John Spence

Lipper Introduces 'Active' Indexes

New York-based fund research firm Lipper last week launched several equity indexes based on actual stocks held by mutual funds from various categories. Lipper joins its competitor fund tracker Morningstar in launching equity indexes that could be the basis of future exchange-traded funds.

Lipper introduced 19 indexes covering several domestic equity categories across style and market capitalization, as well as sector benchmarks. According to Lipper, the active index holdings are updated monthly from a large pool of mutual funds within a category or sector. The performance of the index constituents are updated on a daily basis, with constituent weighting adjusted daily to reflect individual performance since the last monthly rebalancing.

The move represents a significant shift away from the methodology employed by existing passive stock indexes. Membership in most traditional indexes is determined by an objective set of inclusion rules (Russell and FTSE) or by a committee (Standard & Poor's). A major task faced by index providers is to balance mathematical purity and completeness against practical investability.

Some in the industry, including Vanguard index fund guru Gus Sauter, have criticized existing indexes, claiming they don't accurately reflect the way managers make investment decisions in the real world. The argument is that an investment style isn't determined by a set of rules or committee, but rather by fund managers themselves.

The way many existing indexes are constructed, a stock might jump from one index to another when its size or valuation moves beyond a predetermined threshold.

"Managers do not summarily throw a stock overboard because it crosses an imaginary line," wrote Sauter in a recent article. "They frequently continue to hold it even though a manager with a different investment style might consider it to be in a different index classification."

On the surface, it appears that the new Lipper indexes take a unique approach to address the "line in the sand" issue.

"[Traditional] passive indices are valuable tools and will continue to be used to benchmark performance over time, but they do not capture the moving target that fund managers try to outperform: the actively managed funds with which they compete for investor dollars," said Lipper in a statement.

"To create relevant benchmarks for actively-managed investments, our frame of reference should be the active managers themselves," wrote Sauter in the article. "It is these managers, not investment theory, that define growth and value, small-cap and large-cap. With indexes that mimic the thought processes of active managers, investors would have better tools for evaluating the performance of professional managers, helping them to make smarter decisions about their portfolio allocation."

Gary Gastineau has left the building . . .

Dow Jones Newswires reported yesterday that Gary Gastineau has left Nuveen Investments, which could stymie the firm's plan to launch fixed-income ETFs. The timing of the announcement is somewhat curious because Barclays Global Investors yesterday received the initial go-ahead from the SEC to launch fixed-income ETFs possibly as early as July.

A foremost expert who has written a guide to ETFs, Gastineau made waves in the industry with his idea of "silent indexes," which he discussed in this interview.