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Financial benchmarking giant MSCI is working on an “ultimate index” tracking the performance of all markets, which could mark the culmination of half a century of academic theory and practical financial engineering.
One man has been on a quest to create the ultimate index for more than a decade. Now he thinks he’s getting close
Financial benchmarking giant MSCI is working on an “ultimate index” tracking the performance of all markets, which could mark the culmination of half a century of academic theory and practical financial engineering.
Indexing is a booming business, slicing markets up into geographies or categories such as equities or bonds, and then subdividing further by size or industry. These are then used as benchmarks for fund managers, or packaged up into investable products. But a way to combine everything from commodities to venture capital in one gauge has proven elusive.
“It’s the holy grail,” says Mark Makepeace, the head of index provider Wilshire. “It solves a core problem of investing and would be hugely beneficial.”
When Makepeace led FTSE Russell, the group teamed up with Nobel laureate and Stanford economics professor William Sharpe to create an adaptive asset-allocation tool that started to tackle the idea of an ultimate index, but included only stocks and bonds.
A true ultimate index would go further, including other big asset classes, like commodities, and even private assets that do not trade on an exchange, like real estate, infrastructure, bank loans and stakes in hot Silicon Valley companies.
Peter Shepard, head of analytics research and product development at MSCI — one of the indexing industry’s Big Three, alongside FTSE Russell and S&P Dow Jones Indices — has been working on the quest to produce an index of this kind for more than a decade. He thinks he is getting close, although he is reluctant to term the final result an “ultimate index.”
Before he joined MSCI in 2007, Shepard was a theoretical physicist at Berkeley — his PhD thesis was titled On non-perturbative quantum gravity: Holography and matrix models in string theory — and he spent much of his time chasing the holy grail of physicists, a unifying Theory of Everything. He is therefore wary of applying the same label to the realm of indexing.
“I need to be careful about not falling into that trap again,” he said. “I think we may be able to find a grand unified theory of physics at some point, but we’re not going to be able to find a grand unified theory of markets.”
The standard investment industry benchmark has long been the 60/40 portfolio — 60 per cent stocks and 40 per cent bonds. Vanguard’s US 60/40 fund has returned 168 per cent over the past two decades. Yet what to include in a broader index is hotly debated, and how to construct it is fraught with practical complications in sourcing reliable up-to-date data in areas like private markets.
Despite that, Shepard is convinced they must be included. Private equity has returned about 12 per cent a year on average over the past 15 years, and private debt about 8 per cent, according to Morgan Stanley. “If you leave private assets out of this Platonic ideal, you’ll be leaving a whole lot of performance behind,” Shepard said.
Even if one can come up with a decent mix of asset classes, figuring out how to sort by geography and other factors is not straightforward.
Of the many ways that a chief investment officer adds value, some can be standardized
Peter Shepard
What is the best mix of U.S., European, Chinese or Brazilian stocks? How much exposure should there be to larger stocks or smaller ones? Should the bond allocation be weighted by the volume of debt issuance — as is standard for fixed income benchmarks — or is there a smarter way? The optimal answers are still uncertain, Shepard admits, but “simplicity and transparency are key.”
“I could come up with a great black box, but if you don’t understand it, you won’t trust it and you won’t use it,” he said. “My hypothesis is that of the many ways that a chief investment officer adds value, some can be standardized.”
The prospect is not just an object of geeky fascination in the indexing industry. If well constructed it could form the basis of cheap but powerful investment products for everyone from retirees to sovereign wealth funds, by simplifying the often arduous and expensive task of splitting money between different markets.
While the cost of investing in individual asset classes has been hammered down thanks to the invention of index funds, deciding on how to mix them is often handed over to a pricey financial adviser, or in the case of a pension plan, to a team of expensive professionals.
If one could assemble one broad investable benchmark for all assets — a true reflection of what Sharpe termed “the market portfolio” back in the 1960s, rather than a messy or facile proxy — then one could perhaps create a single, simple financial product suitable for most investors.
“I think there’s a huge opportunity here,” Shepard said. “The asset allocation decision is the most important decision for a lot of investors . . . But we’re leaving this really critical decision to people who may not be that skilled, like my parents, or they turn it over to someone who charges fees for it.”
Despite the considerable hurdles, Shepard is optimistic that the quest for the Ultimate Index will soon bear fruit. However, he thinks that in practice the final result will be different flavours of a broad multi-asset benchmark.
“It might be a grand unified theory in terms of the framework. But customization will be essential, as one size will not fit all investors,” he says. “At the same time, it has to be simple.”
© 2021 The Financial Times Ltd
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TORONTO – Canada’s main stock index was down more than 200 points in late-morning trading, weighed down by losses in the technology, base metal and energy sectors, while U.S. stock markets also fell.
The S&P/TSX composite index was down 239.24 points at 22,749.04.
In New York, the Dow Jones industrial average was down 312.36 points at 40,443.39. The S&P 500 index was down 80.94 points at 5,422.47, while the Nasdaq composite was down 380.17 points at 16,747.49.
The Canadian dollar traded for 73.80 cents US compared with 74.00 cents US on Thursday.
The October crude oil contract was down US$1.07 at US$68.08 per barrel and the October natural gas contract was up less than a penny at US$2.26 per mmBTU.
The December gold contract was down US$2.10 at US$2,541.00 an ounce and the December copper contract was down four cents at US$4.10 a pound.
This report by The Canadian Press was first published Sept. 6, 2024.
Companies in this story: (TSX:GSPTSE, TSX:CADUSD)
The Canadian Press. All rights reserved.
TORONTO – Canada’s main stock index was up more than 150 points in late-morning trading, helped by strength in technology, financial and energy stocks, while U.S. stock markets also pushed higher.
The S&P/TSX composite index was up 171.41 points at 23,298.39.
In New York, the Dow Jones industrial average was up 278.37 points at 41,369.79. The S&P 500 index was up 38.17 points at 5,630.35, while the Nasdaq composite was up 177.15 points at 17,733.18.
The Canadian dollar traded for 74.19 cents US compared with 74.23 cents US on Wednesday.
The October crude oil contract was up US$1.75 at US$76.27 per barrel and the October natural gas contract was up less than a penny at US$2.10 per mmBTU.
The December gold contract was up US$18.70 at US$2,556.50 an ounce and the December copper contract was down less than a penny at US$4.22 a pound.
This report by The Canadian Press was first published Aug. 29, 2024.
Companies in this story: (TSX:GSPTSE, TSX:CADUSD)
The Canadian Press. All rights reserved.
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