28 November 2020

Understanding the Role of Indexes in Today’s Markets

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Help your clients understand indexes and the ETFs that track them

As the global ETF market continues to grow, the number and variety of available indexes is also expanding. As investor appetite for index-based strategies swells, financial advisors can add value by helping clients better understand indexes and the investment products that offer access to them.

Recent research conducted by Credo Consulting on behalf of the Canadian ETF Association (CETFA) found that ETF investors are more financially literate than other investors. Specifically, they “scrutinize their investments,” “value transparency” and “are much more likely to get advice.” Importantly, they are also “more prone to leave an advisor if they do not feel they’re getting what they need.”

For advisors, this provides a business opportunity to offer clarity and valuable knowledge around indexes and the investments that track them.

A rich history

Market indexes have been around for decades and have been evolving ever since. In 1896, Charles Dow developed what is now known as the Dow Jones Industrial Average. In 1926, the Standard Statistics Company (predecessor to S&P Global) launched the 90-Stock Composite Price Index. The FTSE Canada Universe Bond Index was introduced nearly 40 years ago.

The world’s first exchange-traded, index-linked investment vehicle — the Toronto 35 Index Participation Units — launched in 1990 on the Toronto Stock Exchange. The ETF industry recently celebrated its 30th anniversary.

Historically, market indexes in Canada have been mainly the “plain vanilla” variety, designed to benchmark the major equity and fixed-income markets for retail products such as mutual funds and ETFs. But more recently, the world of indexing has shifted significantly to include a vast array of approaches that provide investors — both retail and institutional — exposure to specific portions of the market.

The Index Industry Association, a New York-based trade association for index providers, now reports that there are 2.96 million indexes worldwide, as at October 2019, with fixed-income indexes growing the most (7.15%) from the previous year.

Innovation galore

Increased interest in exchange-traded products over the last decade has stimulated innovation in indexing. New indexes have been developed to meet the needs of investors and ETF providers and the offerings continue to evolve and grow.

These include niche indexes covering geography, sector and different investment themes. For example, indexes that track ESG-related sustainable investments have grown dramatically in popularity. Other thematic indexes that have cropped up recently include marijuana, eSports and liquid alternatives.

Other market themes covered by indexes include factor-based concepts, such as momentum or low-volatility, and alternative weighting indexes, such as equal-weighted indexes or dividend-weighted.

ETF providers seek indexes that best suit their requirements. According to Vanguard Canada, choosing the right benchmark for their ETF products is a vital part of the process: “Index providers’ methodologies vary, so two benchmarks tracking the same market segment may deliver very different results. We believe that selecting an appropriate benchmark is crucial to providing a best-in-class ETF.”

With such a range of indexing options available to investors, advisors have a unique opportunity to expand their knowledge in order to utilize the most appropriate tools to meet their clients’ needs.

Staying ahead of the curve

Canadian-listed ETFs surpassed $200 billion in assets last year, clearing $204.8 billion before the New Year’s Eve countdown was complete. It was an historic milestone, absolutely, but less so because of the assets and more because of how quickly they accumulated. It took 26 years (from the 1990 launch of that first ETF in Toronto) to reach the $100 billion mark in May 2016. But the next $100 billion took just a little over three years. In that same time period (May 2016 to December 2019), ETFs share of total investment fund assets in Canada jumped from 7.3% to 11.2%.

With investor demand for ETFs showing no signs of slowing and Canadians more educated about the role indexing plays in their portfolios, advisors can differentiate themselves in the marketplace by better meeting the demands their clients — especially where new and innovative index-based strategies are concerned.

Steve Hawkins is chair of the Canadian ETF Association (CETFA) and CEO of Horizons ETFs Management (Canada) Inc.

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