Evaluating Index Tradeability: A Brief Cross-Asset Class Review
Journal of Indexes Europe, September/October 2012
11 Pages Posted: 6 Oct 2012
Date Written: October 5, 2012
When the first equity index, the Dow Jones Industrial Average, was brought to market in 1896, it consisted of only twelve stocks and was merely an approximate gauge to the performance of the US stock market. Much has evolved since then; today the market abounds with indices covering almost all segments of the global equity and fixed income markets – including frontier markets, micro-capitalisation stocks and emerging market local currency debts. More importantly, indices are no longer simply benchmarks, used only for performance measurement but now often serve as the basis for index-linked investments, giving investors access to diverse strategies at a low cost.
The broad application of indices stretches far beyond traditional asset classes, such as equities and fixed income, to include alternative investments. For instance, the launch in 1991 of the first tradeable futures-based commodity index – the GSCI – has provided an efficient means of obtaining diversified exposure to this asset class. It has also facilitated the opening up of this once niche market to mainstream investors. A more recent example is volatility, where the role of indices has been instrumental in increasing trading volume. Indeed, despite being a widely monitored indicator, the Chicago Board Options Exchange Volatility Index (VIX) – often referred to as the fear index – was once not tradeable. However, the launch of VIX futures in 2004, and the subsequent development of VIX futures indices and exchange-traded products have made volatility products accessible to a broader range of market participants.
In order for an index to be transformed from a passive benchmark to an active investment tool, it must be tradeable. The tradeability of an index ultimately relies upon its widespread adoption in the marketplace, and its construction requires the meticulous balancing of often competing factors, which inevitably lead to trade-offs. This article assesses the tradeability of indices across different asset classes, with a particular focus on index construction.
Keywords: index, investable index, equities, commodities, fixed income, volatility, cross asset class, trade-off, index construction, VIX
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