ETF Investing – Why not all indices are created the same

Why not all indices are created the same

Exchange-traded funds (ETFs) based on indices are meant to be simple, transparent, cheap investment vehicles, which do not require the expertise (and thus avoid the cost) of an “active” fund manager. They instead simply buy exposure to the stocks (or bonds or commodities) in the particular index being tracked – so-called “passive” investing. And they do fulfil this role, pretty successfully in my view.

But when you delve into the indices upon which these ETFs are based, you find that there is a huge number of variations on this particular passive investing theme; it’s like opening a can of worms.

Weighting index members by market cap

For instance, the vast majority of benchmark stock indices that you will have heard of – like the S&P 500, FTSE 100 or Euro STOXX 50 – weight the stocks in their index by market capitalisation. That is to say, the more a particular company (e.g. Vodafone) is worth, the greater its weighting in the index, and thus the more of that company you will buy exposure to when you buy a FTSE 100 index ETF.

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ETFs: Why not all indices are created the same