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Alternative Market Briefing

Other Voices: The danger of indices

Thursday, February 12, 2015

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Andrew Beer
This article was authored by Andrew Beer, founder of Beachhead Capital Management LLC in New York. You can download the full version here.

We’re surrounded by investment products that track indices. S&P index funds seek to replicate the performance of the S&P 500 index – easily accomplished by simply buying the constituent stocks in designated weights. Other indices are more difficult to track – for example when the product invests in futures to approximate spot market returns (GSCI) or acquires only a subsample of index constituents (Barclays Ag).

A new generation of indices promises to emulate more complicated investment strategies, such as currency carry, volatility and roll trades. Investment banks now offer institutional investors an array of derivative products tied to such indices, and asset managers are packaging them into ETFs and other fund products.

One problem, however, is that newly created indices tend to overstate historical, hypothetical performance. From a commercial perspective, there’s little point in launching a new index if the pro forma returns are unattractive; consequently, there’s a strong incentive to adjust the calculation methodology until the results look favorable.

Further, unlike mutual funds, indices can be created and published with minimal disclosure of key information, such a......................

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