The index investing revolution: How passive strategies are reshaping markets | Partner Content

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The index investing revolution: How passive strategies are reshaping markets | Partner Content

The rapid growth of passive strategies, i.e. index-based investing, has been extraordinary.

In 2023, passive fund assets globally surpassed active fund assets1,  driven by the proliferation of exchange-traded funds (ETFs), whose diversification, ease of access and cost efficiency appealed to both the growing retail investor base and institutional investors.

ETFs have democratised access to broad markets, much like stocks. Initially marketed to retail investors for their low fees, ETFs are now being embraced by institutions managing large, diversified portfolios.

While the shift started in equity markets, it has spread to other asset classes, with fixed income ETFs becoming increasingly popular.

The increasing availability of bond index data over the past decade has boosted this trend. Its sufficient track record, given the first bond ETF was launched in 2002, has also made investors more comfortable using an index-based approach in bonds2

The result is the transformation of investment opportunities across markets and asset classes, as growing availability and liquidity of index-based products make them an integral part of the overall financial market structure.

“If you look at the liquidity of ETFs listed in the U.S., many of them have the highest turnover among all listed securities,” says Sue Lee, S&P Dow Jones Indices’ Asia Pacific Head of Index Investment Strategy. “That shows that these passive products are not just a buy and hold vehicle, but individual investors, hedge funds and institutional investors are increasingly using them to access and trade, taking advantage of the ample liquidity around indices.”

Global phenomenon

 

The U.S. has long been the largest and most liquid market for index-based investing, but passive strategies are also proving popular in Asia.

 

Take Taiwan, as an example. Given investors’ preference for income, the ETF market initially developed on fixed income but has expanded to income-driven equity strategies in recent years. Multi-asset ETFs are expected to be launched next year – making the investment choices even more diverse. 

 

South Korea, meanwhile, is among the more innovative markets, witnessing a recent spurt in options-based strategies. This year, an ETF was launched based on a systematic call overwriting strategy using zero-day to expiration (0DTE) options, which are contracts that expire on the same day they trade, pushing the market to new heights. 

 

Lee says the 10-year compound annual growth rate of the global ETF market, by assets under management, is about 18% – with Asia Pacific mirroring that, according to Bloomberg data. Taiwan has seen stellar growth of more than 40%, while China has risen 31%, Japan 21% and Korea 20%.

 

She explains different usage of index-based products, including ETFs and index futures/options, among institutional and retail investors.

 

ETFs are increasingly being adopted by intermediaries to help clients build diversified portfolios based on their goals and risk appetite. Institutional investors have passive mandates, and there is also growing interest in rejigging portfolios using ETFs more tactically to take advantage of low costs, ease of access and the buoyant liquidity that ETFs provide.

 

On index futures and options, Korea has long been active, while India has fast surged into the limelight, driven by flush retail trading demand looking for new investment opportunities.

 

Diversification and fee savings are big draws. Investors can also ride on the better performance of passive funds over many active funds. According to the S&P Indices Versus Active (SPIVA®) Scorecards3,  global equity active managers had a challenging first half of 2024 with 70-85% of funds studied underperforming their relevant benchmarks. Although fixed income active managers had much better results over this six-month period, a majority of them ended up underperforming their benchmarks over the long term, supporting the case of indexing in fixed income.

 

Asia implications

 

As the financial market becomes globalised and global exchanges extend their trading hours, Asia’s investors have wider access to global market products. Ability to trade in their own time zones means risk management becomes easier, allowing more local asset managers to bring global market products into Asian local markets.

 

“This global liquidity also enables price discovery,” said Lee. “In case of the S&P 500® futures/options and ETFs, they trade quite actively during Asian hours when the U.S. market is closed. They are relevant to investors in Asia and also to the rest of the world.”

 

Alternative weighting approaches may also help to address some of the current market challenges. For examples, the dominance of certain mega-cap stocks, the so-called “Magnificent Seven,” has increased in the U.S. equity market and consequently in the S&P 500. This may pose concentration risks, as those select stocks may have outsized influence on the overall index. Such challenges may be addressed by other indices, such as the S&P 500 Equal Weight Index, which aims to mitigate the concentration risk of the market-cap-weighted index in a simple, yet systematic way.

 

Artificial intelligence and machine learning tools are also making their way into indexing. Lee said S&P DJI is leveraging Natural Language Processing technology in the design process of the S&P Kensho Indices. Incorporating this technology helps identify companies relevant to different thematic categories and sometimes detect companies with big future potential in an early stage. Machine learning also comes into play given the availability of vast amounts of data that can be easily broken down by technology for index construction, all with the oversight of the team’s analysts.

 

Another possible trend: direct indexing could be coming soon, reckons Lee. Direct indexing – whereby investors directly buy individual stocks in indices instead of the index fund – has risen in popularity in the U.S. for the autonomy and flexibility it offers.

 

Asia could follow suit, with early-stage discussions with partners already underway.

 

“Our role is bringing our global expertise and knowledge into the local markets,” said Lee. “By building strong partnerships with local exchanges and asset managers, we can connect Asian local markets with foreign investors and can connect Asian investors with global market opportunities. Asia remains one of our key growth areas. We aim to bring innovation, educate the market and work closely with the local managers and exchanges to further develop the capital markets here.”

 

As passive investing continues to gain ground, it will be pivotal in helping Asia’s investors navigate an increasingly complex financial landscape. From broad-market indices with active trading ecosystem to more targeted, complicated strategies, index-based investing’s next chapter in Asia is poised to be dynamic and transformative.

 

Source 

 

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