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Module 2: Types of Indices and Their Characteristics

Module 2: Types of Indices and Their Characteristics
Module 2: Types of Indices and Their Characteristics
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Module 2: Types of Indices and Their Characteristics

Module 2: Types of Indices and Their Characteristics

2.1 Understanding different types of indices

Market indices are used as benchmarks for the economy or sector they represent. They are composed of securities that fit predefined criteria, and the criteria used depend on the goal of the index – i.e., what it is trying to measure. 

Hence, theoretically, there can be any type of index measuring any particular market segment. But that doesn’t mean that all indices are equally popular or useful. For instance, while the Whole Fresh Goat Milk Producer Price Index might be a key indicator for the milk sector, it is likely less well known than, say, the S&P 500, which tracks the performance of the 500 biggest companies listed on the US stock exchange [1]

Still, you may come across several different types of indices in your investing journey, so it is useful to get to know the most common types.

To aid your understanding, bear in mind that indices all share some common core characteristics, such as: 

  • Indices are benchmarks measuring the change in a particular market or segment
  • Indices cannot be traded or directly owned 
  • Indices are composed of securities or assets that have the largest influence on the underlying market 
  • Indices may be weighted or unweighted; the actual weighting used will result in different readings

2.2 Sectoral indices vs national indices

What are sectoral indices?

Sectoral indices measure the performance of a predefined sector or industry. Also known as a sector index, these types of indices are useful for gauging the performance of a stock against the sector it belongs to. 

Doing so helps you discern if good performance is a result of the company’s own efforts, or simply due to an uplift in the sector as a whole. Of course, some correlation is to be expected, especially so when it comes to the top companies listed in a sector index that is weighted according to market-cap.

For example, AAPL and other top tech companies largely mirror the performance of the NASDAQ 100. This is to be expected, since the top 10 holdings account more than 48% of the entire index’s total market capitalisation. [2] 

However, if you see AAPL moving up while the rest of the NASDAQ is falling, that would be a solid reason to increase your conviction in the stock over its peers that fell alongside the index. 

Examples of sectoral indices 

Energy Select Sector (IXE) [3]

A market index by Dow Jones, focused on companies dealing in energy equipment & services; oil, gas & consumable fuels. Its top five constituents at the time of writing by weight include 

– 23% Exxon Mobil Corp.

– 16% Chevron Corp.

– 6% ConocoPhillips

– 5% EOG Resources, Inc.

– 5% Occidental Petroleum Corp.

Health Care Select Sector (IXV) [3]

Another market index by Dow Jones, IXV covers health-focused sectors such as healthcare equipment & supplies; healthcare providers & services; healthcare technology; biotechnology; pharmaceuticals; life sciences tools & services.

The top five constituents of this index at the time of writing, by weight are:

– 10% Johnson & Johnson 

– 7% Pfizer Inc. 

– 7% UnitedHealth Group Inc. 

– 5% Merck & Co., Inc. 

– 4% AbbVie Inc.

Nifty FMCG [4]

Nifty is a series of market indices published by India’s National Stock Exchange. This index tracks the performance of Indian companies in the Fast Moving Consumer Goods sector, aimed at the mass market.

Its top five constituents at the time of writing are: 

– 29.63% ITC Ltd

– 20.22% Hindustan Unilever Ltd. 

– 8.70% Nestle India Ltd. 

– 7.32 Tata Consumer Products Ltd. 

– 6.63% Varun Beverages Ltd. 

What are national indices?

National indices track and measure the performance of the top performing companies listed on a particular nation’s largest stock exchange. Constituents are not sorted into different categories, instead the only requirement is to be listed on the relevant country’s main stock exchange. 

Examples of national indices

Nikkei 225 [5]

The Nikkei 225 is the main market index for Japan, tracking the top 225 companies traded on the Tokyo Stock Exchange. It is highly diversified, with constituents drawn from 35 different sectors and industries. 

The top five constituents of the Nikkei 225, by weight at the time of writing, are:

– 7.5% Tokyo Electron

– 3.81% Advantest Corp.

– 3.75% Softbank Group

– 2.94% Shin-Etsu Chemical

– 2.29% Daikin Industries

Straits Times Index (STI) [6]

This index serves as the main benchmark of Singapore’s economy. It tracks the top 30 publicly traded companies listed on the Singapore Exchange (SGX). 

The STI’s top five constituents at the time of writing are:

– 21.2% DBS Group

– 13.3% OCBC 

– 11.4% UOB

– 6.4% Singtel

– 4% Keppel

Differences between sectoral indices and national indices

The main difference between sectoral indices and national indices lies in how they are organised. 

Sectoral indices collect and track qualifying stocks across a predefined sector, or segment of industry. There may be no geographical restrictions, and such induces may include relevant companies drawn from around the world.

In contrast, national indices only include stocks publicly traded on a particular country’s main or largest stock exchange. Constituents may be selected from several different sectors, but they all share the common trait of being listed on the same stock exchange. 

