The Value of Capital Markets to the UK Economy report - commissioned by BNP Paribas in...
What are the best stock market indexes to “track”?
CAC 40®, S&P500®, Eurostoxx50®—what exactly do these stock market indexes reflect? How are their prices calculated? How should you pick the right index for your investment? Bertrand Alfandari, ETF Development Manager at BNP Paribas Asset Management answers our questions.
To start off, what is a stock market index?
It is an indicator used to evaluate the overall performance of a financial market, thereby establishing the theoretical value of a portfolio composed of stocks, bonds and commodities. The list of shares composing the index may change in response to a certain number of criteria or events (corporate mergers, sharp drop in a share price, exclusion of a specific sector or value, etc.), as determined by the index supplier.
How is the price calculated?
As a general rule, the prices of the main indexes are an arithmetic average weighted by the free float market capitalization of each security in the index. In the stock market, the free float market capitalization of a listed company is calculated by multiplying the number of shares readily available on the market by the equity’s price.
Photo : Bertrand Alfandari
You mentioned free float—why does that factor into calculating the index?
Free float represents the portion of a listed company’s capital that is not held by identified or long-term shareholders, such as family shareholders. This portion is more representative of the actual number of shares available on the market, because these shares may be traded at any moment.
What are the different types of stock market indexes?There are four types.
- First of all, geographic indexes. These are representative of the world’s major stock exchanges—CAC 40 (France), FTSE 100 (United Kingdom), DAX 30 (Germany), Euro Stoxx 50 (Eurozone), Dow Jones or S&P 500 (United States) or the Nikkei 225 (Japan).
- There are also sector-based indexes, which reflect the performance of a specific sector, such as the Nasdaq for tech and biotech stocks, or various European indexes in sectors such as consumer goods, health, automotive or biotech.
- There are also thematic indexes. These may be composed of stock in companies that meet SRI (socially responsible investing) or ESG (environmental, social and governance) criteria. The responsible investing theme includes the Low Carbon 100 Europe Index (which excludes shares in companies that use fossil fuels).
- Finally, the so-called Smart Beta indexes, which are also known as strategy indexes, include equities that are not weighted by market capitalization but are selected based on other criteria—low volatility, strong fundamentals, high dividends, etc.
Do national stock market indexes, such as the CAC 40 in France or the DAX in Germany, reflect a country’s economic health?
These indexes reflect the activity of the national companies owned by corporate groups or multinationals—not the national economy in the strict sense, because that also includes the activity of non-listed SMEs and foreign companies operating in the country. In addition, some economies (and their major listed companies) are open to the international market, without being limited simply to their domestic market. However, a high-growth domestic market is always a positive factor for the local stock market.
a high-growth domestic market is always a positive factor for the local stock market
Among the thousands of stock market indexes in the world, are the most widely known indexes also the most important ones to track?
The indexes that get the most press coverage are not necessarily the most relevant, especially if you want to focus on ESG criteria in your portfolio management
Not necessarily. The most important thing is to learn about the markets you are investing in and to try to understand the major pillars of the economy. Before choosing an index, it is necessary to determine the right asset class (shares, bonds, etc.) and geographic region for your risk profile. Then you have to account for other criteria like the composition of the index (equities, weight of various sectors, frequency of revisions), the transparency of its methodology, foreign exchange risk coverage or exposure, and so on. The indexes that get the most press coverage are not necessarily the most relevant, especially if you want to focus on ESG criteria in your portfolio management or retain Smart Beta indexes.
How can people invest in the main stock market indexes?
The cost of investing directly in each of the equities composing an index can add up, including transaction and custodial fees. It’s easier and much cheaper to invest in an ETF*.
What are the concrete advantages of an ETF over direct investment?
ETFs, or trackers, are index funds that are listed on the market and traded continuously. First of all, they enable investors to buy the equivalent of a full portfolio of shares (the 40 equities in the CAC 40®, the 500 equities of the S&P500®, etc.) as a single equity and in one transaction.
Next, continuous listing makes it possible to track the price of these equities in real time, as well as to buy or sell shares at will during market hours, for anyone seeking to seize a market opportunity or guard against the risk of near-term losses. In this way, investors can invest directly in the underlying index, while paying far fewer brokerage fees than if they had purchased all the equities in the index. We should also add that some ETFs, just like some shares, are eligible for PEA**; they can also be included in many life insurance policies.
What are the risks of investing in an ETF?Below is a (non-exhaustive) list of the main risks when investing in an ETF:
- Market risk: this risk is present for every investment that includes stock in its portfolio. It corresponds to the risk of a drop in the value of the stocks composing the fund and, therefore in the value of the fund
- Foreign exchange risk: this risk applies to any fund listed in a currency other than euros, or a fund replicating assets listed in foreign currencies
BNP Paribas Easywww.easy.bnpparibas.fr
BNP Paribas Easy is BNP Paribas Asset Management’ range of ETFs and index funds.It gives institutional and retail investors exposure to the main asset classes in the main geographical regions and allows them to diversify their portfolios with innovative themes such as real estate and the environment.
*ETF: Exchange-Traded Fund
**PEA: Plan d'Epargne en Actions – a tax-efficient product for residents of France
Investments in funds are subject to market fluctuations and the inherent risks of investing in securities. Investment values and the returns they generate can rise or fall, and investors may not recover the entirety of their initial investment. The funds described above present a risk of capital loss. For a complete definition and description of risks, please review the prospectus and KID (Key Information Document) for each fund. Before investing, you must read the most recent version of the prospectus and KID available at no charge on our site, www.easy.bnpparibas.fr. Past results do not guarantee future performance.
Crédit photo : header © bnenin
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