Is it possible to build a better index? A handful of contenders are trying.
With broad indexes usually beating actively managed mutual funds, investors have turned to exchange traded funds, or ETFs, which generally charge low fees and seek to mirror the return of a particular index, as a cheap way to get winning returns. The market for ETFs has boomed in the last 10 years, growing from $1.05 billion in 1995 to $296 billion in 2005, according to the Investment Company Institute, the mutual fund industry’s trade group.
Hopefuls are crowding in with the new indexes they’ve built. They range in size from Capital Markets Index, which bills itself as “the first and only measure of the total value of U.S. capital markets” including “all investment grade U.S. stocks, bonds and money market investments, and the actual asset allocation among them.” The index, which does not yet trade as an ETF, was launched in May on the American Stock Exchange and includes approximately 2,500 securities.
Then there are the fundamental indexes, where two companies are making the biggest push. In capitalization-weighted indexes, like the Standard & Poor’s 500, the greater the company’s market capitalization, the greater its weight in the index. In fundamental indexing, the indexes’ creators come up with another formula, which gives more weight to a company’s financial performance than its stock price.
The emphasis on stock price in most indexes is “how a stock like Google can become the 20th largest position in the S&P 500 even though its current revenue, earnings and book value wouldn’t even place it among America’s top 200 companies,” the July issue of “The No-Load Fund Investor” explained.
In fundamental indexing, the indexes’ creators came up with another formula.
Wisdom Tree Investments, which introduced 20 fundamentally weighted ETFs in June, weights its indexes on stocks’ dividends paid. Its aim is “to passively outperform traditional benchmarks,” said Bruce Lavine, the company’s president and chief operating officer.
The other big player in fundamental indexing is Research Affiliates LLC. Its indexes weight companies according to earnings, revenue, dividends and book value. Book value is a company’s assets minus its liabilities.
Ellen Simon writes for the AP.
