An index fund ( Eng. Index fund or Eng. Index tracker ) is a type of mutual investment fund or a stock exchange traded fund ( Eng. ETF ), organized in such a way as to follow a certain set of basic tools according to certain rules [1] . Rules may include tracking stock indices, such as S&P 500 or Dow Jones and others, hence the name “index fund”.
The most famous of the index funds, the S&P 500 Index Fund, is based on the S&P 500 Index rules of .
Equity index funds include stock groups with similar characteristics, such as size, value, profitability and / or geographic location of companies. Shares of companies that meet specified criteria are acquired and included in the fund and sold when they go beyond the specified parameters [2] .
The main advantage of index funds is their time savings, because in this case, investors do not need to analyze individual stocks or investment portfolios .
As of 2014, index funds accounted for 20.2% of the value of all US mutual funds [3] .
Content
Appearance
May 24, 1967 Richard Allen Beach founded Qualidex, Fund, Inc. In October 1970, the company was declared as a fund based on the Dow Jones 30 Index (DJI 30). The corresponding registration was received on July 31, 1972. It was the first index fund in history.
In 1975, John Bogle founded the Vanguard 500 Index Fund, based on the S&P 500, and created the first matching security [4] . Starting with a modest amount of assets of $ 11 million, by the end of 1999 the fund reached a volume of $ 100 billion.
Economic Theory
Economists cite the efficient market hypothesis (GER) as the main premise justifying the creation of index funds. The hypothesis assumes that current stock prices reflect all the information available on the market. The random nature of the change in the price of certain shares is also postulated. Thus, it is very difficult to say ahead of time which stocks will analyze the market [5] . Thus, a stock portfolio reflecting the entire market as a whole is the most efficient [5] .
Benefits
Low cost
Since the composition of each index is known, the cost of managing the index fund is lower compared to variable-composition funds [1] . Thus, the indicator of the cost of managing the index fund for large US companies (US Large Company Indexes) is about 0.1% and 0.7% for emerging market indices. On the other hand, the same indicator for actively managed blue chip funds for 2015 was 1.15% [6] .
Easy to manage
The objectives of investing in index funds are easily understood, since the composition of the portfolio in this case is completely determined by the composition of the underlying index [2] .
Low revs
In this case, turnover is understood as the volume of sale and purchase of securities. Selling securities in some countries is subject to capital gains tax . Even in the absence of taxes, turnover entails both explicit and implicit costs that reduce profits. Because index funds are passive investments, turnover is lower than actively managed funds. According to research by John Bogle , in the case of actively managed funds, investors get only 47% of total profit; in the case of the index fund, this indicator averages 87% [2] .
Style Drift
(Further unreadable automatic translation). The so-called “style drift” occurs when, in order to increase profitability, the manager of an actively managed fund goes beyond the initially accepted criteria, such as the value of shares of medium-sized companies ( English mid-cap value ), the profitability of “blue chips”, etc. Such drift hurts portfolios built using diversification as a priority. Moving to other styles can reduce the overall portfolio of diversity and subsequently increase risk. With an index fund, this drift is not possible and the exact portfolio diversification is increasing. Such deviations can disrupt portfolio diversification, respectively, increasing the risk of the latter. In the case of an index fund, style drift is not possible, which ensures continuous portfolio diversification [2] .
Weaknesses
Tribute to Arbitrators
Index funds should periodically adjust their portfolios in accordance with new prices and market capitalization of securities included in monitored stock indices [7] [8] . This allows algorithmic traders to carry out so-called. index arbitrage, anticipating price changes resulting from adjustments to index funds, while benefiting from major transactions involving such adjustments [9] [10] . In fact, any index and, therefore, all funds based on this index, announce ahead of time the transactions that they plan to complete, which allows arbitrators to follow a practice called “ index front running ” [11] [12] .
General Market Impact
Another problem is related to the large amount of money involved in index transactions. According to theory, the value of the company should not change as a result of inclusion in the index or exclusion from it. However, in practice, inclusion in the index leads to an increase in the value of the company and vice versa [13] [14] . By tracking less popular indexes, the fund can avoid such distortions [15] [16] .
