Most exchange traded funds try to passively reflect the performance of an underlying index, and investors should take the time to understand how these underlying benchmarks affect their investments.
For instance, as ETFs have grown more popular, the indexing industry has also grown, writes John Authers for Financial Times.
As competition increase, the growth in index industry has also helped reduce licensing costs, which eventually trickled down to lower fees for end investors.
Additionally, many active managers have compared their performances to benchmarks, and those that have significantly deviated from the benchmarks could risk underperformance and greater asset redemptions. Consequently, many are closely watching index components and any changes to holdings and weightings.
For instance, Adam Parker, chief US equity strategist at Morgan Stanley, pointed out that the S&P 500 index of large-cap U.S. stocks frequently changes up its holdings. On average, the S&P 500 shifts around 4.4% of its index each year. Only 36% of S&P 500 components have remained since 1994 and the tech sector weight has increased to 13% from 8%. Newer components also enjoy faster growing profits while the index has trimmed allocations toward companies with falling revenue. [Why Index-Based ETFs Can Beat Active Funds]
“We want to represent the market, and the market changes.” S&P’s head of indexing, David Blitzer, told Financial Times. “By changing regularly, the S&P is always an up-to-date reflection of the market, and it avoids the huge annual turbulence caused when the rival Russell indices have their once-yearly recomposition.”