2.3 Large-cap, mid-cap and small-cap indices

The terms “large-cap”, “mid-cap” and “small-cap” refer to a popular method of classifying companies according to their size – specifically, their market capitalisation. This is a figure that is derived by multiplying the price-per-share of the company’s stock, by the number of shares outstanding. 

Generally, large-cap refers to companies with total market capitalisation that is USD$10 billion or more. Mid-cap companies have market capitalisation between USD$2 billion and USD$10 billion, while small-cap companies sit in the range of USD$250 million and USD$2 billion. [7]

Therefore, indices that focus on large-, mid- or small-cap stocks would track companies with the corresponding market capitalisations. You can use these indices to look for top performers among companies occupying a certain band of market capitalisation. 

Large-cap vs mid-cap vs small-cap indices

Large-cap indicesMid-cap indicesSmall-cap indices
Company size by market capitalisation USD$10 billion or moreBetween USD$2 and 10 billion Between USD$250 million and 2 billion
Type of companiesBlue-chips, MNCs, global leaders, household namesUp-and-coming companies, brands with long histories that have exhausted growth potentialStartups, trailblazing companies, SMEs
Volatility Lower volatility, as constituents tend to be well established with strong market positions. Moderate volatility, as constituents are more sensitive to macroeconomic shocks.Higher volatility, as constituents may be unproven or not yet have a firm financial foundation. 
Constituents likely to switch rankings often, or even be removed from the index. 

2.4 International indices

International indices (also known as global indices) measure the performance of stock markets around the world. They are composed by taking the prices of different stocks from around the world, compiling them into a singular figure to convey a snapshot of the overall performance of the world’s stock markets.

Global indices are important indicators of market trends, investor sentiment, and broader economic conditions. They play a crucial role in the investment industry, allowing investors to evaluate their own portfolios against global market benchmarks. 

Fund managers also refer to global indices to benchmark their investment strategies against the broader market, and create index funds that replicate the performance of the global stock market. 

Examples of international indices

Dow Jones Global Index [8]

One of the largest international indices, the Dow Jones Global Index attempts to track 95% of the global stock market by market capitalisation. It is calculated in real time, and is weighted according to float adjusted market cap. 

The top five countries represented in the Dow Jones Global Index, by weight at the time of writing, are:

– 60.9% US

– 6.7% Japan

– 3.3% UK

– 2.9% China

– 2.7% Canada

MSCI ACWI Investable Market Index [9]

The MSCI ACWI Investable Market Index tracks over USD$4.3 trillion worth of securities around the globe, equivalent to 99% of the inevitable global equity market as of March 2023. This makes it one of the foremost global indices for the international stock market.

A total of 47 markets are represented in the index – 23 developed and 24 emerging – and stocks are drawn from 11 sectors in total. 

By weight, the top five constituent countries in the MSCI ACWI Investable Market Index at the time of writing are:

– 59.3% US

– 6.1% Japan

– 3.9% UK

– 3.5% Other EMEA

– 3.3% China

FTSE Global All-cap Index [10]

The FTSE Global All Cap Index is a market-capitalisation weighted index representing the

performance of the large-, mid- and small-cap stocks globally. The index covers both developed and emerging markets for greater diversification, and is reviewed annually in March and September to ensure accuracy. 

The top five constituent countries, by weight at the time of writing, are as follows:

– 62.18% US

– 6.29% Japan

– 3.52% UK

– 2.67% Canada

– 2.56% China

2.5 ETFs tracking indices

It’s important to note that an index does not own any of the constituent stocks that it tracks. That’s because stock prices of publicly traded stocks are openly displayed for all to see, so an index can simply plug into the relevant data and update itself as prices change in real time.

Hence, you cannot trade or own an index directly, because it does not contain any security. Instead, you may purchase and trade shares of an index fund, which is an ETF set up to mimic the performance of a reference index.

These ETF tracking indices can return the same performance as a reference index simply by holding stocks of the same constituent companies in the corresponding proportions. When the index is reviewed and changes are made, the index fund makes the same changes,

ETF tracking indices, or index funds, offer a fuss-free way to “invest” in an index with the aim of replicating its performance closely over time. However, such funds charge a management fee which impacts their total returns.

Trading index funds via your online brokerage is convenient and time-saving, as you do not need to research several different stocks on your own. You can also start investing with relatively little capital, purchasing small numbers of fund units as you invest at your own pace.

2.6 Comparison table – indices vs index ETFs

IndicesIndex ETFs
Benchmark used to measure the performance of stock marketsInvestable fund set up to mimic the returns of a reference market index
Cannot be directly traded or ownedUnits of index ETFs are available of trade on online brokerages
Can measure conditions in different markets, sectors, countries or categories of companies, such as market capUsually offered based on an underlying index, although some fund managers may make adjustments to constituents to achieve different outcomes  

2.7 Indices CFDs

Besides trading units of index ETFs, there is another way to trade indices to potentially benefit from their price action. 

