factors such as internal socio-political proceedings as well as international events.

Standard & Poor’s 500 (1957)Index as a cap-weighting, broad market measure – Many felt the Dow, consisting of only 30 stocks, represented too narrow a slice of the American economy to truly represent the national market. Standard & Poor’s, after decades of using a smaller (90 stock) index, initiated the 500 stock index on March 4, 1957. Like the Dow 30, a committee determines the make-up of the S&P 500. The Conference Board includes the S&P 500 among its ten indicators on the Leading Economic Index.

MSCI EAFE (1970)Index as a measure of international investing – On December 31, 1969, Capital International (“CI”) formed an index to track international markets. Morgan Stanley (MS) bought the data in 1986. Also referred to as simply as “the EAFE Index” (as in “Europe – Australia – Far East”), the index became the S&P 500 of the global market.

Vanguard (1976)Index as an investment – This now oft-told tale marries the blackboard of academia with the board room of high finance and – voila! – we witness the birth of a new product. Today, this simple idea represents a trillion dollar industry.

ETFs (2000s)Index as a way to realize alpha – somewhere between pure passive index investing and active portfolio management emerged the concept of active allocation to beat the benchmark. Krause maintains we’ve only put our first foot into this new realm. Just as the index industry has become a dominant player in the financial services sector, so, too, he asserts, will advisers be able to leverage ETF’s transparency to add value through active allocation.

Krause might consider adding the following:

Russell Indexes (1984)Index as an investment benchmark –Russell introduces the broad market Russell 3000 and its two components, the large-cap Russell 1000 and the small-cap Russell 2000. According to a 2008 Russell report, “over 63% of all products and more than half of all U.S. equity assets use a Russell Index.”

If this timeline tells us anything regarding the evolution of indexing, it tells us today’s budding index products “are not your father’s” index.

About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

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