A Guide to Equity Index Construction (2nd Edition)
First published:
ISBN: 9781782724483
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Sampling and selection
Sampling and selection
Preface
Acknowledgements
Introduction
Which benchmark?
Modern portfolio theory and the benchmark index
Sampling and selection
Construction method
Making the index investable
Collection and processing of data
Servicing and maintenance
How to handle industries
How to handle countries and currencies
Factor indices and smart beta
Innovative indices
The commercial indices
Indexation and exchange-traded funds
Bespoke “custom-made” indices
Tying it all together
Appendix: The GICS methodology
Bibliography
Disclaimer
INTRODUCTION
“There are two ways to construct an index. You can build it from the top down, working from the proverbial Ivory Tower to craft an index that fits a preconceived notion of how the equity markets should work. Or you can build it from the bottom up, studying investment managers to determine how the equity markets and investors actually do work.”
—Kelly Haughton, CEO of Global Index Group
This chapter explains how index constructors select the index constituents and their weights. At its core, the process of index construction closely resembles the principles of sampling, drawing parallels with the methodology of portfolio creation. Sampling is used in place of full market capitalisation replication, which would involve including all the securities in the marketplace in the same proportion as their weight, something that is clearly impractical in all but the smallest market universes.
The act of sampling is therefore focused on specific strata within the market. In the context of stock selection in index construction, various sampling methods offer different advantages and considerations. The choice of approach depends on factors like the index’s objectives, risk profile and
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