Index
An index is a method of measuring the value of a section of a capital market, such as stocks and bonds. It is computed from the prices of selected marketable securities of the given market, market segment or asset class.
The value of an index is calculated on a regular basis using either the actual or estimated market prices of the individual securities, known as constituent securities, within the index.
Indexes are used to gauge market sentiment, benchmarks for actively managed portfolios and the underlying portfolios for investment products such as index funds and exchange-traded funds (ETFs).
Types of indexes
As the name suggests, a price return index, also known as a price index, reflects only the prices of the constituent securities within the index. A total return index, in contrast, reflects not only the prices of the constituent securities, but also the reinvestment of all income received since inception.[1] It is a tool used by investors and financial managers to describe the market, and to compare the return on specific investments.
Index methodologies
All the major market indexes have been developed by long-established, well-respected providers. Investors generally assume that these indexes are equally fair, relevant, and accurate representations of market performance.[2]
Index providers make choices when creating an index. These choices typically include:[1]
- the target market to represent
- which securities should be selected
- how much weight should be allocated to each security. Choices include equal weighted, fundamentally weighted, market capitalization weighted, or price weighted.
- when should the index be rebalanced
- when should the security selection and weighting decision be reviewed
Weighting methodologies
The most common weighting methodology for equity markets is market capitalization weighted.[2]
Market capitalization weighted
In a market capitalization weighted index, securities are held in proportion to their value (market capitalization).
Large, mid and small caps
In general, the stock market of each country is composed of three levels of market capitalization: large, mid and small. Indexes are generally available for each segment. An example of a large-cap index for US Equities is the S&P500.
Total market index
A total stock market index, sometimes known as an 'all-cap' index, attemps to capture the entire stock market of a country. Such indexes will have minimal turnover and are becoming more popular among ETF providers (e.g., [3][4]) and investors.
Other weighting methods
Equal weighted
An equal weighted index is simple but results in under- and over-representation and requires frequent rebalancing.[1]
Fundamentally weight
A fundamentally weighted index is based on screening for specific fundamentals as specified by the index provider. It results in an index that is data intensive and that provides a value or contrarian tilt.[1]
Price weighted
A price weighted index is also a simple index. However high price stocks have a greater impact and stock splits result in arbitrary changes to the index.[1]
Equity indices
The following indices are market capitalization weighted unless otherwise noted. They are highlighted given their relevance for Canadian investors.
Canadian indices
The S&P/TSX Composite Index[5] is an index of the stock (equity) prices of the largest companies on the Toronto Stock Exchange (TSX) as measured by market capitalization. It "covers approximately 95% of the Canadian equities market"; towards the end of 2021 it had 234 constituents and the top-ten companies made up 39% of the index. [5] It is the headline index for the Canadian equity market and the broadest available Canadian index. It replaced the earlier TSE 300 index. Most index funds and ETFs track the capped version (where each company is capped to a 10% weight), but towards the end of 2021 no constituent made up more than 7% (e.g., [6]).
A competing broad market index is the FTSE Canada All Cap Index, with 179 constituents, covering Canadian large, mid and small cap stocks [7]. Based on their yearly total returns over the period 2005-2020, the FTSE Canada All Cap Index and the S&P/TSX Capped Composite Index are perfectly correlated (coefficient of correlation of 0.999) and have almost the same annualized return (7.0% and 7.1%, respectively), as shown in the following graph:
The S&P/TSX 60 Index[8] is a stock market index of 60 large companies listed on the TSX.
US indices
The best known US equity indices are the S&P 500[9] and the Dow Jones Industrial Average (also known as the Dow, or the Dow 30). The Dow Jones Industrial Average is not a market capitalization weighted index.[10] and includes only 30 companies. The S&P500 is a more representative large-cap index containing 500 companies which, according to S&P, "captures approximately 80% coverage of available market capitalization". Towards the end of 2021, the top-ten constituents made up 28% of the index.[9] The S&P500 is the typical benchmark for US equity funds in Canada, and numerous index funds and ETFs track this.
Total market indexes for US equities are presented on the Bogleheads wiki; these include thousands of companies.
International indices
The MSCI EAFE (Europe, Australasia, Far East) index is a widely used index for developed market equities from countries outside of North America. In Canada the Canadian dollar version of the EAFE index is the typical benchmark for international equity funds. According to MSCI, toward the end of 2021 the EAFE index had 843 constituents and covered "approximately 85% of the free float-adjusted market capitalization in each country", i.e small-cap stocks are not represented.[11] At this date, the top-five countries in the index were Japan, the UK, France, Switzerland and Germany. The top-ten constituents (companies) made up only 13% of the index.
Several ETFs offered on the Canadian and US exchanges explicitly seek to track the EAFE index. Other relevant international-developed indices from MSCI and FTSE are discussed under International equities.
Emerging market indices
Dow Jones, FTSE, Morningstar, MSCI, Russell, and S&P now provide emerging market indexes. Country representation varies among providers. The variation in index composition results in a dispersion of index returns. The MSCI Emerging Markets Index seems to be the most popular basis for indexed products in Canada. Towards the end of 2021, it had 1407 constituents covering 85% of the market capitalization in 27 countries; the top-five countries were China (34%), Taiwan (15%), South Korea (13%), India (12%) and Brazil (5%); and the top-ten companies made up 25% of the index.[12]
Other relevant EM indices from MSCI and FTSE are discussed under Emerging markets.
