According to recent study from the Index Industry Association, there are over 3.3 million stock market indices worldwide (IIA).
Given that there are 43,192 public firms, as reported by the World Bank, there are more than 70 times as many stock market indices as there are actual stocks listed worldwide.
At first look, the index-mania appears to be caused most obviously by the rising popularity of passive investments.
However, the IIA notes that there are only about 5,000 or so ETFs in existence, which cannot by itself account for the large number of indices.
Instead, active asset managers and their need to compare their performance to an index appear to be driving the expansion of indexes.
“The data reveal that benchmarking is undoubtedly the major usage for indices around the world,” says Rick Redding, chief executive of the IIA. Asset managers and investors desire options when selecting a benchmark that best represents their portfolio and the underlying market because there are more than three million indexes accessible.
Active managers have more options when choosing which benchmark to measure themselves against the more indexes there are. Index providers have taken note of this and have been making changes to indexes to meet demand. Instead of the fund comparing itself to a more widely used index, it is not rare to see funds with “blended benchmarks,” which, for instance, can involve combining two stock market indices.
There’s a strong reason for this, according to Ben Willis of asset management Whitechurch Securities. Managers can “evaluate fund performance against a comparable like-for-like benchmark” by using blended benchmarks.
-How technology can outsmart investors
It is now more crucial than ever to demonstrate relative performance assessed against a benchmark as the fees paid to active managers continue to be impacted by ETF competition.
The cynical viewpoint, according to Willis, is that they are developing these benchmarks in order to demonstrate outperformance.
‘ Managers are able to “create a composite that they think they can beat” by setting their own standard.
“Benchmark invention” by active managers is likely a result of how challenging it has become in recent years to outperform traditional benchmark indices, according to Willis. By employing a composite or blended benchmark, they can shield themselves from criticism for underperformance relative to regular indices and the possibility of asset loss as a result.
Join our newsletter to receive the most recent financial news and investment advice. Additionally, a complimentary print edition of Money Observer magazine will be sent to email subscribers.
