Survey: European Institutional Investors, Asset Managers Redefine Indices

(October 18, 2011) — A new survey conducted by London-based EDHEC-Risk Institute has revealed that European investors no longer define indices as buy-and-hold.

According to the study, investors define passive investing as being exposed to normal returns, as opposed to abnormal returns. “For institutional investors there is a clear separation today that is no longer ‘passive investment = static’ and ‘active investment = dynamic,’ but instead between beta and alpha. Alpha assumes that we can predict the future and that we take decisions on the basis of this prediction (active view). Beta management relies on a series of systematic rules based on data from the present or the past depending on the rebalancing methods used,” Noel Amenc, Director of the EDHEC-Risk Institute, told aiCIO, explaining investors’ redefinition of passive investing. 

Investors were asked to list various criteria on a scale of -1 to three, with three being the most important. Having the index represent a buy-and-hold strategy ranked a low 1.28. Meanwhile, liquidity, objectivity and transparency were ranked as the the most important quality criteria investors have for indices.

The survey — which collected responses from 104 European institutional investors — showed that more than 50% of respondents have redefined passive investing and are no longer concerned with indices representing a buy-and-hold strategy. “This finding is interesting as the dominance of cap-weighted indices in various asset classes is often attributed to their buy-and-hold nature. This new attitude from investors opens the door to new approaches based on dynamic rebalancing rules, as long as these are transparent and systematic,” EDHEC stated.

The study asserted: “Indexation continues to play an important role in global asset allocation. Total worldwide assets under internal indexed management rose to $5.994 trillion as of June 30, 2011, a 25% increase over $4.781trillion as of one year earlier. In view of the growing volumes in assets under management in passive indexing strategies, a great many index providers have emerged worldwide; not only the organizations specializing in the index service but also stock exchanges, as well as investment banks. Each provider has created or is creating a host of indices representing a full complement of asset classes, as well as asset class subsegments.”

Addressing confusion between indexing and “passive investing,” 58% of respondents said they do not think that indices should only reflect passive strategies. Respondents did however indicate that indices should not be based on alpha (75.2%), according to a release from the firm.

In addition, the survey revealed that equity investors are mainly concerned that standard cap-weighted indices over-invest in overpriced stocks and provide poor diversification within the constituent universe. On the other hand, fixed-income index users pay more attention to reliable duration exposure and are concerned with liquidity issues, the study noted.

EDHEC’s findings come during an environment when a growing number of investors are seeking alternatives to traditional market-cap indices — alternative equity indices, such as fundamentally weighted indices, along with alternative bond indices, and alternative corporate bond indices.

Another recent study by the institute revealed that hedge funds outperformed equities in September. “In September, panic seemed to set in among stock market investors,” the firm claimed. “After a severe setback (-5.43%) last month, the S&P 500 index plunged again (-7.03%), back to its level of October 2010, while implicit volatility (43.0%) soared by one third to reach its highest level since April 2009. Relatively spared until last month, emerging markets also took a blow as their stumble of last month (-9.21%) turned into free fall in September (-14.80%).”

Meanwhile, on the fixed-income market, convertible bonds (-5.92%) registered a fifth consecutive month of losses and regular bonds (-1.11%) recorded their worst monthly performance for 2011.