May 20238 By Kevin Gleason, Vice President, Chief Compliance Officer MainStay Funds and Index IQ ETFs, New York Life InvestmentsINDEX INVESTING ISN'T JUST ABOUT BEING PASSIVE ANYMOREIndex investing isn't just about being passive anymore ­ it has expanded to meet changing investor needs and demands making index investing more personalized and more customized. Given the changing index investing marketplace, indices and their construction are far more active leveraging improvements in technology and data. As a consequence, index investing and index providers have drawn more scrutiny from regulators. This increased regulatory scrutiny has necessitated the development of more rigorous compliance programs. This article will conclude with describing elements of a compliance program which are reasonably designed to address regulators' concerns. Growth of Index Investing:What started as an intriguing idea in the 1960s was finally implemented in the 1970s, when the first index fund was offered to investors. By 2021, passively managed index funds for the first time accounted for a greater share of the U.S. stock market than actively managed funds' ownership, according to the Investment Company Institute's 2022 Factbook. Index funds accounted for 16% of the U.S. stock market at the end of 2021, compared with 14% held by active funds. A decade ago, active funds held 20% and index ones, 8%. The surge in indexing investing over the past twenty-five years has fundamentally changed the structure of the investment management industry. Three asset management firms have come to dominate this market ­ Vanguard, BlackRock, and State Street ­ through the use of passive index mutual funds, and in particular, exchange traded funds ("ETFs). Index providers, such as MSCI, FTSE, Bloomberg, Dow Jones, and S&P have grown rich from licensing fees related to the use of their indices. The success of index investing has been fueled by a number of factors: the rapid growth in equity markets, the emphasis on lower asset management fees and costs, the desire for broader diversification, and the need for greater tax efficiency. However, the two greatest reasons index investing has become so predominant may indeed be advances in technology and data. Technology, Automation and Data:Standard indices have a single methodology; one ruleset dictating what they own and how they rebalance. The next evolution in index investing has been the advent of custom indices, direct indexing, and self-indexing. With these forms of index investing, the methodology is specialized or personalized by individual, cause, interest, theme, preference, or a variety of other factors. Indexing is a great example of a product which sits on what Josh Wolfe, Co-Founder and Managing Partner at Lux Capital, calls a "directional arrow of progress." In technology, one can observe trend lines, arrows of progress, that show improvement in key product dimensions that matter to customers ­ often related to cost, speed, convenience, selection, variety, and personalization. Index investing in all of its forms has been able to capture these technology-based advantages and trends. Technology, including sophisticated algorithms and the computing power needed to continuously analyze and execute trades across hundreds of thousands of portfolios and positions Growth of index assetsAssets managed internally, including passive and enhanced strategies, in trillions, as of June 30, 2021.
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