The business of financial indexes
In this article, Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2023) explains the business of financial indexes.
Introduction
Indexes are frequently used in the financial sector to measure the evolution of market prices for a set of financial assets over time. These sets of assets can be defined to represent an asset class, country or geographical zone, or sector of the economy, and provide a comprehensive and accurate overview of the market.
Financial indexes serve as a benchmark for assessing the performance of an investor’s asset portfolio and give investors a way to monitor the performance of a given set of assets. By using financial indexes, investors can gain knowledge of market trends and conditions and make informed investment decisions. Index providers are responsible for creating and maintaining financial indexes.
Financial indexes can be developed to track particular geographical areas or market segments and can be created for a variety of asset classes, including equities, bonds, commodities, and currencies. Financial indexes are primarily provided by specialized companies with experience in data compilation and index value calculation, such as S&P Dow Jones Indices, MSCI, and FTSE Russell. Overall, the business of financial indexes is a critical component of the financial industry, providing valuable data and insights to investors.
Key Players
Index providers
An index provider is a specialized business that specializes in developing and computing market indices as well as licensing its intellectual property to be used as the foundation of passive products. The index providers are essential to the investment professionals in charge of looking after these assets because they provide reliable data distribution, sound index construction, and strict index maintenance. The primary activities of an index provider are product development, licensing, distribution, and related service and support.
Index Industry Association (IIA)
The production of indexes has become an industry! And every industry has a professional association. The index industry is no exception. The Index Industry Association (IIA) was founded in 2012. Some of the founding members are MSCI and S&P Dow Jones Indexes.
As stated on the IIA website, the association mandate is “to educate investors on the attributes and role of indexes within the investment process, to advocate for the interests of index users and providers worldwide, and to push for industry standards of best practice, independence and transparency”.
Business models
Index providers typically employ one of the following business models to make money from their indexes: licensing, creating index-linked products, getting charged for index inclusion, and selling data for index-related research and analysis.
Licensing
Index providers make money by licensing financial institutions like asset managers, banks, and insurance companies to use their indexes. These financial institutions pay a fee to the index provider for the right to use the indexes as a benchmark for their investment products, such as exchange-traded funds (ETFs) and index funds.
Creation of index-linked products
Index providers make money by developing their own index-linked products, such as index funds and ETFs. The investors that are invested in the product pay a management fee to the index provider.
Selling data
By selling the data that has been produced from the history, research, and analysis, the index providers make money.
Regulation of indexes
Index providers build and maintain indexes. In order to ensure that the index accurately reflects the performance of the market or sector it is meant to represent, they are in charge of defining the methodology used to construct the index, choosing the stocks or bonds included in the index, and performing routine index rebalancing.
Beyond the activity of index providers, financial authorities play a role to authorize indexes. The main objective of authorization is to safeguard investors who use the index as a benchmark for their investment decisions and to make sure that the index accurately reflects the performance of the market or sector it is meant to represent. In the United States, the US Securities and Exchange Commission (SEC) has the power to approve specific indexes that serve as the foundation for exchange-traded funds (ETFs) and other investment products. This is done to make sure that these products operate in the best interests of investors and are compliant with SEC regulations.
Why should I be interested in this post?
A wide range of professionals, including portfolio managers, investment advisors, and financial analysts, use financial indexes, which are a crucial part of the financial sector. Financial indexes change over time to take into account adjustments to the economy and market conditions.
You can stay on top of the curve and adjust to changes in the industry by staying informed of the most recent financial index developments. So, in my opinion, studying the business of financial indexes can give business students useful skills and knowledge that they can use in a variety of fields and jobs.
Related posts on the SimTrade blog
About financial indexes
▶ Nithisha CHALLA Financial indexes
▶ Nithisha CHALLA Calculation of financial indexes
Examples of financial indexes
▶ Nithisha CHALLA The S&P 500 index
▶ Nithisha CHALLA The Euro Stoxx 50 index
▶ Nithisha CHALLA The FTSE 100 index
▶ Nithisha CHALLA The CSI 300 index
▶ Nithisha CHALLA The Nikkei 225 index
Useful resources
Index Industry Association (IIA)
S&P Global Who’s Behind the Index?
Committee for Economic Development of The Conference Board (CED) The Financial Index Industry
About the author
The article was written in March 2023 by Nithisha CHALLA (ESSEC Business School, Grande Ecole Program – Master in Management, 2021-2023).