Diversification
Diversification means the number of different securities in the Fund. Funds with more securities are considered more diversified than funds with fewer securities. Owning a wide range of securities reduces the volatility of the value of the fund by reducing the impact of sharp fluctuations in the prices of individual securities. So, the index can be considered diversified, but the bio-technology index can not be [17] .
Since some indices, such as the S&P 500 and FTSE 100, are comprised mainly of shares of large companies, an index fund based on such indices will have a high percentage of shares of several large companies. This situation means a decrease in diversification and may lead to increased volatility and investment risk [18] .
Some experts advise a strategy of investing in each existing instrument in proportion to the market capitalization of the latter, namely, investment in national ETFs, in proportion to the market capitalization of the latter in the corresponding local market [19] .
Asset Allocation
is the process of forming a portfolio of stocks, bonds and other types of high liquidity assets in accordance with the ratio of this investor to risk, as well as the requirements for profitability, equity and time horizon. Index funds allow you to effectively distribute assets in terms of taxation and get balanced portfolios .
Ratings
The famous American investor Warren Buffett calls long-term investments in index funds one of the best investment strategies [20] . According to Buffett, the success of index investments is explained by the tendency to long-term growth of the US economy and the effect of compound interest [4] .
See also
- Exchange Investment Fund
- Stock market index
Literature
- Jeremy Miller Investment Rules of Warren Buffett = Jeremy Miller: Warren Buffett's Ground Rules: Words of Wisdom from the Partnership Letters of the World's Greatest Investor. - M .: Alpina Publisher, 2017 .-- 374 p. - ISBN 978-5-9614-6212-8 .
Notes
- ↑ 1 2 Reasonable Investor (s), Boston University Law Review, available at: https://ssrn.com/abstract=2579510
- ↑ 1 2 3 4 Index Funds
- ↑ 2014 Investment Company Fact Book (unavailable link) . Date of treatment June 10, 2017. Archived June 20, 2016.
- ↑ 1 2 Miller, 2017 , p. 50.
- ↑ 1 2 Burton G. Malkiel, A Random Walk Down Wall Street , WW Norton, 1996, ISBN 0-393-03888-2
- ↑ Index Fund Advisors
- ↑ High-Frequency Firms Tripled Trades in Stock Rout, Wedbush Says (August 12, 2011). Date of treatment March 26, 2013.
- ↑ Siedle, Ted . Americans Want More Social Security, Not Less (March 25, 2013). Date of treatment March 26, 2013.
- ↑ Amery, Paul . Know Your Enemy (November 11, 2010). Date of treatment March 26, 2013.
- ↑ Salmon, Felix . What's driving the Total Return ETF? (July 18, 2012). Date of treatment March 26, 2013.
- ↑ Understanding index front running . The Trade Magazine . The TRADE Ltd .. Date of access March 24, 2009.
- ↑ Bloomberg - Are you a robot?
- ↑ Market Reactions to Changes in the S&P 500 Index: An Industry Analysis (PDF). Date of treatment July 30, 2014.
- ↑ The Price Response to S&P 500 Index Additions and Deletions: Evidence of Asymmetry and a New Explanation (PDF). Date of treatment July 30, 2014.
- ↑ Small-Cap Indexing: Popularity Can Be a Pain
- ↑ Arvedlund, Erin E. Keeping Costs Down - Barron's . Online.barrons.com (April 3, 2006). Date of treatment July 30, 2014.
- ↑ Bogle, John C. As The Index Fund Moves from Heresy to Dogma. . . What More Do We Need To Know? . The Gary P. Brinson Distinguished Lecture . Bogle Financial Center (April 13, 2004). Date of treatment February 20, 2007.
- ↑ Practice Essentials - Equal Weight Indexing . S&P Dow Jones Indices .
- ↑ Gale, Martin. Building a Globally Efficient Equity Portfolio with Exchange Traded Funds . Date of treatment January 8, 2008.
- ↑ “Why the world's biggest investor backs the simplest investment”, BBC, 07.17.2017
Links
- “Why the world's biggest investor backs the simplest investment”, BBC, July 17, 2017 - Warren Buffett recommends investing in an index fund. (eng.)