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Figure 8
Important Issues When Selecting/Assessing An Index
Do you consider the following characteristics important for selecting and assessing an index?
Full information on the construction
methodology is publicly available
Using objective guidelines
to select constituents
15.1%
82.0%
30.2% 66.2%
Full information on historical
index weights is available
27.3% 62.2%
The index has high liquidity
34.5%
54.7%
Backed by economic and/or
theoretical concepts
The index has a reasonably
low turnover
The index represents
a buy-and-hold strategy
38.1% 44.6%
43.9% 37.4%
35.3% 34.5%
Avoiding any discretionary choices
through, e.g. committee decisions
35.3% 34.5%
0% 20%
40% 60% 80% 100%
Important
Very Important
Source: EDHEC
Note: The above chart depicts the percentages of respondents who think certain construction and management issues are important or very important when selecting and
assessing an index. The questions apply to indexes generally, and thus reflect the basic qualities and characteristics of an index’s construction and management rules deemed
important by respondents.
regarding liquidity and pricing sources similarly received
strong recognition as important issues.
Another implication of the results is that government
bond indexes, generally, may lack sufficient coordination
with investors’ needs. A substantial percentage of respondents
recognized risk-factor instability, with stable duration
exposure appearing to be more important to respondents
than stable credit risk: 63.2 percent of respondents
found duration instability important or very important,
while 57.9 percent found the same for credit risk exposure
instability. Thus, a substantial percentage of investors recognize
the incongruity between investors’ needs and the
unstable risk factor exposures present in government bond
indexes—and the accompanying difficulty in integrating
unpredictable risk into a portfolio.
Inconsistent security selection rules across index
providers received fair attention from investors, with
about 58 percent of respondents considering it important
or very important. Finally, exposition to currency risk
appears to be a major issue for only about 40 percent of
respondents. These findings also suggest that the issues
associated with government bond indexes are very different
from those with equity indexes (Figure 5).
A similar assessment was conducted with corporate
bond indexes, with liquidity and the instability of risk-factor
exposure emerging as important issues. As Figure 7 illustrates,
overinvestment in risky bonds is evidently a crucial
concern held by investors, and although the distinction
may be less profound in light of the current sovereign credit
crisis, corporate bond indexes were perceived as more susceptible
to the “bums problem” than their sovereign counterparts.
Similar views on the importance of credit risk with
corporate bond indexes are reflected in the large percentage
of respondents (71.4 percent) who view the instability of
credit risk exposure as important or very important.
It is evident that there are problems that are recognized
by investors, and there has been a very recent, rapid
trend in indexing development; further changes will likely
come as indexing innovation matures. Thus, it is also
important to analyze perceptions on index properties and
construction methodologies, which will both guide and
constrain index development in the future.
Basic Quality Requirements:
What Indexes Need To Deliver
As a result of the sheer variety of new index offerings
and the lack of clarity of market participants on the meaning
of key terms and concepts such as “active” vs. “passive”
management and “beta” vs. “alpha,” the current
framework for analyzing indexes is convoluted, leaving
some investors clinging to familiar standard indexes as a
response. One of the key revelations of our survey was the
elucidation of the qualities of indexes deemed most important
by users. Fifteen questions related to various characteristics,
rules, and general construction and rebalancing
methods were asked. Most notable were the responses to
March / April 2013
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