Indices Contracts-for-Difference (CFDs) are agreements between an investor and a CFD broker to exchange the difference in the value of an underlying index between the time the contract opens and closes.

Essentially, indices CFDs allow you to speculate on whether a particular stock market index will move up or down, and take a corresponding position. If the index moves in your favour, you can close the contract for a profit. If it does not, closing the trade would result in a loss. 

When trading indices CFDs, no fund units or stocks are changing hands. Rather, the difference in price at the close of the contract is settled directly in your account. 

Indices CFDs are flexible, as you can take long or short positions in your trade, allowing you to potentially capture returns from both market directions. CFDs are also typically closed quickly, making them suitable for those pursuing short-term investment strategies. 

Another benefit of indices CFDs is that you can start trading with relatively low capital. You may also use leverage to amplify the results of your trade, but be aware that in leveraged trades, both profits and losses will be magnified.

Finally, it’s important to recognise that indices CFDs are an advanced trading strategy, and may not be suitable for risk-averse investors. 

Quiz

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Module recap

  • There are many different indices available that measure all manner of markets, regions, and segments. However, indices share some core characteristics, such as they cannot be directly traded or owned, often composed of the most influential securities or assets, and can produce different readings depending on how they are weighted. 
  • Sectoral indices measure the performance of a particular market sector, such as energy, consumer goods, health care or aerospace. They are useful in gauging the performance of a stock compared to the rest of its peers. 
  • National indices compile the most influential stocks listed on a country’s main stock exchange. They are helpful for quickly gauging the state of the stock market of the underlying country. 
  • Indices can also be organised along market capitalisation, which is a measure of the size of a company derived by multiplying its share price by the number of outstanding stocks.
    • Large-cap indices track companies with market caps of USD 10 billion or more. These are blue-chip companies, global leaders and the like.
    • Mid-cap indices track companies with market caps ranging from USD 2 to 10 billion. These may be up-and-coming companies, or conversely long established companies that have exhausted their growth runway. 
    • Small-cap indices track companies with market cap from USD 250 million to 2 billion. These are usually startups, SMEs, young trailblazing.
  • International indices cuts across segments and borders, compiling the most influential stocks from companies around the world. They are important indicators of market trends, investor sentiment, and broader economic conditions, allowing investors to benchmark their own portfolios, and form the basis for investment managers to launch new funds.
  • ETF tracking indices are funds set up to mimic the performance of a reference index. They offer a way for investors to “trade: in the underlying index, by purchasing and selling units of the fund. 
  • Indices CFDs are an advanced trading strategy that allow speculation of a reference index. No fund units or stocks are traded, instead the difference in the index’s price between the opening and the closing of the contract is settled directly into your account. 

References

  1. “Whole Fresh Goat Milk Producer Price Index – NationMaster”. https://www.nationmaster.com/nmx/ranking/whole-fresh-goat-milk-producer-price-index. Accessed 16 April 2024.
  2. “The Nasdaq-100: More Than Meets The Eye – Invesco”. https://www.invesco.com/qqq-etf/en/etf-insights/the-nasdaq-100-more-then-meets-the-eye.html. Accessed 16 April 2024.
  3. “Side-by-side Sectors – SP Global”. https://www.spglobal.com/spdji/en/documents/additional-material/brochure-side-by-side-sectors.pdf. Accessed 16 April 2024.
  4. “Nifty FMCG – NSE Indices”. https://www.niftyindices.com/indices/equity/sectoral-indices/nifty-fmcg. Accessed 16 April 2024.
  5. “Straits Times Index STI Constituents Target Prices & Stock Ratings – SGinvestors.io”. https://sginvestors.io/analysts/sti-straits-times-index-constituents-target-price. Accessed 16 April 2024.
  6. “Nikkei 225 – MarketScreener”. https://www.marketscreener.com/quote/index/NIKKEI-225-4987/components/. Accessed 16 April 2024.
  7. “Market Capitalization: What It Is, Formula for Calculating It – Investopedia”. https://www.investopedia.com/terms/m/marketcapitalization.asp. Accessed 16 April 2024.
  8. “Dow Jones Global Index – S&P Dow Jones Indices”. https://www.spglobal.com/spdji/en/indices/equity/dow-jones-global-index/#overview. Accessed 16 April 2024.
  9. “ACWI IMI’s Complete Geographic Breakdown – MSCI”. https://www.msci.com/research-and-insights/visualizing-investment-data/acwi-imi-complete-geographic-breakdown. Accessed 16 April 2024.
  10. “FTSE Global Equity Index Series (FTSE GEIS) – FTSE Russell”. https://www.lseg.com/en/ftse-russell/indices/global-equity-index-series. Accessed 16 April 2024.
Module 2: Types of Indices and Their Characteristics