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ETFs- Indexes, Indices

ETF Education for the Week of January 12, 2009.
Indexes, Indices- their roles in ETF construction and performance
By: Rick Walter Maduro,
UCS Investment Co.

Description: Our weekly ETF review is an education blog for investors to learn about ETF funds; how to buy or trade them; when to buy or trade them and more. ETFs are a great way to add broad based diversification and liquidity to an otherwise static portfolio and a great way to add stability to your portfolio for the long-term.

Picking up where we left off- our last post was 2/23/2008. Our last topic was Benchmarks. Our next topic is indexes, or indices. An index (a composite figure like the Dow Jones Industrial Average) becomes a benchmark index when you choose it as the standard against which to measure your own portfolio’s performance over time. Indexes provide transparency to your portfolio. You need transparency in these markets.

Again the key to ETFs’ success is the broad based exposure you receive, their ability to trade like a stock, and flexibility. Although being able to benchmark your ETF portfolio against an index is a great thing, there are still inherent weaknesses in this methodology. An ETF may not be better than the index it tracks, for example, the all time criticisms leveled at the DJIA index. Although the DJIA index is one of the most followed indices, it is most criticized for 1) not being a very accurate representation of the overall market performance. 2) for being a price-weighted average rather than float-adjusted market-value weight, which gives relatively higher-priced stocks more influence over the average than their lower-priced counterparts. 3) not accurately reflect the true opening prices of all its components.

Of course, modern day indexes have relatively answered and solved most of these issues. Not getting to technical about indexes, most of them are proprietary tools used by institutions to manage equity, fixed income and multi-asset class portfolios. Indexes are designed to reflect a percentage or total capitalization of stock, bonds, futures and even other indexes in an aggregate which are then used as a measure in predictions of a funds’ performance. You cannot invest directly in an index. The leaders in index design are Dow Jones and Company, Inc., Standard and Poors, Goldman Sachs, and Morgan Stanley and Barra Indices. Remember, not all indexes are created equally.

For a professional consultation on how ETF Funds can help you achieve your financial goals call us for a no cost consultation at 770-572-2715 or email me with your
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