Traditional and custom indexes follow distinct methodologies for investment and rebalancing. However, the personalized nature of Custom Indexes sets them apart, tailoring methodologies to individual investor preferences. Despite this, many investments are still linked to a few dominant indices.
Diversified, low-cost index funds are resilient, mirroring the market without emotional interference. However, the market is dominated by four major providers, limiting diversification and flexibility.
In response, index technology providers offer alternative solutions, aligning with the trend of commission-free trading and fractional shares. Designing a custom index offers various benefits, such as alignment with values, financial goals, and risk tolerance.
When choosing an index technology provider, consider essential services like data sources, backtesting, calculation frequency, discretionary execution, integration of quantitative models, regulatory compliance, licensing, distribution, and technology infrastructure.
For the complete article "Beyond the Basics: Revolutionising Your Portfolio with Customised Indexes" see below.
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Abilities of Index Technology Providers
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Beyond the Basics: Revolutionising Your Portfolio with Customised Indexes
Traditional indexes adhere to a singular methodology, with uniform rules governing their holdings and a rebalancing approach. They epitomise a "one size fits all" approach. Similarly, Custom Indexes engage in the investment and rebalancing process guided by a specific methodology. However, the distinctive feature of Custom Indexes lies in the personalisation of this methodology, tailored to individual investors' unique circumstances and preferences.
So why are there still so many investments linked or referenced to the very few indices like S&P 500, Nasdaq, FTSE 100, and EURO STOXX 50?
To quote Jack Bogle, "The primary adversaries for equity fund investors are the costs associated with fund management and the impact of emotional decision making."
Diversified, low-cost index funds are tough to beat. They are a living account of the market, perpetually changing with every trade. By owning the market, these funds collect all the bets made by active managers, then turn around and sell that portfolio back to investors at a low price. The index rule book ensures that emotions stay out of the decision making.
The four largest index providers globally dominate the market with an approximately 80% market share, with indices that usually follow a simple capital weighted methodology. As a result, such indices behave like a trend-following strategy as they increase their weighted exposure to stocks that go up. (In the S&P 500, the Top 10 stocks out of 500 represent 30% weighting; the sector information technology represents 28% of the S&P500 index.) This works well until you reach an inflexion point with the least desired risk profile regarding diversification.
Over the last decade, more and more index technology providers have started up their businesses offering alternative solutions. At the same time, the average trading commission trend by the major platforms is going to zero, plus many allow the trading of fractional shares — the perfect win-win situation to have a tailored index implemented that aligns with your values.
Why design your own index?
Designing a customised financial index empowers the initiator to tailor their investment offering to specific circumstances, leading to a more satisfying and effective investment experience.
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Your values, like ESG, which is often a personal matter
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Specific financial goals like growth, regular dividends or income
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Different or new exposures like a factor-based approaches or options-based indices
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Better Risk-adjusted performance, like using volatility targets
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Tax optimisation: Taxes significantly impact performance and depend on the individual circumstances.
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Independent calculation with the assurance of having an independent party oversee the entire calculation process.
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Integrate your quantitative models like AI that allows you to sift through large amounts of data and use models that can change their opinion depending on market circumstances. Such qualitative models can stay proprietary.
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Keep ownership, build a track record, own the branding
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Monetisation of your idea
What to look for when picking an index technology provider?
When looking for the right index technology provider, one needs to decide what services are essential and which are nice to have. For example:
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Data Sources: What kind of data is available and what is its quality. This may include pricing data, financial statements, and other relevant market information. Sometimes, it is better to go with a specialist index technology provider, particularly regarding non-equity underlings like commodities.
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Backtesting capabilities to conduct a thorough backtesting to evaluate how the index would have performed historically under various market conditions.
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Frequency: How often does the index need to be calculated? Some providers can calculate the index up to one tick every 100ms.
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Discretion: Does the index allocator have the possibility to execute discretion and send their portfolio asset allocation on a daily/weekly/monthly/quarterly/annual basis? This enables a more active index management while staying aligned with the permissible regulation.
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Integration of proprietary models: Can quantitative models like AI-based tools be integrated? Some providers offer Python Editor “Workspace” to develop more complex index and trading strategies. Others use AI to discover new investment topics and supports the research process through their own GPT model.
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Regulatory Compliance: Ensure compliance with relevant financial regulations and standards. This may include adherence to regulatory bodies such as the SEC. EU Benchmark regulation
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Licensing and Distribution: Can the name of the index be 100% tailored to client wishes? Who owns the IP of the index sponsor, and who can get rewarded for such? Determine how it will be disseminated to the public and whether licensing fees will apply.
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Technology Infrastructure: What type of integrations with other platforms are available? How robust is the technology infrastructure to support the index's calculation, maintenance, and dissemination?
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Stakeholder Communication: How are the methodology and characteristics of the index communicated to stakeholders, including investors, financial professionals, and regulatory bodies?
How to make your index investable?
Developing your investment idea into an index is not enough. How do you make it into a product that allows your investor to invest, and who is responsible for its implementation?
The fastest time to market for your investment idea is to use an Actively Managed Certificate (AMC) tracking such an index and work with somebody who can offer the index development and the set-up of the investment vehicle out of one hand. Only a few companies can offer the whole package, and one of them is Super Global. Super Global allows the initiator to design and backtest their investment idea as an index. Once the index has been finalised, an EU Benchmark regulated index calculation agent calculates and publishes the index daily. Super Global ensures that the AMC tracks the index as closely as possible. As an index creator, you keep the IP with your branding and get compensated for it.
If you want to learn more about Super Global's index-linked investment solutions, please listen to the interview with Daniel Knoblach, Managing Director of Super Global via the SOUNDCLOUD Player.
If you would like to find out more about Actively Managed Certificates, you can download the e-book via this link https://www.vestr.com/amcs-white-paper