Financial market indexes are nearly a century old, and their role has evolved over time. Initially, indices were used as an information tool, primarily as a means of gauging business conditions and market sentiment. In the last few decades, indices have assumed a central place in the investment business, both as a means of benchmarking investors’ performance and as the basis for index-based fund management.
In their role as benchmarks, the leading indices now play a vital role in the global capital markets. For example, around $10.7trn of assets - including over two-thirds of active US equity institutional assets - are benchmarked to the Russell US indices. Despite the variety of index choices now available to professional and retail investors, there are some design standards that any market-leading benchmark should follow. In particular, we believe that three important principles help define a good benchmark: objectivity, modularity and reliability.
In this paper we provide a series of examples to illustrate what those principles mean in the context of benchmark construction, and why they matter.
