Indexes play a crucial role when it comes to investing.
Back to Overview
Index Education - Ch4 Intro
Measuring investment markets
Market indexes were originally created to measure markets and how they moved over time. In equities, they will also be called market cap indexes, as they usually built using the value of a company’s market capitalization. Fixed income market indexes also exist and have a similar goal of measuring the market.
Seeking to capture market returns, institutional investors started to create investment products to replicate those indexes partially or fully. Today, market indexes are widely used to create financial products across both equities and fixed income, while still retaining their measurement function
Advances in technology and data availability have led to newer, more granular types of indexes. In addition to market indexes, there is now a broader set of indexes. They may incorporate securities that would fit within an objectively measured market as defined by an investment style.
Focusing on different exposures
These newer indexes are derived from market indexes and can broadly be divided into the following categories:
- Factor indexes
These are designed to reflect the return of markets defined by style factors such as volatility, yield, quality, momentum, value, size, and growth. MSCI’s research has shown how these factors historically may have helped explain returns and risks1 .
- Environmental, social and governance (ESG) indexes
These are based on ESG criteria and designed to help measure exposure to ESG related risks.
- Climate indexes
These are based on Climate metrics and measurements. They are designed to help measure exposure to climate related risks.
- Thematic indexes
These are based on quantitative measurements of macroeconomic, geopolitical, and technological trends that may have far-reaching effects on markets.
Index Education Audio Series
Our index audio series
Listen to the voice of index experts across MSCI.
new ep - AudioSeries4
The Expansion of Indexes (06:00)
Learn how advances in technology and data availability have led to newer types of indexes and accelerated the adoption by investors.
Index Education - Ch4 Intro 2
Targeting style factors
Factor indexes aim to measure specific factors that may explain risk and returns of an asset. For example: volatility, yield, quality and momentum. These were first incorporated by investors who had access to unique data sets and state-of-the-art processing tools and techniques.
Factors exist in both equities2 and fixed income3 . The metrics or measurements used will differ and be specific to the asset class, but the motivation will be similar.
Incorporating ESG dimensions
ESG indexes can be constructed in different ways. From simple exclusions such as removing higher ESG-risk securities, to more complex constructions where the index integrates ESG ratings.
They can also be constructed with an impact objective in mind, for example, around a specific topic, like sustainability or gender diversity, and include the securities with a greater exposure to that topic. A green bond index is an example of a fixed income impact index.
Index providers may select from a wide range of techniques when integrating ESG ratings. Institutional investors can choose the index and the methodology that is most optimally aligned with their goals and constraints.
Addressing climate change
Climate indexes help investors address the impact on climate change in their portfolios. They are grouped by objectives, for example, minimizing the exposure to carbon emissions and stranded asset risks, maximizing the weight of companies providing climate solutions, green opportunities, positive environmental impact, or targeting temperature alignment goals.
To address different investor use cases, a wide range of climate indexes can be used as the basis for products. They may be deployed for active or passive financial products, or they may be incorporated as policy or reference benchmarks by institutional investors.
Seizing long-term opportunities
Thematic indexes aim to represent the performance of companies that may derive revenue from opportunities generated from macroeconomic, geopolitical, and technological trends. These trends may be seen by investors as long-term, structural, and transformative shifts.
Traditionally, seeking to capture innovation and the potential of emerging trends has been seen as something that only active managers could do. But as data and technology evolved, there were new ways of measuring and representing the performance of these concepts in a quantitative and systematic manner. This led to the creation of thematic indexes.
Institutional investors can use thematic indexes in passive products that target a specific theme or themes, or in active solutions as a benchmark of performance.
Today’s institutional investors have a more expansive index toolkit than ever before. The rise of indexes such as factor, thematic, ESG and climate indexes, has not only accelerated the adoption of financial indexes but has also widened the scope of their usage.