December 7, 2010

Super Bowl of Indexing Conferees Debate Strategy Indexes

Innovative indexes can help investors lower volatility and improve investment quality

Representatives of Dow Jones, MSCI, Russell and Standard & Poor’s and other industry players on Tuesday shared the roundtable at the second day of the Super Bowl of Indexing conference held in Phoenix. At the center of the debate was the proliferation of strategy indexes versus plain vanilla market indexes and their place in portfolio management.

“The largest holdings in the typical bond index are from companies or countries most deeply in debt,” said Robert Arnott, chairman and founder of Research Affiliates. “Who would ever want to have Ireland or Greece’s bonds as their largest positions?” One way to get around this, according to Arnott, could be by weighting bonds according to GDP and other blended financial factors rather than by the party that has issued the most debt. This strategy could help financial advisors to build bond exposure with lower volatility and higher quality debt investments.

This kind of index innovation has been a hallmark of the industry. “Index providers have sometimes been ahead of the curve — especially with commodities,” said John Prestbo, editor and executive director at Dow Jones Indexes. In 1998, Prestbo noted, his company launched a diversified commodities index when oil was at a lowly price of $10 per barrel. “While floor traders were reading comic books and hoping for a drought we were there.” Today, commodities have gained more recognition as an important asset class that deserves a place inside an investment portfolio.

Conferees also revisited the debate between actively managed versus passive investing. Market outperformance is often the result of increased risk and there’s little consistency in top performance, observed Richard Ferri, president of Portfolio Solutions and author of the Power of Passive Investing (Wiley 2010). As such, using a low-cost ETF portfolio can help investors to work around these problems. “It’s possible to outperform the market; it’s just not probable.”

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