All-World ex-Canada
The FTSE All-World ex Canada Index[13] covers the entire world except Canada, including developed and emerging markets. At the end of 2014 the index had 2951 consituents; the US represented 53%, Japan 8%, the UK 7%, France, Germany and Switzerland each 3%; and the top-ten companies represented 9%. [13]
An index with a similar mandate is the MSCI ACWI ex Canada IMI Index.[14]
Fixed income indices
Canadian bond indices
FTSE Russell is the predominant provider of fixed income indices in Canada. It is best known for the FTSE Canada Universe Bond Index, which consisted of over 1500 investment-grade securities towards the end of 2021.[15] The Universe Bond Index is compared with a global bond index in terms of maturities, credit ratings and issuers below.
Well-known sub-indices of the Universe Bond Index include:[16]
- Short Term Bond Index, one to five years.
- Mid Term Bond Index, five to ten years.
- Long Term Bond Index, 10+ years.
These all include a mixture of federal, provincial and corporate bonds.
Global bond indices
Two bond indexes used by ETFs trading on the TSX are:
- The Bloomberg U.S. Aggregate Float Adjusted Bond Index (CAD Hedged) is "a market-capitalization-weighted index that represents a wide spectrum of public, investment-grade, taxable, fixed income securities in the U.S. — including government, corporate and international dollar-denominated bonds, as well as mortgage-backed and asset-backed securities".[17] The index includes over 12,000 bonds, with an average duration of about 7 years.
- The Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index (CAD Hedged) is "a market-capitalization-weighted index that represents a wide spectrum of the global investment-grade, fixed rate, and fixed income markets outside the U.S."[18] The index includes about 12,000 issues and has an average duration of about 9 years. Europe represents over 55% and the Pacific region is over 20%. Canada and emerging markets are each about 6%.
Canadian vs. US and global bonds
The following table compares the Canada Universe Bond index with a US bond index and a global ex-US bond index, based on ETFs that tracks them, since the information is not forthcoming on the index providers' websites. Totals may not add to 100% due to rounding. (Municipal bonds are not included in the US bond index because of their different tax status.)
This table shows that the Canadian bond market is well diversified by term (short, medium, long), issuer, and credit rating.
Canada[19] US[20] Global ex-US[21] Credit ratings AAA 42% 69%[22] 22% AA 23% 3% 27% A 24% 12% 30% BBB 9% 16% 20% Junk 0% 0% 2% Maturities <1 year 0% 1% 2% 1-5 years 41% 48% 37% 5-10 years 26% 30% 30% >10 years 32% 21% 31% Weighted ave 10.7 years 8.8 years 9.9 years Duration 8.1 years 7.0 years 8.6 years Issuers Federal govt/US treasury 34% 44% ? Government mortgage-backed ? 20% ? Provinces/states 37% ? ? Municipalities 2% 0% ? Corporate 27% 27% 14% Other 0% 7% ?
See also
References
- ^ a b c d e CFA Institute, Chapter 2 Security Market Indices (Powerpoint presentation - undated), viewed January 21, 2015.
- ^ a b Determining the appropriate benchmark: A review of major market indexes, Vanguard research, April 2010. Viewed January 22, 2015.
- ^ Canadian Couch Potato, New iShares ETFs Give Canadians the World, April 13, 2013, viewed December 30, 2015
- ^ Canadian Couch Potato, Vanguard’s VXC Gets a Facelift, June 16, 2015, viewed December 30, 2015
- ^ a b S&P/TSX Composite (CAD) - S&P Dow Jones Indices, viewed October 2, 2021.
- ^ iShares Core S&P/TSX Capped Composite Index ETF, viewed October 2, 2021.
- ^ FTSE, FTSE Canada All Cap Index, viewed October 2, 2021.
- ^ S&P/TSX 60 - S&P Dow Jones Indices, viewed October 2, 2021.
- ^ a b S&P 500®, S&P Dow Jones Indices, viewed October 3, 2021.
- ^ Dow Jones Industrial Average Overview, S&P Dow Jones Indices, viewed October 3, 2021.
- ^ MSCI, MSCI EAFE Index (CAD), viewed October 3, 2021.
- ^ MSCI, MSCI Emerging Markets Index (CAD), viewed October 3, 2021.
- ^ a b FTSE, FTSE All-World ex Canada Index (CAD), viewed January 21, 2015
- ^ MSCI, MSCI ACWI ex Canada IMI Index, viewed December 30, 2015
- ^ FTSE, FTSE Canada Universe Bond Index, factsheet, viewed October 3, 2021.
- ^ FTSE Russell, Ground Rules -- FTSE Canada Universe Bond Index, viewed October 3, 2021.
- ^ U.S. Aggregate Bond Index ETF (CAD-hedged) (VBU), viewed October 5, 2021.
- ^ Global ex-U.S. Aggregate Bond Index ETF (CAD-hedged) (VBG), viewed October 5, 2021.
- ^ Data from XBB (iShares Canadian Universe Bond Index ETF), viewed October 5, 2021.
- ^ Data from VBU (Vanguard U.S. Aggregate Bond Index), viewed October 5, 2021.
- ^ Data from VBG (Vanguard Global ex-U.S. Aggregate Bond Index), viewed October 5, 2021.
- ^ US government debt included in the AAA rating.