Funds that track market indexes have historically offered investors a cost-effective and efficient way to gain exposure to the performance of a market benchmark or index. "Traditional" market indexes such as the S&P 500 or Dow Jones Industrial Average provide investors with exposure to a broad basket of securities and, as a result, generally offer less risk as compared to investing in individual securities. Increasingly, opportunities are also available to invest in alternative investments and strategies through funds that track "non-traditional" indexes.
Funds tracking non-traditional indexes can provide investors with an expanded set of investment opportunities beyond those offered by traditional indexes. But they can also create additional complexities and risks to consider.
The Basics of Non-Traditional Indexes
Traditional indexes are generally designed with rules governing investment selection that seek to match the performance of a specific market. These parameters may relate to price, market capitalization, industry or sector, growth or value orientation, and more. Indexes can be broad-based (such as the S&P 500) or narrow (such as an index focused on gold miner stocks).
In comparison, some non-traditional indexes can be more customized according to specific goals or needs. For example, a non-traditional index might track risk tolerance or exposure to specific investment themes.
Non-traditional indexes can be tracked by a variety of products, including mutual funds or exchange-traded products (ETPs), as well as other instruments like structured notes. These investment vehicles can use more complex or targeted investing strategies than traditional indexes that provide direct exposure only to a particular market or sector. Some non-traditional indexes may be based on academic research and focus on factors other than market capitalization (such as dividends), while others can be rules-based versions of strategies that investment professionals have developed for their customers and can create more personalized investment exposures.
A Closer Look at Non-Traditional Index Funds
Non-traditional indexes might include some criteria that an active fund manager would consider, such as choosing components based on valuation, earnings growth and other factors. But funds tracking these indexes are passively managed, meaning they don't use a fund manager's independent judgment to manage investments day-to-day. Such funds that include active characteristics but are passively managed are sometimes referred to as being "quasi-active."