What Value Do Indexes Provide?

Indexes allow users to understand and research broad or narrow swaths of the market by aggregating performance.

This provides investors and researchers with another key tool in their investor toolkit. If an investor wanted to understand the health and growth of the global stock market, there is a broad-based index for that, while if they want to understand the United States’ automobile equity performance, there is also a sector index for that.

While indexes often are synonymous with equity markets, they can track any financial market or asset class, such as fixed income, real estate, commodities, private equity and now thanks to Coin Metrics, cryptoassets.

Another use case for indexes is to benchmark performance for both professional and retail traders.

By comparing their own returns to that of a representative index, an investor can better understand their own performance and risk. For example, say a crypto hedge fund is delivering 80% annualized returns over the last three years. On face value that sounds like a great performance.

However, if the performance is compared to the CMBI 10, which returned 130% annualized over that same time period, those same returns look significantly worse. Therefore, benchmarking would help show the need for the fund to pivot strategies or even tell money managers and investors that they should invest their money somewhere else.

Indexes can also help investors backtest potential investment thesis before launching a fund. By comparing potential trades against an index, investors can help determine if the basis for their strategy could be successful or not.

Perhaps the most well known use of indexes is through index-linked investment products.

Examples of index-linked investment products are ETFs, mutual funds, ETNs, and index-linked options and futures. The first index-linked mutual fund, the Vanguard S&P 500, came to market in 1976, and since then financial institutions have created thousands of index-linked products. In the great majority of cases, these index-linked products are required by regulators to be linked specifically to a benchmark.

Index-linked investments have helped democratize markets by creating passive, low- or no-cost options for retail investors to get access to a wide range of assets. Now individuals can reap the benefits of product diversification with access to equity and other financial asset classes without having to pay the fees for active management or specialized financial products.