EDHEC-Risk - EDHEC survey shows that professionals agree with the conclusions of a study on the shortcomings of stock market indices

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Indices - September 17, 2007

EDHEC survey shows that professionals agree with the conclusions of a study on the shortcomings of stock market indices

A recent publication¹ by the EDHEC Risk and Asset Management Research Centre has drawn conclusions that highlight the shortcomings of well known capitalisation- or price-weighted stock market indices and argues that the choice of benchmark for asset allocation or performance measurement is a task requiring particular care.

In a call for reactions to this publication, EDHEC finds that the answers of the more than eighty respondents (asset management firms, pension funds, insurance companies, private banks, etc.) tend to reinforce the conclusions drawn by the original publication.

Although it would at first appear that the majority of respondents are not, in general, dissatisfied with the indices they use as benchmarks (18.82% of respondents express degrees of dissatisfaction), further examination soon reveals that the shortcomings of these indices, such as inefficiency, lack of stability, and susceptibility to price bubbles, are widely recognised by the industry professionals responding to EDHEC’s call for reactions. The call for reactions also shows that a considerable majority of respondents plan to review the indices they use as benchmarks, either immediately or in the future.

Overall, responses to the call for reactions suggest that, in some ways, industry practices reflect the concerns highlighted by EDHEC in its 2006 publication on the quality of stock market indices. Nearly 70% of the respondents, after all, indicated that they used customised benchmarks and other indices in an attempt to compensate for the flaws inherent in the use as benchmarks of such indices as the CAC 40, the S&P 500, the DAX 30, the FTSE 100, or the Dow Jones Industrials 30. It is clear then that, for a significant majority of investors, the choice of benchmark is a fundamental choice. In the end, the name of the index provider, the volumes managed, turn out to matter less than such attributes as its efficiency, its stability, its immunity to bubbles, or its risk exposure.

Footnote

¹ EDHEC, 2006, “Assessing the Quality of Stock Market Indices: Requirements for Asset Allocation and Performance Measurement”, EDHEC Publication.