A New Framework to Bring Clarity to Index Investment Products; CFA Institute

The CFA Institute Research and Policy Center has developed a new investment classification framework and issued policy recommendations for regulators and firms to improve transparency, communication, and investor comprehension associated with smart-beta, direct indexing, and index-based investment products.

Detailed in research published today, the newly launched classification framework offers investment firms a tool to better communicate index-based products to clients by describing index-based strategies according to their level of active decision-making. It proposes a framework of indexing along a spectrum of strategies beyond traditional market capitalization weighting. The framework is based upon three dimensions of strategy, sources of returns, and level of discretion -- with the goal of increasing transparency among index-based investment products.

Accompanying policy recommendations emphasize the importance of transparency and clear disclosures around the active investment decisions involved in index-based products.

Rhodri Preece, CFA, Senior Head of Research, CFA Institute said:

“The notion of a simple bifurcation between active and passive investment products is outdated. Index-based strategies are varied in their design features and involve different layers of active decision-making, dispelling the historical distinction between active and passive management. As index-based products have proliferated, incorporating more complex features than market capitalization weighting, there is a need for greater transparency and improved investor comprehension of these strategies. This new framework intends to support investment advisers and end-investors through clearer disclosure and communication of the key features of index-based products.”

The research includes recommendations for investment firms grounded in the principles of improved disclosures for clients, including:

• Educate and inform investors of the active decisions made throughout the investment process for index-based investments.
• Communicate to investors about the decision-making processes involved in index fund creation, including security selection and weighting methodologies used in the creation of the investment product or strategy.
• Provide prospective clients with access to more detailed information on index product features as part of the pre-sale product literature.

The index investment products framework and policy recommendations are available in full at: https://rpc.cfainstitute.org/en/research/reports/2024/smart-beta-direct-indexing-and-index-based-investment-strategies.