The fund will take overweight, underweight and market-weight positions on stocks or sectors in that index. For example, the fund might have a bullish view on Australian resource stocks. So, instead of holding a 21.5% weighting in Materials (like the S&P/ASX 200 index currently has), the fund takes an “overweight” 30% position, to enhance returns.
Within that, the fund might have overweight positions in BHP Group (ASX: BHP), Rio Tinto (ASX: RIO) and Fortescue Metals Group (ASX: FMG), compared to their weightings in the S&P/ASX 200, because it likes the long-term outlook for iron-ore prices.
Some investors use market and sector indices to identify opportunities. For example, an investor might compare the performance of the S&P 500 index in the United States to the S&P/ASX 200 index in Australia over 10 years. The investor finds the S&P 500 has outperformed over that period and believes it is time to increase exposure to Australian shares.
Another investor compares the S&P/ASX 300 index to a sector, such as energy. The investor notes the S&P/ASX 300 Energy index has underperformed the S&P/ASX 300 for the past decade, and that the gap between the two indices has widened. The investor believes there could be a contrarian buying opportunity in the energy sector, so does more research.
Meanwhile, an active investor uses indices to capitalise on short-term market volatility. When global equities tumbled in March 2020 because of Covid uncertainty, the investor believed technology would be the first sector to recover, as it was after the 2003 SARS pandemic.
The investor bought an ETF over the S&P/ASX All Technology index and another ASX-quoted ETF over the Nasdaq 100 index, to gain exposure to local and global tech stocks via ASX.
Some professional investors closely follow quarterly index rebalancing, when new stocks are added to an index and others are excluded. They believe the share price of new index constituents might rise as they attract new buying from index funds, and vice versa.
Whatever your investment strategy, it’s a good idea to follow index movements to get a sense of which markets and sectors are outperforming or underperforming.
4. Exchange Traded Funds
No essay on ASX indices is complete without a section on Exchange Traded Funds. ETFs aim to match the price and yield return of an underlying index. For example, an ETF over the ASX 200 index should provide a similar total return to that index.
ETFs are the fastest-growing investment-product category on ASX and a global investment phenomenon. The combined market capitalisation of ETFs on ASX rose 74.1% to $116.5 billion over the year to end-July 2021. There are now 223 ETFs on ASX.
By asset class, there are ETFs over Australian shares, global shares, fixed income, property, commodities, currencies, and cash. It’s possible to construct a portfolio across asset classes entirely with ASX ETFs, and then rebalance that portfolio, perhaps quarterly or annually.
By ETF styles, there are index-tracking ETFs, such as those over the ASX 200. There are also smart-beta ETFs that use investment rules based on certain factors. For example, an ETF over an index that has been constructed to include companies with a history of higher dividends.
By contrast, active ETFs – a fast-growing category of ETFs on ASX – are actively managed funds that benchmark their performance against an index.
Some investors use ETFs to construct a long-term portfolio because they have lower fees than most comparable active funds, and are bought and sold on ASX-like shares, making them transparent, convenient and simple to use.
Also, S&P research shows about 80% of active funds managers underperformed the S&P/ASX 200 index over 10 years, reinforcing the case for index funds.
Active investors also use ETFs to “tilt” portfolios and time markets. A trader might believe Australian shares will rally after a correction, so buys an ETF over the ASX 200 index. Another believes our sharemarket will fall, so buys an ETF that rises when our market falls.
Indices also provide useful clues on investor sentiment. The S&P/ASX VIX index measures the 30-day implied volatility of the Australian sharemarket using the settlement prices of S&P/ASX 200 put and call options.
Volatility indices are closely followed overseas. The Chicago Board of Options Exchange’s VIX index has been called the “fear and greed” index, based on its tracking of investor sentiment.
Some investors buy stocks when the VIX is high and sell when it is low. A high VIX reading signals high implied market volatility and is usually accompanied by market fear.
No investment rule is infallible, but buying when market fear is high can be a profitable strategy. So, too, can selling when implied volatility is low and investors are more interested in greed than fear. There’s an old investment saying: “When the VIX is high, it’s time to buy; when the VIX is low, look about below.”
Index futures are another sentiment gauge. Those such as the ASX SPI 200 Futures can provide a pointer to whether the Australian sharemarket will open up or down, and by how much. Unlike the ASX equities market, which trades from 10am to 4pm, futures trade through the night and reflect offshore market moves.
No index future is foolproof, and the signal sometimes only works briefly, or not at all, on a particular day. But most traders watch what the ASX SPI 200 says for the day ahead.
Indices on ASX have come a long way during ASX’s modern history – and even further compared to the days when data on the All Ords was published monthly. But there is plenty of innovation ahead as indices evolve to reflect changing investor needs.
Recent growth in Environmental, Social and Governance (ESG) indices on ASX is an important trend. As more investors look to allocate their capital to companies that help rather than harm the planet, they will need indices that factor ESG criteria into stock selection.
Several ESG-related ETFs on ASX have been launched in the past few years, providing investors with exposure to local and global companies that rate higher on sustainability rankings.
It’s now possible to compare the ESG carbon characteristics of the S&P/ASX 200 index to other global markets. Or compare the carbon intensity of sectors.
Over time, it’s possible that retail investors could use portfolio services that measure the total carbon emissions of listed companies they own and compare that to a benchmark index.
ESG-focused investors will want their portfolio to have fewer carbon emissions than the average in the S&P/ASX 200 – while still providing an attractive financial and social return.
Index issuers continue to launch ESG-related indices here and overseas, but this could just be the start as investors increasingly seek non-financial information on issues, such as carbon emissions, to factor into their investment strategy.
And more ways to invest in ESG leaders – and avoid ESG laggards – through indices.