What Is An INDEX? by dqr Aug 5, 2018 Academy, Crypto Trading. De nition

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1 U a What Is An INDEX? by dqr Aug 5, 2018 Academy, Crypto Trading De nition When examining the speci c topic of investments and portfolio management, an INDEX is a carefully selected sample from a larger group of stocks within a portfolio. As the sample stocks within a speci c portfolio either increase or decrease in value, there should be a direct correlation to the amount of up or down movement within the index as a whole. An index is made up of the following components: Composition: The sample of stocks that have been chosen for inclusion in the index. Weightings: How much of each stock or category of investment is contained within the sample group. Weightings are generally broken down into one of 3 types. Capitalization-weighted: Based on the individual stock price which is then multiplied by the amount of stock that is still available for purchase. This is 1/6

2 the most common of the index types and the one that is cited most often in reports and future predictions. Equally-weighted: No matter the size of the stock that is held in this grouping, all of the stocks in these indexes are given an equal amount of weight or importance Price-weighted: The higher the price of a stock, the more weight or value is assigned to it when doing assessments. Having the weight be in uenced by the price also means that a small shift in a more expensive stock has a greater overall impact than a small shift in a less expensive stock. Background History When investors and portfolio managers need a way to assess a category or classi cation of investment products, they turn to an index such as the ones noted below. The historic Dow Jones Industrial Average (DJIA), founded in the late 1800s, continues to be a valid means of tracking the performance of the 30 premium assets in that particular portfolio but whereas the DJIA uses price-based weighting to determine the value of each individual asset, most contemporary indexes use a market capitalisation method to determine the value. Other indexes in the U.S. include the more diversi ed Standard and Poor s 500, the Wilshire 5000 Total Market Index (only monitoring 3,618 listings at present instead of 5,000), the Nasdaq Composite Index, and the Russell 2000 Index. Beyond the indexes that relate to the New York Stock Exchange, there are thousands of indexes in other parts of the world that monitor the performance of investments in their particular region. Broken down by region, the larger and more in uential include: London Stock Exchange: FTSE 100 Frankfurt Stock Exchange: DAX Paris Bourse: CAC 40 Hong Kong Exchange: Hang Seng Tokyo Stock Exchange: Nikkei Toronto Stock Exchange: S&P/TSX Composite The Impact of Covariance and Correlation Covariance is a way of measuring how much or in what direction two variables are moving. As applied to an index or a stock portfolio, the variables refer to the individual assets within the portfolio or index. Correlation is a statistical measurement of the movement of two variables over a speci ed period of time. Used together, both covariance and correlation explain whether a variable is either positively related (moving in the same direction) or negatively/inversely related (moving in an opposite 2/6

3 direction. How much the variables move in the same direction is measured by the degree of correlation. Portfolio Optimisation Portfolio optimization maximizing return on a given sample of stocks can be achieved by combing speci c stocks according to their variance or level of risk. The Sharpe Index otherwise known as the reward-to-variability ratio was created by William Sharpe in 1966 as a way of analyzing the performance of mutual funds. Diversifying a portfolio can reduce risk since your assets are not all comprised of the same or too-similar stocks. The Sharpe Index notes that overall portfolio risk can be decreased by increasing the number of assets with a negative covariance. However, it is also essential to determine the strength that exists between the assets through their correlation. Another investment strategy is the employment of the MPT or Modern Portfolio Theory. The risk can be lessened on certain individual stocks or funds through a planned diversi cation. This approach lowers overall portfolio risk by balancing high-risk elements against low-risk elements. A further enhancement of the MPT is the Tactical Asset Allocation. In this strategy, a mix of stocks, bonds, and cash are held in the portfolio and adjusted as needed according to market conditions that may appear in an index that is being tracked. The Importance of Bogle and Vanguard on Index Funds After growing up in a household that had been profoundly impacted by the Great Depression, Jack Bogle went on to attend Princeton University and graduate in the early 1950s with an honors degree in economics. A pioneer in the index fund movement, Bogle believed that it was important for everyone, not just those from the upper classes, to be able to invest for the future. Bogle founded the Vanguard Group in the 1970s. The introduction of the Vanguard 500 mutual fund in 1976 helped to ful ll his dream of lower cost investment options that were open to all. Bogle may now be in his late-80s and retired from his position as CEO of Vanguard, but his advice continues to be sought out for its wisdom and common sense. He also has rm opinions on current trends in investing and in interviews given at the end of 2017, Bogle noted that he believes the market will become a bit more challenging and funds may only create a 4% return on average in the coming years instead of the expected 10% that everyone has become accustomed to. He believes that the downturn in returns will put pressure on Wall Street professionals as more and more investors become aware of the percentage of fees that they have been paying for management. In Bogle s opinion, the revolutionary change will come due to the constant uptick in the number of funds being invested in via index funds funds that can be set up and managed at a very low cost and which now contain 41% of all stock market assets. How are Indexes Used by Investment Professionals? 3/6

4 Investment professionals such as funds managers, asset managers, and institutional investors use an index in several ways including the monitoring of ESG Environmental, Social, and Governance issues. (Morgan Stanley, n.d.) CIS Collective Investment Schemes such as index funds have used index tracking for many years to mimic the performance of the index and thus lower the cost of running the fund. Funds managers and asset managers have been tasked with ensuring that the assets contained in the funds actually do match the speci ed index that it is meant to be tracking. Another rapidly-growing investment strategy that is employed by institutional investors is the use of Smart Beta. As a counter-measure to the concentration on capitalizationweighted indexes, alternative index forms are employed. The use of a factor index is considered preferable. The factors that are measured include: Volatility Quality Yield Size Value Momentum Another important item to note is that European investors have indicated that they are happily embracing Smart Beta and are active early-adopters. Advantages and Disadvantages Monitoring investment performance through an index has the following advantages: Steady and long-term results. Low risk since the assets track a group of proven performers. Low fees for set-up and ongoing management. An easy way to track the economic state of a country or region based on the performance of the assets in the index. Disadvantages include: Fund managers may only look at the outcome of the overall portfolio instead of the health of individual assets. Less exibility in the assets that are contained in the index or index fund. Low opportunity for huge pro ts compared to managed funds. More sensitive to market volatility. The Importance of Using An Index 4/6

5 You may prefer to look at index used as a weather forecast that predicts up and downs in the market. Or you could regard the consultation of an index as a form of health check-up regarding the economic health of a country, region, or group of assets. In either case, monitoring an index provides you with a snapshot of both performance and trends. Whether you are tracking blue-chip funds, a speci c sector of the market, or cryptocurrency it is essential to be able to assess the movement and make decisions that allow you to adjust your portfolio for either better returns or more safety. Search Recent Posts Guest Contribution : Thoughts on Decentralisation Stellar Cryptocurrency Wallets Cryptocurrency Exchanges Decentralized Applications (Dapps) The DQR Group provides global Cryptocurrency exchange platforms, products and advisory services for qualifying retail and institutional clients. CONSULTING DQR Coin DQR Markets DQR Media DQR Comply DQR Services 5/6